0000950148-01-502071.txt : 20011031 0000950148-01-502071.hdr.sgml : 20011031 ACCESSION NUMBER: 0000950148-01-502071 CONFORMED SUBMISSION TYPE: S-1/A PUBLIC DOCUMENT COUNT: 4 FILED AS OF DATE: 20011029 FILER: COMPANY DATA: COMPANY CONFORMED NAME: BAM ENTERTAINMENT INC CENTRAL INDEX KEY: 0001132809 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 770553117 FILING VALUES: FORM TYPE: S-1/A SEC ACT: 1933 Act SEC FILE NUMBER: 333-62436 FILM NUMBER: 1768334 BUSINESS ADDRESS: STREET 1: 333 WEST SANTA CLARA BLVD STE 930 CITY: SAN JOSE STATE: CA ZIP: 95113 BUSINESS PHONE: 4082987500 S-1/A 1 v72115a3s-1a.txt FORM S-1 AMENDMENT 3 AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON OCTOBER 29, 2001 REGISTRATION NO. 333-62436 -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ AMENDMENT NO. 3 TO FORM S-1 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 ------------------------ BAM! ENTERTAINMENT, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 7372 77-0553117 (STATE OR OTHER JURISDICTION OF (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) CLASSIFICATION NUMBER) IDENTIFICATION NUMBER)
333 WEST SANTA CLARA STREET, SUITE 716 SAN JOSE, CA 95113 (408) 298-7500 (ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES) ------------------------ RAYMOND C. MUSCI CHIEF EXECUTIVE OFFICER BAM! ENTERTAINMENT, INC. 333 WEST SANTA CLARA STREET, SUITE 716 SAN JOSE, CA 95113 (408) 298-7500 (NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF AGENT FOR SERVICE) ------------------------ COPIES TO THOMAS J. POLETTI, ESQ. TIMOTHY R. CURRY, ESQ. TED WEITZMAN, ESQ. COLBY R. GARTIN, ESQ. DAVID R. SCHWARTZ, ESQ. BENJAMIN H. DEBERRY, ESQ. KIRKPATRICK & LOCKHART LLP DANIEL H. MORRIS, ESQ. 10100 SANTA MONICA BLVD., 7TH FLOOR BROBECK, PHLEGER & HARRISON LLP LOS ANGELES, CALIFORNIA 90067 TWO EMBARCADERO PLACE TELEPHONE (310) 552-5000 2200 GENG ROAD FACSIMILE (310) 552-5001 PALO ALTO, CALIFORNIA 94303 TELEPHONE (650) 424-0160 FACSIMILE (650) 496-2885
------------------------ APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as practicable after the effective date of this Registration Statement. If any of the securities being registered on this form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box. [ ] If this form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] If this form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] If this form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box. [ ] ------------------------ THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL HEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE SECURITIES AND EXCHANGE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a), MAY DETERMINE. -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- THE INFORMATION IN THIS PRELIMINARY PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. WE MAY NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER TO SELL THESE SECURITIES AND IT IS NOT SOLICITING AN OFFER TO BUY THESE SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED. PRELIMINARY PROSPECTUS (Subject to Completion) October 29, 2001 -------------------------------------------------------------------------------- 4,000,000 SHARES [BAM! ENTERTAINMENT LOGO] COMMON STOCK -------------------------------------------------------------------------------- We are selling 4,000,000 shares of our common stock. This is our initial public offering of shares of our common stock. No public market currently exists for any shares of our capital stock. We currently estimate that the initial public offering price of our common stock will be between $8.00 and $10.00 per share. Our common stock has been approved for quotation on the Nasdaq National Market under the symbol "BFUN", subject to official notice of issuance. BEFORE BUYING ANY SHARES YOU SHOULD READ THE DISCUSSION OF MATERIAL RISKS OF INVESTING IN OUR COMMON STOCK IN "RISK FACTORS" BEGINNING ON PAGE 5. NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR DETERMINED IF THIS PROSPECTUS IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
PER SHARE TOTAL ------------------------------------------------------------------------------------------ Public offering price $ $ ------------------------------------------------------------------------------------------ Underwriting discounts and commissions $ $ ------------------------------------------------------------------------------------------ Proceeds, before expenses, to us $ $ ------------------------------------------------------------------------------------------
The underwriters may also purchase up to 600,000 shares of our common stock from us at the public offering price, less underwriting discounts and commissions, within 30 days from the date of this prospectus. The underwriters may exercise this option to only cover over-allotments, if any. The underwriters are offering our common stock on a firm commitment basis as described under "Underwriting." Delivery of the shares will be made on or about , 2001. JEFFERIES & COMPANY, INC. MORGAN KEEGAN & COMPANY, INC. The inside front cover page of the prospectus consists of artwork that contains animated character drawings and logos of licensors with whom the company has contractual relationships. In this collage, the top third of the page contains animated drawings of characters from Cartoon Network television programs. In the top left hand corner is a depiction of the logo for the BAM! Entertainment, Inc. video game "Robot Rampage," based on the animated television program "Dexter's Laboratory," and a depiction of the animated character "Dexter" from "Dexter's Laboratory." In the left center of this section is a depiction of the logo for the Cartoon Network television network. On the right side of the page are depictions of animated characters based on the animated television program "The Powerpuff Girls" and depictions of logos for the BAM! Entertainment, Inc. video games based on that television program. In clockwise sequence, from the top left, those depictions are: the animated character "Buttercup"; the logo for the "Bad Mojo Jojo" video game; the animated character "Blossom"; the logo for the "Battle Him" video game; the animated character "Bubbles"; and the logo for the "Paint the Townsville Green" video game. In the middle section of the page, starting from the left, immediately below Dexter is a depiction of the logo for Sports Illustrated for Kids, a publication of Time, Inc. Immediately below the depiction of the logo for Sports Illustrated for Kids is a depiction of the logo for the BAM! Entertainment, Inc. video game "Hot Potato," which features two animated potato characters. In the center of this section is a depiction of an animated character from and logo for the BAM! Entertainment, Inc. video game "Fire Pro Wrestling." On the right side of this section is, in clockwise sequence: a depiction of the logo for Spyglass Entertainment; a depiction of the logo for the BAM! Entertainment, Inc. video game "Yogi Bear Great Baloon Blast" along with a depiction of the animated character "Yogi Bear"; a depiction of the logo for Warner Bros. Interactive Entertainment; and a depiction of the promotional poster for the motion picture "Driven," along with a depiction of the logo for Franchise Pictures. In the bottom section of the page, in the left hand corner are two rows of depictions of logos for video game hardware console systems. The top row in the left hand corner contains two logo depictions: on the left, a depiction of the logo for the "NINTENDO GAMECUBE" from Nintendo Co., Ltd.; and on the right, a depiction of the logo for "Xbox" from Microsoft Corporation. The bottom row in the left hand corner contains three logo depictions, all from Nintendo Co., Ltd.: on the left, a depiction of the logo for the "Nintendo 64"; in the center, a depiction of the logo for the Nintendo "Game Boy Advance"; and on the right, a depiction of the logo for the Nintendo "Game Boy Color." In the right hand corner of the bottom of the page is a depiction of a logo for BAM! Entertainment, Inc. At the bottom of the page below the artwork is text as follows: NINTENDO GAMECUBE and Microsoft's Xbox have not yet been released. -------------------------------------------------------------------------------- Through and including (25 days after the date of this prospectus), all dealers selling shares of our common stock, whether or not participating in this offering, may need to deliver a prospectus. This delivery requirement is in addition to the obligation of dealers to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions. TABLE OF CONTENTS -------------------------------------------------------------------------------- Prospectus summary.................... 1 The offering.......................... 3 Summary consolidated financial data... 4 Risk factors.......................... 5 Forward looking information........... 16 Use of proceeds....................... 16 Dividend policy....................... 17 Capitalization........................ 18 Dilution.............................. 19 Selected consolidated financial data................................ 20 Management's discussion and analysis of financial condition and results of operations.......................... 22 Business.............................. 36 Management............................ 50 Related party transactions............ 60 Principal stockholders................ 63 Description of capital stock.......... 65 Shares eligible for future sale....... 68 Underwriting.......................... 70 Legal matters......................... 73 Experts............................... 73 Where you can find additional information......................... 73 Index to consolidated financial statements.......................... 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-------------------------------------------------------------------------------- i (THIS PAGE INTENTIONALLY LEFT BLANK) Prospectus summary This summary highlights the information contained elsewhere in this prospectus. You should read the entire prospectus carefully, especially the risks of investing in our common stock discussed under "Risk factors." OUR BUSINESS We are a rapidly emerging developer and publisher of interactive entertainment software. We license properties from a wide variety of sources including entertainment and media companies and we publish software based on their motion picture, sports and television properties. We currently publish software for many of the most popular interactive entertainment hardware platforms, such as the PlayStation manufactured by Sony Computer Entertainment, Nintendo 64 and Nintendo's Game Boy Color and Game Boy Advance, as well as for portable handheld devices manufactured by Palm and Handspring and for personal computers. We are developing and plan to publish software for next generation hardware platforms such as the PlayStation 2 manufactured by Sony Computer Entertainment, NINTENDO GAMECUBE and Microsoft's Xbox, as well as for other portable handheld devices. According to Euromonitor, a research group and statistical source, worldwide sales of consoles, console games and games for personal computers grew from $17.0 billion in 1996 to $26.9 billion in 2000. Forrester, a research group and statistical source, predicts that in the United States alone, interactive entertainment console manufacturers and software publishers will generate $29.4 billion in revenues in 2005. Of that $29.4 billion, Forrester estimates that $12.8 billion will be generated by sales of console game software alone. For additional information regarding these statistical sources, see "Business -- Sources of Statistical Data." We believe that our ability to license popular properties, develop content with internal and third-party developers and distribute titles through our broad distribution channels provides us with significant competitive advantages. The key elements of our business approach are: + Development and promotion of titles based on properties with existing brand recognition. We believe that by developing interactive entertainment software titles based on popular properties and existing brands that appeal to specific segments of the interactive entertainment industry, we enhance consumer acceptance and product life cycles. We are developing titles in the following categories: - Adventure. We target game players ages 10 and under with titles based on licensed properties such as the popular television cartoons POWERPUFF GIRLS and DEXTER'S LABORATORY distributed by AOL Time Warner's Cartoon Network; - Sports. We target game players nine to 14, as well as the casual sports fan, with sports-based titles based on licensed properties of AOL Time Warner's Sports Illustrated for Kids; and - Action. We target the mass market with titles based on the licensed content originated by film production companies such as Spyglass Entertainment Group and Franchise Films. + Management experience. Our executive management team has substantial domestic and international experience in the interactive entertainment software industry. Key members of our management team have been founders and executives of other interactive entertainment software companies and in their current and past service have successfully identified and secured licenses for popular properties, established relationships with key third-party product developers and successfully negotiated distribution arrangements with multiple retail channels. Our team has developed strong working relationships with hardware platform manufacturers, which we believe provide substantial benefits in managing the product approval and development process. We believe our executive management team has the necessary experience to capitalize on opportunities afforded by the industry transition to next generation hardware platforms. + Strategic management of product development. We maintain a balanced mix of internal and external production efforts. We have an experienced in-house development staff and an internal product development studio where we -------------------------------------------------------------------------------- 1 develop titles. We have also established relationships with third-party interactive entertainment software developers with proven track records of developing successful titles. + Broad distribution channels. Our sales and marketing efforts are designed to broaden product distribution and increase the penetration of our products in domestic and international markets. We further seek to leverage and expand our channels of distribution in order to reach a larger number of consumers in the retail, direct and online markets, both domestically and internationally. We sell our interactive entertainment software to mass merchandisers such as Toys "R" Us, Target, Kmart, Wal-Mart and Best Buy, specialty chains such as Babbages, Etc. and Electronics Boutique and independent distributors. + Hardware platform flexibility. While we have the technical ability to develop products for all current hardware platforms, our development efforts focus on specific hardware platforms for specific demographics. In addition, we leverage our more popular titles across multiple hardware platforms that have sufficient installed bases and appropriate demographics for development to be successful. We believe this approach reduces both our reliance on any one hardware platform and the risks associated with product development. COMPANY INFORMATION We were incorporated in California in October 1999 under the name Bay Area Multimedia, Inc. We reincorporated in Delaware in September 2000 and changed our name to BAM! Entertainment, Inc. in December 2000. Our principal executive offices are located at 333 West Santa Clara Street, Suite 716, San Jose, California 95113. Our telephone number is (408) 298-7500. Our web site is http://www.bam4fun.com. The information found on our web site is not a part of this prospectus. -------------------------------------------------------------------------------- 2 The offering Unless otherwise noted, all information in this prospectus assumes that the underwriters do not exercise the over-allotment option we granted to them to purchase additional shares in the offering. Common stock we are offering....... 4,000,000 shares Common stock to be outstanding after this offering................ 12,678,984 shares Proposed Nasdaq National Market symbol............................. BFUN Use of proceeds.................... For general corporate purposes, including additional product development, expansion of our sales and marketing activities, international operations and possible acquisitions. See "Use of proceeds." The number of shares of our common stock to be outstanding after this offering is based upon 8,678,984 shares of our common stock outstanding as of September 30, 2001 and gives effect to the issuance of 4,000,000 shares of common stock being sold by us in this offering and the conversion of all outstanding shares of our redeemable convertible preferred stock into shares of our common stock upon the completion of this offering, and excludes: + 966,056 shares of our common stock issuable upon exercise of options outstanding as of September 30, 2001 at a weighted average exercise price of $4.93 per share under our 2000 Stock Incentive Plan and 18,800 shares of our common stock issuable at an exercise price of $4.79 upon exercise of options granted outside of our 2000 Stock Incentive Plan. For a description of our 2000 Stock Incentive Plan, please see "Management -- 2000 Stock Incentive Plan"; + 774,450 shares issuable upon exercise of warrants outstanding as of September 30, 2001 which were comprised of warrants to purchase 674,450 shares having a weighted average exercise price of $1.98 per share; and a warrant to purchase 100,000 shares issued to Transcap Associates, Inc. at an exercise price equal to the initial public offering price; and + up to 618,637 shares of our common stock which may be issued pursuant to a third-party entertainment property license agreement with Franchise Films as of September 30, 2001. Unless otherwise noted, all share and per share information in this prospectus gives effect to: + an amendment to our certificate of incorporation on August 15, 2001 effecting a 4.7-for-one split of our common stock and increasing the number of authorized shares of our common stock to 100,000,000 and our preferred stock to 10,000,000; + a 0.195-for-one reverse split of our common stock effected as of May 11, 2000; and + the automatic conversion of all outstanding shares of our redeemable convertible preferred stock into shares of our common stock upon the completion of this offering. -------------------------------------------------------------------------------- 3 Summary consolidated financial data Our summary consolidated financial data is presented in the following table to aid you in your analysis of a potential investment in our common stock. You should read this data in conjunction with "Management's discussion and analysis of financial condition and results of operations," our consolidated financial statements and the notes to those financial statements appearing elsewhere in this prospectus. The pro forma basic and diluted calculations below reflect the automatic conversion, upon the completion of this offering, of all outstanding shares of our redeemable convertible preferred stock into shares of our common stock, as if it occurred on the dates of original issuance.
THREE MONTHS ENDED OCTOBER 7, 1999 SEPTEMBER 30, (INCEPTION) THROUGH YEAR ENDED ----------------- JUNE 30, 2000 JUNE 30, 2001 2000 2001 CONSOLIDATED STATEMENT OF OPERATIONS DATA (In thousands, except per share data) ------------------------------------------------------------------------------------------------ Net revenues............................................... $ 1,377 $ 25,351 $ 495 $10,827 Costs and expenses......................................... 2,158 25,704 923 10,608 ------------------- ------------- ------ ------- Income (loss) from operations.............................. (781) (353) (428) 219 Other expense, net......................................... (22) (1,249) (7) (708) ------------------- ------------- ------ ------- Net loss................................................... (803) (1,602) (435) (489) Redeemable convertible preferred stock dividend............ -- (5,540) -- -- ------------------- ------------- ------ ------- Net loss attributable to common stockholders............... $ (803) $ (7,142) $ (435) $ (489) =================== ============= ====== ======= Net loss per share: Basic and diluted........................................ $ (0.96) $ (4.82) $(0.30) $ (0.32) Pro forma basic and diluted.............................. $ (1.04) $ (0.06) Shares used in computation: Basic and diluted........................................ 834 1,482 1,470 1,544 Pro forma basic and diluted.............................. 6,898 8,672
SEPTEMBER 30, 2001 ----------------------------------- PRO FORMA ACTUAL PRO FORMA AS ADJUSTED CONSOLIDATED BALANCE SHEET DATA (In thousands) ------------------------------------------------------------------------------------------------- Cash and cash equivalents................................... $ 474 $ 474 $32,915 Working capital............................................. 9,105 9,105 41,546 Total assets................................................ 28,672 28,672 58,852 Long-term portion of debt................................... -- -- -- Redeemable convertible preferred stock...................... 17,329 -- -- Total stockholders' equity (deficit)........................ (3,878) 13,451 43,631
The preceding table presents a summary of our consolidated balance sheet data as of September 30, 2001: + on an actual basis; + on a pro forma basis to reflect the automatic conversion of all outstanding shares of our redeemable convertible preferred stock into shares of our common stock upon the completion of this offering; and + on a pro forma as adjusted basis to give effect to the receipt of the estimated net proceeds from the sale of 4,000,000 shares of common stock in this offering, at an assumed initial public offering price of $9.00 per share, after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us. -------------------------------------------------------------------------------- 4 -------------------------------------------------------------------------------- Risk factors You should carefully consider the risks described below together with all of the other information included in this prospectus before making an investment decision. The risks and uncertainties described below are not the only ones facing us. Additional risks and uncertainties that we are unaware of, or that we currently deem immaterial, also may become important factors that adversely affect us. If any of the following risks actually occurs, our business, financial condition or results of operations could be materially adversely affected. In that case, the trading price of our common stock would decline and you may lose all or part of your investment. RISKS RELATED TO OUR FINANCIAL RESULTS BECAUSE WE HAVE A LIMITED OPERATING HISTORY, IT IS DIFFICULT TO EVALUATE AN INVESTMENT IN OUR COMMON STOCK. We were organized in October 1999 and released our first interactive entertainment software product in June 2000. It is difficult to evaluate our future prospects and an investment in our common stock because we have a limited operating history and the market for our products is rapidly evolving. Our prospects are uncertain and must be considered in light of the risks, expenses and difficulties frequently encountered by companies in the early stage of development. Our future performance will depend upon a number of factors, including our ability to: + expand our customer base; + secure popular entertainment properties upon which to base future products; + develop and enhance products in response to new interactive entertainment hardware platform releases, customer demand and competitive market conditions; + expand our interactive entertainment software development and sales and marketing capabilities; + expand our international operations; + attract, retain and motivate qualified personnel; and + maintain adequate control of our expenses. WE HAVE A HISTORY OF OPERATING LOSSES AND MAY NEVER ACHIEVE PROFITABILITY. We incurred net losses of $489,000 for the three months ended September 30, 2001, $1.6 million for the year ended June 30, 2001 and $803,000 for the period from October 7, 1999 (inception) to June 30, 2000. We will need to generate significant revenues to achieve profitability. There can be no assurance that our revenues will grow in the future or that we will achieve sufficient revenues for profitability. If our revenues do not grow as quickly as we anticipate, or if our operating expenses exceed our expectations, our business would be severely harmed. OUR REVENUES FLUCTUATE DUE TO SEASONAL DEMAND AND THE NATURE OF THE INTERACTIVE ENTERTAINMENT INDUSTRY. We have experienced and may continue to experience significant quarterly fluctuations in net sales and operating results. The interactive entertainment industry is highly seasonal, with sales typically higher during the fourth and first calendar quarters. This is due primarily to the increased demand for games during and immediately following the holiday buying season. Our failure or inability to introduce products on a timely basis to meet seasonal fluctuations in demand will harm our business and operating results. Although we are attempting to reduce the effect of seasonal patterns on our business by distributing our product release dates more evenly throughout the year, we may not be successful. These fluctuations, as well as fluctuations caused by other factors, could cause our stock price to decline. Our expense levels are based, in part, on our expectations regarding future sales. Therefore, our operating results would be harmed by a decrease in sales or a failure to meet our sales expectations. Uncertainties associated with interactive entertainment software development, lengthy manufacturing lead times, production delays and the approval process for products by hardware manufacturers and other licensors make it difficult to predict the quarter in -------------------------------------------------------------------------------- 5 RISK FACTORS -------------------------------------------------------------------------------- which our products will ship. As a result of these and other factors, in some future quarters our operating results may fall below the expectations of securities analysts and investors. In this event, the trading price of our common stock could significantly decline. OUR EARNINGS WILL BE AFFECTED UPON THE ISSUANCE OF SHARES OF OUR COMMON STOCK PURSUANT TO THIRD-PARTY ENTERTAINMENT PROPERTY LICENSE AGREEMENTS AND BY A WARRANT HELD BY A FINANCE COMPANY. Pursuant to a license agreement with Franchise Films, we are obligated to issue 68,738 shares of our common stock after the release of any film for which we elect to produce interactive entertainment software products. This agreement covers up to 10 films or 687,375 shares of common stock. To date, we have elected to produce titles for three films and have issued 68,738 shares under this agreement. We are required to issue these shares when the films are released and will then incur a non-cash charge. If the software product is released after the release of the film, we will amortize the non-cash charge over the life of the product, which is expected to be between three and six months. If the software product is released prior to the release of the film, we will at each interim period assess whether it is probable that the value of the shares issued is recoverable through future sales of the product to which it relates. If this is probable, the non-cash charge will be amortized to licensed costs over the life of the product. In the alternative, we will expense the non-cash charge at the time of the issuance of the shares if it is not probable that the value of the shares issued is recoverable through future sales of the product to which these shares relate. We cannot estimate the aggregate dollar amount of future non-cash charges as they are based on our share price at a future point in time. However, these charges may be substantial. The non-cash charge of $746,000 on the initial shares issued is expected to be incurred in the second and third fiscal quarters of 2002. In addition, in connection with the issuance of warrants pursuant to a license agreement with Spyglass Entertainment, we incurred a non-cash charge of $354,000. This charge is being amortized on a straight-line basis over five years and commenced in October 2000. In connection with these warrants, a further non-cash charge of $556,000 will be amortized over a period, expected to be between three and six months, commencing on the release of the subject interactive entertainment software products. These releases are expected to be in the first or second fiscal quarter of 2003. Each of these charges will affect our gross margins and profitability and may cause the trading price of our common stock to decline significantly. In addition, pursuant to an August 2001 amendment to our master purchase order assignment agreement with an affiliate of Transcap Associates, Inc. and the execution of a $7.0 million factoring arrangement with an affiliate of Transcap, we issued Transcap a warrant to purchase 100,000 shares of our common stock at an exercise price equal to the initial public offering price. In connection with this issuance, we incurred a non-cash charge of $806,000. This charge is subject to remeasurement up to the date of this offering and is being amortized on a straight-line basis through March 2002, which is the remaining term of the agreement. RISKS RELATED TO OUR BUSINESS OUR MARKET IS CHARACTERIZED BY CHANGING CONSUMER PREFERENCES AND SHORT PRODUCT LIFE CYCLES. TO COMPETE EFFECTIVELY WE MUST CONTINUALLY INTRODUCE NEW PRODUCTS THAT ACHIEVE MARKET ACCEPTANCE. The interactive entertainment software market is characterized by short product life cycles, changing consumer preferences and frequent introduction of new products. We believe that our success will be dependent on the production of successful titles on a continuous basis. We cannot assure you that new products introduced by us will achieve significant market acceptance or that such acceptance, if achieved, will be sufficient to permit us to recover development and other associated costs. Consumer preferences for interactive entertainment software products are continually changing and are difficult to predict. Even the most successful titles remain popular for only limited periods of time, often less than six months. The life cycle of a game generally consists of a relatively high level of sales during the first few months after introduction, followed by a decline in sales. Accordingly, we expect that substantially all of our net sales for a particular year will be generated by titles released in that year and in the latter part of the prior year. -------------------------------------------------------------------------------- 6 RISK FACTORS -------------------------------------------------------------------------------- THE DEVELOPMENT CYCLE FOR NEW TITLES IS LONG AND DURING THIS TIME THE MARKET APPEAL OF A TITLE MAY DECLINE. We believe the development cycle for new titles is long, typically ranging from 12 to 24 months. After development of the initial product, we believe it may take between six to 12 additional months to develop the product for additional hardware platforms. In order to distribute a product, we must develop and test the necessary game software, obtain approval from the manufacturer and licensor if required, and have the initial order of cartridges or disks manufactured. During the development cycle, the market appeal of a title or of a property on which the title is based may decline. If market acceptance is not achieved, we may grant markdown allowances to maintain our relationship with retailers and our access to distribution channels. Because we introduce a relatively limited number of new products in a given period, the failure of one or more of our products to achieve market acceptance could harm our business. THE INTRODUCTION OF NEW INTERACTIVE ENTERTAINMENT HARDWARE PLATFORMS CREATES RISKS RELATING TO THE DEVELOPMENT OF TITLES FOR THOSE HARDWARE PLATFORMS. The interactive entertainment industry is also characterized by rapid technological change. For example, the 128-bit hardware platform was released within five years of the release of the 64-bit hardware platform. As a result, we must continually anticipate these changes and adapt our offerings to emerging hardware platforms and evolving consumer preferences. Generally, because of the length of the development cycle, our development efforts must begin well in advance of the release of new hardware platforms in order to introduce titles on a timely basis with the release of such hardware platforms. Further, we have no control over the release dates of new hardware platforms or the number of units that will be shipped upon such release. It is difficult to ensure that our schedule for releasing new titles will coincide with the release of the corresponding hardware platforms. Additionally, if fewer than expected units of a new hardware platform are produced or shipped, such as recently occurred with Sony's PlayStation 2, developers of titles for those hardware platforms may experience lower than expected sales. The introduction of new hardware platforms and technologies can also render existing titles obsolete and unmarketable. Generally, as more advanced hardware platforms are introduced, consumer demand for titles for older hardware platforms diminishes. In addition, a broad range of competing and incompatible emerging technologies may lead consumers to postpone buying decisions until a particular hardware platform gains widespread acceptance. As a result of such reduced consumer demand for titles on older hardware platforms, our titles for older hardware platforms may not generate sufficient sales to make our titles profitable. THE DEVELOPMENT OF SOFTWARE PRODUCTS IS COMPLEX AND TIME CONSUMING AND MAY NOT LEAD TO MARKETABLE TITLES. The development of software products is complex and time consuming. Our development efforts may not lead to marketable titles or titles that generate sufficient revenues to recover their development and marketing costs, especially if a hardware platform does not reach or sustain an expected level of acceptance. This risk may increase in the future, as continuing increases in development costs require corresponding increases in net sales in order for us to maintain profitability. The technological advancements of the new hardware platforms also allow more complex software products. As software products become more complex, the risk of undetected errors in products when first introduced increases. We cannot assure you that, despite testing, errors will not be found in new products or releases after shipments have been made, resulting in loss of or delay in timely market acceptance, product returns, loss of revenues and damage to our reputation. In the past, we have experienced delays in the introduction of new titles and we anticipate that we will experience similar delays in the future in connection with the introduction of additional new titles, including products currently under development. Because net revenues associated with the initial shipments of a new product generally constitute a high percentage of the total net revenues associated with the life of a product, any delay in the introduction of, or the presence of a defect in, one or more new products could harm the ultimate success of the products or our business and operating results. -------------------------------------------------------------------------------- 7 RISK FACTORS -------------------------------------------------------------------------------- THE COSTS OF DEVELOPING AND MARKETING PRODUCTS FOR NEW INTERACTIVE ENTERTAINMENT HARDWARE PLATFORMS MAY BE SUBSTANTIAL AND COULD HARM OUR BUSINESS. The costs associated with the introduction of products for new hardware platforms, such as NINTENDO GAMECUBE, Sony's PlayStation 2 and Microsoft's Xbox, could harm our business. We anticipate that it will be more costly to develop titles for new hardware platforms. We also believe the costs of developing and publishing titles for these hardware platforms may require greater financial and technical resources than prior development and publishing efforts. Additionally, during periods of new technology introductions, forecasting our revenues and earnings is more difficult than in more stable or rising product markets. IF NEW INTERACTIVE ENTERTAINMENT HARDWARE PLATFORMS FAIL TO ACHIEVE SIGNIFICANT MARKET ACCEPTANCE, IT MAY HARM OUR BUSINESS. Our sales are dependent on, among other factors, the popularity and unit sales of the interactive entertainment hardware platforms of the various manufacturers. The interactive entertainment industry has experienced periods of significant growth in consumer interest and popularity, followed by periods in which consumer demand for interactive entertainment products has slowed. Unexpected shortfalls in the market acceptance of a particular hardware platform can significantly harm consumer demand for titles released or scheduled for release for that hardware platform. Therefore, we are dependent upon the successful marketing efforts of the manufacturers of the various hardware platforms to meet financial expectations. PRODUCT RETURNS AND MARKDOWN ALLOWANCES COULD HARM OUR BUSINESS. We are exposed to the risk of product returns and markdown allowances with respect to our customers. The decrease in demand for products based upon older hardware platforms may lead to a high level of these product returns and markdown allowances. We allow distributors and retailers to return defective and damaged products in accordance with negotiated terms. In addition, from time to time we provide markdown allowances to our larger customers on certain unsold merchandise. Product returns and markdown allowances that exceed our expectations could harm our business. A SUBSTANTIAL PORTION OF OUR REVENUES HAVE BEEN DERIVED FROM A LIMITED NUMBER OF PRODUCTS. To date, a substantial portion of our revenues have been derived from a limited number of products. Sales of our three POWERPUFF GIRLS products accounted for 66% of our net revenues for the year ended June 30, 2001. Sales of our BEAST WARS product accounted for 100% of our net revenues for the period from inception through June 30, 2000. If we fail to replace these titles with additional products generating significant revenues, our business will be harmed. OVER 40% OF OUR NET REVENUES ARE DERIVED FROM SALES TO OUR THREE LARGEST CUSTOMERS. WE COULD BE ADVERSELY AFFECTED IF ANY OF THEM REDUCED OR TERMINATED THEIR PURCHASES FROM US OR DID NOT PAY THEIR OBLIGATIONS TO US. Revenues from our three largest customers collectively accounted for 49% of our net revenues for the three months ended September 30, 2001 as compared to 43% of our net revenues for the year ended June 30, 2001 and 75% for the period from inception through June 30, 2000. Customers which comprised over 10% of our net revenues for the three months ended September 30, 2001 were Toys "R" Us, which accounted for 19% of our net revenues, Kmart, which accounted for 19% of our net revenues, Ingram, which accounted for 11% of our net revenues, and Electronics Boutique, which accounted for 10% of our net revenues. For the year ended June 30, 2001 Toys "R" Us accounted for 17% of our net revenues, Wal-Mart accounted for 14% of our net revenues and Target accounted for 12% of our net revenues. For the period from inception through June 30, 2000, Blockbuster accounted for 49% of our net revenues, Wal-Mart accounted for 16% of our net revenues and KB Toys accounted for 10% of our net revenues. We have no written agreements or other understandings with any of our customers that relate to future purchases. Therefore, purchases by these customers or any others could be reduced or terminated at any time. A substantial reduction or a termination of purchases by any of our largest customers would harm us. -------------------------------------------------------------------------------- 8 RISK FACTORS -------------------------------------------------------------------------------- SUBSTANTIALLY ALL OF OUR SALES ARE MADE ON CREDIT, WHICH EXPOSES US TO BAD DEBT. Our sales are typically made on credit, with terms that vary depending upon the customer and other factors. While we attempt to carefully monitor the creditworthiness of our customers and distributors, we bear the risk of their inability to pay our receivables and of any delay in payment. A business failure by any of our largest customers would harm us, as could a business failure by any of our distributors or other retailers. WE CANNOT PUBLISH OUR INTERACTIVE ENTERTAINMENT SOFTWARE TITLES WITHOUT THE APPROVAL OF HARDWARE MANUFACTURERS. OUR ABILITY TO CONTINUE TO DEVELOP AND MARKET OUR TITLES IS DEPENDENT ON THE HARDWARE MANUFACTURERS CONTINUING TO DO BUSINESS WITH US. We are wholly dependent on the manufacturers of interactive entertainment hardware platforms and our ability to obtain or maintain non-exclusive licenses with them, both for the rights to publish and to manufacture titles for their hardware platforms. We are required to obtain a license to develop and publish titles for each hardware platform for which we develop and publish titles. Each license specifies the territory to which it applies, and such licenses range from as broad as multi-national distribution to as narrow as approval on a title-by-title basis. Our existing hardware platform licenses for Sony's PlayStation and PlayStation 2, Nintendo's Game Boy Color and Game Boy Advance, Nintendo 64 and Microsoft's Xbox, and our pending license for NINTENDO GAMECUBE, require that we obtain approval for the publication of new titles on a title-by-title basis. As a result, the number of titles we are able to publish for these hardware platforms, along with our ability to time the release of these titles is dependent upon decisions made by third party manufacturers. Accordingly, our revenues from titles for these hardware platforms may be limited. Should any manufacturer choose not to renew or extend our license agreement at the end of its current term, or if the manufacturer were to terminate our license for any reason, we would be unable to publish additional titles for that manufacturer's hardware platform. WE ARE DEPENDENT ON SONY AND NINTENDO FOR THE MANUFACTURE OF PRODUCTS THAT WE DEVELOP FOR THEIR HARDWARE PLATFORMS. When we develop interactive entertainment software titles for a hardware platform offered by Sony or Nintendo, the products are manufactured exclusively by that hardware manufacturer. Our hardware platform licenses with Sony and Nintendo provide that the manufacturer may change prices for the manufacturing of products at any time. In addition, these licenses include other provisions that give the manufacturer substantial control over our costs and the release of new titles. Since each of the manufacturers is also a publisher of games for its own hardware platforms and manufactures products for all of its other licensees, a manufacturer may give priority to its own products or those of our competitors in the event of insufficient manufacturing capacity. We would be materially harmed by unanticipated delays in the manufacturing and delivery of products. IF WE CANNOT RETAIN OUR EXECUTIVE MANAGEMENT TEAM AND ATTRACT AND RETAIN ADDITIONAL KEY PERSONNEL, OUR BUSINESS WILL BE HARMED. Our success has been due to a significant extent on the contributions and industry experience of our executive management team, in particular our Chief Executive Officer and President, Raymond C. Musci, and our Vice Chairman, Anthony R. Williams. If we fail to retain the services of our executive management team, our ability to secure additional licenses and develop and sell new products would be significantly impaired. In addition, our future success will also depend upon our ability to continue to attract, motivate and retain highly qualified employees and third-party contractors, particularly software design and development personnel and outside sales representatives. Competition for highly skilled employees is intense and we may not be successful in attracting and retaining such personnel. WE ARE DEPENDENT UPON LICENSES TO PROPERTIES ORIGINATED AND OWNED BY THIRD PARTIES FOR THE DEVELOPMENT OF OUR TITLES. Many of our titles, such as those from our POWERPUFF GIRLS series, DEXTER'S LABORATORY and DRIVEN, are based upon entertainment properties licensed from third parties. We cannot assure you that we will be able to obtain new licenses, or renew existing ones, on reasonable terms, if at all. If we are unable to obtain licenses for the properties -------------------------------------------------------------------------------- 9 RISK FACTORS -------------------------------------------------------------------------------- which we believe offer significant consumer appeal, we would be required to obtain licenses for less popular properties or have to develop all of our titles based upon internally developed concepts. Titles based on less popular properties or on internally developed concepts typically require greater marketing expense in order to establish brand identity and may not achieve broad market acceptance or prove to be successful. WE ARE DEPENDENT ON THIRD-PARTY INTERACTIVE ENTERTAINMENT SOFTWARE DEVELOPERS FOR DEVELOPING AND COMPLETING MANY OF OUR TITLES. We rely on third-party interactive entertainment software developers for the development of a significant number of our interactive entertainment software titles. Quality third-party developers are continually in high demand. For this reason, we cannot assure you that the third-party software developers who have developed titles for us in the past will continue to be available to develop software for us in the future. Due to the limited number of third-party software developers and the lack of control that we exercise over them, we cannot assure you that these developers will complete titles for us on a timely basis or within acceptable quality standards, if at all. OUR SUCCESS DEPENDS ON OUR ABILITY TO EFFECTIVELY MANAGE OUR GROWTH. Our operations have rapidly expanded since our inception in October 1999 and we plan to continue to significantly expand our operations. Our rapid growth has placed, and will continue to place, significant strain on our management and operational systems and resources. We anticipate that as our business grows, we will have to improve and enhance our overall financial and managerial controls, reporting systems and procedures. We will also need to continue to expand, train and manage our workforce. Additionally, we will be required to increase the capacity of our current systems to meet additional demands. An inability to manage our growth and meet these additional demands will impair the success of our business. OBTAINING ADDITIONAL CAPITAL TO FUND OUR OPERATIONS AND FINANCE OUR GROWTH COULD IMPAIR THE VALUE OF YOUR INVESTMENT. If we expand more rapidly than currently anticipated or if our working capital needs exceed our current expectations, we may need to raise additional capital through public or private equity offerings or debt financings. If we cannot raise needed funds on acceptable terms, we may not be able to develop or enhance our products, take advantage of future opportunities or respond to competitive pressures or unanticipated requirements. To the extent we raise additional capital by issuing equity securities, our stockholders may experience substantial dilution. Also, any new equity securities may have greater rights, preferences or privileges than our existing common stock. A material shortage of capital may require us to take drastic steps such as reducing our level of operations, disposing of selected assets or seeking an acquisition partner. OUR SUCCESS IS HIGHLY DEPENDENT ON OUR PROPRIETARY SOFTWARE AND INTELLECTUAL PROPERTY. We rely primarily on a combination of copyright, trademark and trade secret laws, employee and third-party nondisclosure agreements and other methods to protect our proprietary rights. We require our employees, consultants and other outside individuals and entities to execute confidentiality and nondisclosure agreements upon the start of employment, consulting or other contractual relationships with us. However, our ability to police these individuals and entities and enforce these agreements is costly and uncertain. We are aware that unauthorized copying occurs within our industry. If a significantly greater amount of unauthorized copying of our interactive entertainment software products were to occur, our business would be harmed. We generally obtain ownership of the software code and related documentation from third-party software developers. In instances where we do not retain sole ownership of the source code, the owner may use or license the code for development of other software products that may compete directly with our products and we may not have sufficient rights in the source code to produce derivative products. We rely on existing copyright laws to prevent unauthorized distribution of our products. Existing copyright laws afford only limited protection. Policing unauthorized use of our products is difficult, and software piracy is a persistent problem, especially in international markets. In addition, the laws of some countries in which our products -------------------------------------------------------------------------------- 10 RISK FACTORS -------------------------------------------------------------------------------- are or may be distributed either do not protect our products and intellectual property rights to the same extent as the laws of the United States or are weakly enforced. Legal protection of our rights may be ineffective in these countries. Any unauthorized use of our proprietary information could result in costly and time-consuming litigation to enforce our proprietary rights. OTHER PARTIES MAY ASSERT CLAIMS AGAINST US THAT WE ARE INFRINGING UPON THEIR INTELLECTUAL PROPERTY RIGHTS AND WE ARE REQUIRED TO INDEMNIFY HARDWARE MANUFACTURERS FROM CERTAIN CLAIMS IN EXCHANGE FOR THE RIGHT TO PURCHASE TITLES AND MANUFACTURE OUR SOFTWARE FOR THEIR HARDWARE PLATFORMS. We cannot be certain that our products do not infringe upon the intellectual property rights of others. We may be subject to legal proceedings and claims from time to time in the ordinary course of our business, including claims of alleged infringement of the intellectual property rights of third parties. If our products violate third-party proprietary rights, we cannot assure you that we would be able to obtain licenses to continue offering such products on commercially reasonable terms, or at all. In addition, we must indemnify the hardware manufacturers with respect to all loss, liability and expense resulting from any claim against them involving the development, marketing, sale or use of our products. This includes any claims for copyright or trademark infringement brought against them. As a result, we bear the risk that the properties upon which our software titles are based, or that the information and technology licensed from the hardware manufacturer and incorporated in our software, may infringe the rights of third parties. Any claims against us or the parties we indemnify relating to the infringement of third-party proprietary rights, even if not meritorious, could result in the expenditure of significant financial and managerial resources. Their claims could also result in injunctions preventing us from offering these products. Such claims could severely harm our financial condition and ability to compete. For information concerning pending intellectual property matters, see "Business -- Intellectual Property." THE CALIFORNIA ENERGY CRISIS COULD HARM OUR BUSINESS. California is currently experiencing a utility crisis and often does not have sufficient sources of affordable power. This energy crisis could impact our business, financial condition and results of operations. Our domestic headquarters and principal operations are located in San Jose, California, which has undergone several periods of rolling blackouts, a technique used by our power providers to conserve resources. Although our operations have not been halted for significant periods of time as a result of these conservation measures, potential suspensions of our operations could result in lost productivity, materially higher costs and lost revenues. In addition, regulators have announced electricity rate increases in California, which will also increase our cost of operations. THE INTERACTIVE ENTERTAINMENT INDUSTRY IS CONSOLIDATING. IN MAKING ACQUISITIONS, WE FACE SIGNIFICANT COMPETITION FROM OTHER COMPANIES WITH GREATER FINANCIAL RESOURCES. WE ALSO FACE INTEGRATION CHALLENGES WITH ANY COMPANIES THAT WE ACQUIRE. To enhance our product development and distribution capabilities, we may pursue acquisitions of companies, intellectual property rights and other assets that can be acquired on acceptable terms and which we believe can be operated or exploited profitably. We cannot assure you that we will be successful in identifying suitable acquisition opportunities. As the interactive entertainment industry continues to consolidate, we face significant competition in making acquisitions. This may constrain our ability to complete suitable transactions. Many of our competitors for potential acquisitions have significant financial and other resources. If we attempt an acquisition, we cannot assure you that, given the competitive environment, we will complete the acquisition or that any completed acquisitions will benefit our business or operations. In addition, the integration of any newly acquired company's operations with our existing operations will take management time and effort. There is a possibility that we may not be successful in integrating operations of any newly acquired companies. Additionally, there is a risk of loss of key employees, customers and vendors of any recently acquired companies. -------------------------------------------------------------------------------- 11 RISK FACTORS -------------------------------------------------------------------------------- WE FACE RISKS ASSOCIATED WITH DOING BUSINESS IN FOREIGN COUNTRIES, INCLUDING OUR ABILITY TO GENERATE INTERNATIONAL DEMAND FOR OUR PRODUCTS. We intend to expand our international sales and marketing activities. This expansion will require significant management time and attention and financial resources in order to develop our international operations. We cannot assure you that we will be able to generate international market demand for our products. International sales and operations are subject to a number of risks, including: + international consumer acceptance of existing and proposed titles; + the impact of possible recessions in foreign economies; + our ability to protect our intellectual property; + the time and costs associated with translating and localizing products for foreign markets; + foreign currency fluctuations; + unexpected changes in regulatory requirements; + difficulties and costs of staffing and managing foreign operations; and + political and economic instability. ANY SIGNIFICANT DOWNTURN IN GENERAL ECONOMIC CONDITION WHICH RESULTS IN A REDUCTION IN DISCRETIONARY SPENDING COULD REDUCE DEMAND FOR OUR PRODUCTS AND HARM OUR BUSINESS. Our product sales are affected by a retail customer's ability and desire to spend disposable income on the purchase of our software titles. Any significant downturn in general economic conditions which results in a reduction of discretionary spending could result in a reduction in demand for our products and could harm our business. The Untied States economy is currently undergoing a period of slowdown, which some observers view as a recession. The United States and world economic condition has been worsened by the September 11th terrorist attacks in New York City and Washington, D.C. Moreover, any further terrorist activities, or the effect of the United States' political, economic or military response to such activities, could result in the further deterioration of the United States and world economy. Such industry downturns have been, and may continue to be, characterized by diminished product demand and erosion of average selling prices. A continued economic downturn or recession would have a significant adverse effect on our operating results in future periods. OUR OFFICERS AND DIRECTORS OWN A SUBSTANTIAL AMOUNT OF OUR COMMON STOCK AND THEREFORE HAVE SUBSTANTIAL INFLUENCE OVER OUR OPERATIONS AND CAN SIGNIFICANTLY INFLUENCE MATTERS REQUIRING STOCKHOLDER APPROVAL. Our officers and directors will beneficially own approximately 60% of our common stock following the completion of this offering, or approximately 57% if the underwriters' over-allotment option is exercised in full. As a result, they will have the ability to control all matters requiring approval by our stockholders, including the election and removal of directors, approval of significant corporate transactions and the decision of whether a change in control will occur. RISKS RELATED TO OUR INDUSTRY COMPETITION WITHIN THE INTERACTIVE ENTERTAINMENT SOFTWARE INDUSTRY IS INTENSE AND POSES AN ONGOING THREAT TO THE SUCCESS OF OUR BUSINESS. The interactive entertainment industry is intensely competitive. Many of our competitors have greater name recognition among consumers and licensors of entertainment properties, broader product lines and greater financial, marketing and other resources than us. Accordingly, these competitors may be able to market their products more effectively, make larger offers or guarantees in connection with the acquisition of licensed entertainment properties, adopt more aggressive pricing policies or pay more to third-party developers. We believe that other technology, entertainment and media companies are increasing their focus on the interactive entertainment software market, which might result in greater competition for us. In addition, many of our competitors are developing online -------------------------------------------------------------------------------- 12 RISK FACTORS -------------------------------------------------------------------------------- interactive entertainment software products and interactive networks that will be competitive with our interactive entertainment software products. Competitive pressures could have the following effects on us: + as competition for popular entertainment properties increases, our cost of acquiring licenses for those properties may increase, resulting in reduced margins; + as competition for retail shelf space becomes more intense, we may need to increase our marketing expenditures to maintain sales of our interactive entertainment software titles; and + we could be required to reduce the wholesale unit prices of our titles. COMPETITION FOR LIMITED SHELF SPACE AND PROMOTIONAL RESOURCES AMONG INTERACTIVE ENTERTAINMENT SOFTWARE PUBLISHERS IS INTENSE AND POSES AN ONGOING THREAT TO THE SUCCESS OF OUR BUSINESS. There is intense competition among developers and publishers of interactive entertainment software products for high quality retail shelf space and promotional support from retailers. As the number of titles and hardware platforms increases, competition for shelf space will intensify and may require us to increase our marketing expenditures. Due to increased competition for limited shelf space, retailers and distributors are in an increasingly better position to negotiate favorable terms of sale, including price discounts, price protection, marketing and display fees and product return policies. Our products constitute a relatively small percentage of any retailer's sales volume, and we cannot assure you that retailers will continue to purchase our products or to provide our products with adequate levels of shelf space and promotional support. As a result of their positions in the industry, the manufacturers of interactive entertainment hardware platforms generally have better bargaining positions with respect to retail pricing, shelf space and retailer accommodations than do any of their licensees, including us. GOVERNMENT RESTRICTIONS INCLUDING THE LIKELY ADOPTION OF AN INTERACTIVE ENTERTAINMENT SOFTWARE RATING SYSTEM COULD HARM OUR BUSINESS. Legislation is periodically introduced at the state and federal levels in the United States and in foreign countries to establish a system for providing consumers with information about graphic violence and sexually explicit material contained in interactive entertainment software products. Under such a system, interactive entertainment software publishers would be expected to comply by identifying particular products within defined rating categories. In addition, these publishers would be required to communicate these ratings to consumers through appropriate package labeling and through advertising and marketing presentations consistent with each product's rating. Many foreign countries have laws which permit governmental entities to censor the content of products, including interactive entertainment software. In some instances, we may be required to modify our products to comply with the requirement of such governmental entities, which could delay the release of those products in such countries. These delays could harm our business. We currently voluntarily submit our products to industry-created review boards and publish their ratings on our game packaging. Some retailers may refuse to carry titles that bear an unacceptable rating. We believe that mandatory government-run interactive entertainment software products rating systems eventually will be adopted in many countries which represent significant markets or potential markets for us. Due to the uncertainties in the implementation of such a rating system, confusion in the marketplace may occur. We are unable to predict what effect, if any, such a rating system would have on our business. POTENTIAL OPPOSITION BY CONSUMER ADVOCACY GROUPS TO CERTAIN SOFTWARE CONTENT COULD HARM OUR BUSINESS. Consumer advocacy groups have in the past opposed sales of interactive entertainment software products containing graphic violence and sexually explicit content. These groups have pressed for legislation in these areas and engaged in public demonstrations and media campaigns. While to date such actions have not harmed our business, we cannot assure you that these groups will not target our products in the future. If that occurs, we may be required to significantly change or discontinue one or more of our titles. -------------------------------------------------------------------------------- 13 RISK FACTORS -------------------------------------------------------------------------------- RISKS RELATED TO THIS OFFERING WE EXPECT OUR STOCK PRICE TO BE VOLATILE. Prior to this offering, there has been no public market for our common stock. Accordingly, we cannot assure you that an active trading market will develop or be sustained or that the market price of our common stock will not decline. The initial public offering price for the shares of our common stock will be determined by us and the representatives of the underwriters and may not be indicative of prices that will prevail in the trading market. The price at which our common stock will trade after this offering is likely to be highly volatile and may fluctuate substantially due to many factors, some of which are outside of our control. In addition, the stock market has experienced significant price and volume fluctuations that affected the market price for the common stock of many technology, communications and entertainment and media companies. These market fluctuations were sometimes unrelated or disproportionate to the operating performance of these companies. Any significant stock market fluctuations in the future, whether due to our actual performance or prospects or not, could result in a significant decline in the market price of our common stock. ANTI-TAKEOVER PROVISIONS IN OUR CHARTER DOCUMENTS AND IN DELAWARE LAW COULD PREVENT OR DELAY A CHANGE IN CONTROL AND, AS A RESULT, NEGATIVELY IMPACT OUR STOCKHOLDERS. Provisions of our certificate of incorporation and bylaws may discourage, delay or prevent a merger or acquisition or make removal of incumbent directors or officers more difficult. These provisions may discourage takeover attempts and bids for our common stock at a premium over the market price. These provisions include: + the ability of our board of directors to alter our bylaws without stockholder approval; + the restriction on the ability of stockholders to call special meetings; + the restriction on the ability of our stockholders to act by written consent; + the establishment of advance notice requirements for nominations for election to our board of directors or for proposing matters that can be acted on by stockholders at stockholders meetings; and + the establishment of a classified board of directors with staggered, three-year terms, which prevents a majority of the board from being elected at one time. In addition, we are subject to Section 203 of the Delaware General Corporation Law, which prohibits a publicly held Delaware corporation from engaging in a merger, asset or stock sale or other transaction with an interested stockholder for a period of three years following the date such person became an interested stockholder, unless prior approval of our board of directors is obtained or as otherwise provided. These provisions of Delaware law also may discourage, delay or prevent someone from acquiring or merging with us without obtaining the prior approval of our board of directors, which may cause the market price of our common stock to decline. MANAGEMENT WILL HAVE BROAD DISCRETION OVER THE USE OF PROCEEDS FROM THIS OFFERING. The net proceeds from this offering will be used for general corporate purposes. Although we list expanding our product development, expanding our international operations and possible acquisitions and expanding our sales and marketing activities, as examples of general corporate purposes, we are not obligated to pursue any of these opportunities. We have not reserved or allocated the net proceeds for any specific transaction, and we cannot specify with certainty how we will use the net proceeds. Accordingly, our management will have considerable discretion in the application of the net proceeds, and you will not have the opportunity, as part of your investment decision, to assess whether the proceeds are being used appropriately. The net proceeds may be used for corporate purposes that do not increase our operating results or market value. Until the net proceeds are used, they may be placed in investments that do not produce income or that lose value. -------------------------------------------------------------------------------- 14 RISK FACTORS -------------------------------------------------------------------------------- A SUBSTANTIAL AMOUNT OF OUR SHARES WILL BE ELIGIBLE FOR SALE SHORTLY AFTER THIS OFFERING. If our stockholders sell substantial amounts of common stock in the public market following this offering, the market price of our common stock could fall. These sales also might make it more difficult for us to sell equity or equity- related securities at a time and price that we deem appropriate. Based on shares outstanding as of September 30, 2001, upon completion of this offering, we will have 12,678,984 shares of common stock outstanding. Of these shares, the 4,000,000 shares being offered hereby will be freely tradable and the remaining shares will become eligible for sale in the public market pursuant to Rule 144. All of the remaining shares are subject to contractual restrictions with the underwriters that prevent them from being sold until 180 days after the date of this prospectus without the consent of Jefferies & Company, Inc. Jefferies & Company, Inc. may, in its sole discretion, at any time without notice, release all or any portion of the shares subject to the lock-up agreements, which would result in more shares being available for sale in the public market at an earlier date. Sales of common stock by existing stockholders in the public market, or the availability of such shares for sale, could materially and adversely affect the market price of our common stock. OUR SHARES PURCHASED IN THIS OFFERING WILL INCUR IMMEDIATE AND SUBSTANTIAL DILUTION OF APPROXIMATELY $5.56 PER SHARE. The assumed initial public offering price of our common stock is substantially higher than the pro forma net tangible book value per share of the outstanding common stock immediately after this offering. Accordingly, assuming an initial public offering price of $9.00 per share, if you purchase common stock in this offering, you will incur immediate and substantial dilution of $5.56 in the pro forma net tangible book value per share of the common stock. In addition, investors will incur additional dilution upon the exercise of outstanding stock options and warrants after this offering. -------------------------------------------------------------------------------- 15 -------------------------------------------------------------------------------- Forward looking information This prospectus may contain forward-looking statements. When used in this prospectus, the words "anticipate," "believe," "estimate," "will," "plan," "intend" and "expect" and similar expressions identify forward-looking statements. Although we believe that our plans, intensions and expectations reflected in those forward-looking statements are reasonable, we cannot assure you that these plans, intentions or expectations will be achieved. Actual results, performance or achievements could differ materially from those contemplated, expressed or implied by the forward-looking statements contained in this prospectus. Important factors that could cause actual results to differ materially from our forward-looking statements are set forth in this prospectus, including under the heading "Risk factors." Our actual results could differ materially from those predicated in these forward-looking statements, and the events anticipated in the forward-looking statements may not actually occur. All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements set forth in this prospectus. Other than as required by federal securities law, we are under no obligation to update any forward-looking statement, whether as a result of new information, future events or otherwise. You should rely only on the information contained in this prospectus. We have not authorized anyone to provide you with information different from that contained in this prospectus. We are offering to sell and seeking offers to buy shares of our common stock only in jurisdictions where offers and sales are permitted. The information contained in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or of any sale of our common stock. Use of proceeds The net proceeds to us from this offering, at an assumed initial public offering price of $9.00 per share, after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us, are estimated to be $30.2 million, or $35.2 million if the underwriters' over-allotment option is exercised in full. We expect to use the net proceeds of the offering for general corporate purposes in the following estimated amounts: + $23.0 million for product development; + $3.9 million for international operations and possible acquisitions; + $2.9 million for expansion of sales and marketing activities; and + the remainder of the proceeds for additional working capital, which includes the payment of up to $394,000 in accrued salaries owed to our President and Vice Chairman. We currently have no commitments or agreements and are not involved in any negotiations with respect to any acquisitions of companies, products or assets. However, we may engage in such acquisitions in the future. The amounts and timing of our actual expenditures will depend on numerous factors, including the status of our product development efforts, sales and marketing activities, technological advances, the amount of cash generated or used by our operations, whether or not we pursue acquisitions, and competition. We may find it necessary or advisable to use the net proceeds for other purposes, and we will have broad discretion in the application of the balance of the net proceeds. Pending the uses described above, we intend to invest the net proceeds in short-term, interest-bearing, investment grade securities. Our management team made the determination to offer our shares to the public to fund our future expansion, to compensate our employees and to attract new employees. We determined the portion of our company to be sold in this offering through a combination of estimates of our future expansion plans, evaluation of market conditions and recent offerings of comparable companies. -------------------------------------------------------------------------------- 16 -------------------------------------------------------------------------------- Dividend policy We have never declared or paid any cash dividends on our capital stock. We anticipate that we will retain any earnings to support operations and to finance the growth and development of our business. Therefore, we do not expect to pay cash dividends on our capital stock in the foreseeable future. Any future determination relating to our dividend policy will be made at the discretion of our board of directors and will depend on a number of factors, including future earnings, capital requirements, financial conditions, contractual obligations, future prospects and other factors the board of directors may deem relevant. -------------------------------------------------------------------------------- 17 -------------------------------------------------------------------------------- Capitalization Our capitalization as of September 30, 2001 is set forth in the following table on: + an actual basis; + a pro forma basis to reflect the automatic conversion of all outstanding shares of our redeemable convertible preferred stock into shares of our common stock upon the completion of this offering; and + the pro forma information on an as adjusted basis to give effect to the receipt of the estimated net proceeds from the sale of 4,000,000 shares of common stock in this offering, at an assumed initial public offering price of $9.00 per share after deducting the estimated underwriting discounts and commissions and estimating offering expenses payable by us. The table does not include: + 966,056 shares of our common stock issuable upon exercise of options outstanding as of September 30, 2001 with a weighted average exercise price of $4.93 under our 2000 Stock Incentive Plan and 18,800 shares of our common stock issuable at an exercise price of $4.79 upon exercise of options granted outside of our 2000 Stock Incentive Plan; + 774,450 shares of our common stock issuable upon exercise of warrants outstanding as of September 30, 2001 which were comprised of warrants to purchase 674,450 shares having a weighted average exercise price of $1.98 and a warrant to purchase 100,000 shares issued to Transcap Associates, Inc. at an exercise price equal to the initial public offering price; and + up to 618,637 shares of our common stock that may be issued pursuant to a third-party entertainment property license agreement with Franchise Films as of September 30, 2001. This is in addition to 68,738 shares of our common stock that were issued to Franchise Films in April 2001 for an aggregate value of $746,000 pursuant to the license agreement. You should read this table in conjunction with "Management's discussion and analysis of financial condition and results of operations" and our consolidated financial statements and the notes to those financial statements included elsewhere in this prospectus.
SEPTEMBER 30, 2001 ------------------------------------ PRO PRO FORMA ACTUAL FORMA AS ADJUSTED (In thousands, except share and per share data) -------------------------------------------------------------------------------------------------- Long-term debt.............................................. $ -- $ -- $ -- ------- ------- ------- Redeemable convertible preferred stock: $0.001 par value; 10,000,000 shares authorized; 1,516,499 shares issued and outstanding, actual; no shares issued and outstanding, pro forma and pro forma as adjusted.... 17,329 -- -- ------- ------- ------- Common stock: $0.001 par value; 100,000,000 shares authorized, 1,551,439 shares issued and outstanding, actual; 8,678,984 shares issued and outstanding, pro forma; 12,678,984 shares issued and outstanding, pro forma as adjusted........... 1 9 13 Additional paid-in-capital.................................. 6,337 23,658 53,834 Deferred stock compensation................................. (1,833) (1,833) (1,833) Accumulated deficit......................................... (8,434) (8,434) (8,434) Accumulated other comprehensive income (loss)............... 51 51 51 ------- ------- ------- Total stockholders' equity (deficit)............... (3,878) 13,451 43,631 ------- ------- ------- Total capitalization............................... $13,451 $13,451 $43,631 ======= ======= =======
-------------------------------------------------------------------------------- 18 -------------------------------------------------------------------------------- Dilution Our pro forma net tangible book value as of September 30, 2001 was approximately $1.55 per share of our common stock. Our net tangible book value per share represents the amount of our total tangible assets reduced by the amount of our total liabilities and divided by the total number of shares of our common stock outstanding, as of September 30, 2001. In making this calculation, we gave effect to the conversion of all outstanding shares of our redeemable convertible preferred stock into shares of our common stock upon the completion of this offering. After giving effect to our sale in this offering of 4,000,000 shares of our common stock at an assumed initial public offering price of $9.00 per share and after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us, our pro forma net tangible book value as of September 30, 2001 would have been $3.44 per share of our common stock. This represents an immediate increase in net tangible book value of $1.89 per share to our existing stockholders and an immediate dilution of $5.56 per share to you. The following table illustrates this per share dilution: Assumed initial public offering price per share............. $ 9.00 Pro forma net tangible book value per share before this offering................................................ $ 1.55 Increase attributable to investors in this offering....... $ 1.89 --------- Pro forma net tangible book value after the offering........ 3.44 --------- Dilution per share to investors in this offering............ $ 5.56 =========
The differences between our existing stockholders and investors with respect to the number of shares of common stock purchased from us, the total consideration paid to us and the average price per share paid for both common and preferred stock is summarized on a pro forma basis, as of September 30, 2001 before underwriting discounts and commissions and estimated offering expenses payable by us in the following table, after giving effect to the automatic conversion of all outstanding shares of our redeemable convertible preferred stock into shares of our common stock upon the completion of this offering. The following table does not include 966,056 shares of our common stock issuable upon exercise of options outstanding as of September 30, 2001 with a weighted average exercise price of $4.93 under our 2000 Stock Incentive Plan and 18,800 shares of our common stock issuable at an exercise price of $4.79 upon exercise of options granted outside of our 2000 Stock Incentive Plan; 774,450 shares of our common stock issuable upon exercise of warrants outstanding as of September 30, 2001, which were comprised of warrants to purchase 674,450 shares having a weighted average exercise price of $1.98 and a warrant to purchase 100,000 shares issued to Transcap Associates, Inc. at an exercise price equal to the initial public offering price and, up to 618,637 shares of our common stock issuable pursuant to a third-party entertainment property license agreement with Franchise Films. This is in addition to 68,738 shares of our common stock that were issued to Franchise Films in April 2001 for an aggregate value of $746,000 pursuant to the license agreement. You should read this table in conjunction with "Management's discussion and analysis of financial condition and results of operations" and our consolidated financial statements and the notes to those financial statements included elsewhere in this prospectus. See "Management -- 2000 Stock Incentive Plan" and note 6 to our consolidated financial statements.
SHARES PURCHASED TOTAL CONSIDERATION ---------------------- -------------------- AVERAGE NUMBER PERCENT AMOUNT PERCENT PRICE (In thousands) PER SHARE -------------------------------------------------------------------------------------------------------------------- Existing stockholders.................................. 8,678,984 68.5% $13,708 27.6% $ 1.58 Investors in this offering............................. 4,000,000 31.5 36,000 72.4 9.00 ----------- ------- ------- ------- --------- Total......................................... 12,678,984 100.0% $49,708 100.0% $ 3.92 =========== ======= ======= ======= =========
-------------------------------------------------------------------------------- 19 -------------------------------------------------------------------------------- Selected consolidated financial data The selected consolidated financial data set forth below should be read in conjunction with our consolidated financial statements and related notes thereto and "Management's discussion and analysis of financial condition and results of operations" included elsewhere in this prospectus. The selected consolidated financial data as of June 30, 2001 and for the period from October 7, 1999 (inception) through June 30, 2000 and for the year ended June 30, 2001 are derived from our audited consolidated financial statements included elsewhere in this prospectus. The selected consolidated financial data as of September 30, 2001 and for the three month periods ended September 30, 2000 and 2001 are derived from our unaudited consolidated financial statements included elsewhere in this prospectus. Our unaudited consolidated financial statements include all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the results of operations for these periods. The historical results are not necessarily indicative of results to be expected for any future period.
PERIOD FROM THREE MONTHS OCTOBER 7, 1999 ENDED (INCEPTION) SEPTEMBER 30, THROUGH YEAR ENDED ----------------- JUNE 30, 2000 JUNE 30, 2001 2000 2001 CONSOLIDATED STATEMENT OF OPERATIONS DATA (IN THOUSANDS, EXCEPT PER SHARE DATA) ---------------------------------------------------------------------------------------------- Net revenues................................................ $ 1,377 $ 25,351 $ 495 $10,827 ------- -------- ------ ------- Costs and expenses: Cost of revenues: Cost of goods sold...................................... 807 14,827 179 6,155 Royalties, software costs, license costs and project abandonment........................................... 248 2,898 126 1,548 ------- -------- ------ ------- Total cost of revenues............................. 1,055 17,725 305 7,703 Research and development*................................. 260 1,073 114 449 Sales and marketing*...................................... 132 4,292 252 1,375 General and administrative*............................... 711 1,996 252 729 Amortization of deferred stock compensation............... -- 618 -- 352 ------- -------- ------ ------- Total costs and expenses........................... 2,158 25,704 923 10,608 ------- -------- ------ ------- Income (loss) from operations............................... (781) (353) (428) 219 Other expense, net.......................................... (22) (1,249) (7) (708) ------- -------- ------ ------- Net loss.................................................... (803) (1,602) (435) (489) Redeemable convertible preferred stock dividend............. -- (5,540) -- -- ------- -------- ------ ------- Net loss attributable to common stockholders................ $ (803) $ (7,142) $ (435) $ (489) ======= ======== ====== ======= Net loss per share: Basic and diluted (1)..................................... $ (0.96) $ (4.82) $(0.30) $ (0.32) Pro forma net loss per share: Basic and diluted (2)..................................... $ (1.04) $ (0.06) Shares used in computation: Basic and diluted (1)..................................... 834 1,482 1,470 1,544 Pro forma basic and diluted (2)........................... 6,898 8,672 *Excludes amortization of deferred stock compensation: Research and development.................................. $ -- $ 72 $ -- $ 58 Sales and marketing....................................... -- 28 -- 25 General and administrative................................ -- 518 -- 269 ------- -------- ------ ------- $ -- $ 618 $ -- $ 352 ======= ======== ====== =======
-------------------------------------------------------------------------------- 20 SELECTED CONSOLIDATED FINANCIAL DATA --------------------------------------------------------------------------------
JUNE 30, SEPTEMBER 30, ----------------- ------------- 2000 2001 2001 CONSOLIDATED BALANCE SHEET DATA (In thousands) ------------------------------------------------------------------------------- Cash and cash equivalents................................... $ 908 $ 2,170 $ 474 Working capital............................................. 1,318 8,990 9,105 Total assets................................................ 2,712 20,992 28,672 Long-term portion of debt................................... -- -- -- Redeemable convertible preferred stock...................... 2,103 17,329 17,329 Total stockholders' equity (deficit)........................ (706) (4,669) (3,878)
(1) The diluted net loss per share computation excludes potential shares of common stock issuable upon conversion of redeemable convertible preferred stock and exercise of options to purchase common stock, as their effect would be antidilutive. See Notes 1 and 9 of notes to consolidated financial statements for a detailed explanation of the determination of the shares used in computing basic and diluted net loss per share. (2) Includes the weighted average number of shares resulting from the assumed conversion of all outstanding shares of redeemable convertible preferred stock upon the completion of this offering. See notes 1 and 9 of notes to our consolidated financial statements for a detailed explanation of the determination of the shares used in computing pro forma net loss per share. The diluted pro forma net loss per share computation excludes potential shares of common stock issuable upon exercise of options to purchase common stock as their effect would be antidilutive. -------------------------------------------------------------------------------- 21 -------------------------------------------------------------------------------- Management's discussion and analysis of financial condition and results of operations The following discussion and analysis of financial condition and results of operations should be read in conjunction with "Selected consolidated financial data" and the consolidated financial statements and related notes to those statements included elsewhere in this prospectus. This discussion and analysis may contain forward-looking statements that involve risks, uncertainties and assumptions. As a result of many factors, such as those set forth under "Risk factors" and elsewhere in this prospectus, our actual results may differ materially from those anticipated in the forward-looking statements. OVERVIEW We develop and publish interactive entertainment software. We currently publish titles for many of the most popular interactive entertainment hardware platforms, such as Sony's PlayStation, Nintendo 64 and Nintendo's Game Boy Color and Game Boy Advance, as well as for portable handheld devices manufactured by Palm and Handspring and for personal computers or PCs. We are developing and plan to publish titles for next generation hardware platforms such as Sony's PlayStation 2, NINTENDO GAMECUBE and Microsoft's Xbox, as well as for other portable handheld devices. We were incorporated in California in October 1999 under the name Bay Area Multimedia, Inc. We reincorporated in Delaware in September 2000 and changed our name to BAM! Entertainment, Inc. in December 2000. We commenced operations in October 1999 and shipped our first products in June 2000. We license properties from a wide variety of sources, and publish titles based on the motion picture, sports and television properties of our licensors. We have entered into strategic license arrangements with entertainment and media companies that have developed well-known characters and brands and that are producing popular properties that are expected to form the basis of some of our future products. Our agreements with licensors and developers generally require us to make advance royalty payments, and we may be required to spend money on advertising and promotion. We generally pay royalties based on net revenues. We design and develop our titles internally, or through third parties with whom we have established relationships. We believe that the development cycle for new titles is long, typically ranging from 12 to 24 months. After development of the initial product, we believe that it may take between six to 12 additional months to develop the product for, or port the product to, a different hardware platform. We sell our products to mass merchandisers such as Toys "R" Us, Target, Kmart, Wal-Mart and Best Buy, specialty chains such as Babbages, Etc. and Electronics Boutique and independent distributors. Our products are manufactured exclusively by third parties. We have operations in both the United States and Europe. Our international operations are conducted through our offices in England, where we have our internal product development studio, perform international sales and marketing activities and manage local third-party developers. We anticipate that international revenues will increase as we increase the number of products we ship and localize these products for international markets. NET REVENUES We derive revenues from shipment of finished products to the customer. We may allow customers to exchange and return our products within certain specified periods after shipment and from time to time provide price protection on certain unsold merchandise in the form of a credit against amounts due from the customer. Net revenues from product sales are reflected after deducting the estimated cost of allowances for returns and price protection as well as discounts given. These estimates are based upon current known circumstances and historical results. The calculation of net revenues will be affected by many factors, including pricing strategies, the channels through which our products are distributed, product maturity, exchange and return privileges and price protection. -------------------------------------------------------------------------------- 22 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -------------------------------------------------------------------------------- Net revenues are recognized when we have satisfied the following conditions: persuasive evidence of an arrangement exists, delivery has occurred, the price has been fixed or is determinable and collectibility has been reasonably assured. We expect that substantially all of our net revenues for a particular year will be generated by titles released in that year or in the latter part of the prior year. The market for interactive entertainment software is characterized by short product life cycles, changing consumer preferences and frequent introduction of new products. The life cycle of a title generally consists of a relatively high level of sales during the first few months after introduction, followed by a decline in sales, with only a small percentage of sales occurring more than six months after release. We have experienced, and are likely to continue to experience, quarterly fluctuations in net revenues. The interactive entertainment industry is highly seasonal, with net revenues typically significantly higher during the fourth and first calendar quarters, due primarily to the increased demand for titles during the year-end holiday buying season. Our failure or inability to introduce products on a timely basis to meet seasonal increases in demand will harm our business and operating results. While we are attempting to reduce the effect of seasonal patterns on our business by distributing our product release dates more evenly throughout the year, we may not be successful in this endeavor. COST OF REVENUES Cost of revenues consists of cost of goods sold and royalties, software costs, license costs and project abandonment. Cost of goods sold. Cost of goods sold includes manufacturing costs of finished goods, freight, inventory management costs and inventory obsolescence costs. Cost of goods sold will vary depending on the volume of products manufactured and shipped, the mix of products sold and the shipping channel used. Royalties, software costs, license costs and project abandonment. Royalties, software costs, license costs and project abandonment includes royalties paid to software licensors, software amortization and amortization of non-cash charges related to warrants and rights to acquire our common stock issued to certain production companies. These costs will be affected in particular periods by many factors, including the specific terms or agreements under which royalties are paid to third parties, the commercial acceptance of products, the cost of developing a product and the timing of stock and warrants issued pursuant to the terms of our license agreements as described below. Our agreements with licensors and developers generally require us to make advance royalty payments and pay royalties based on product sales, which may have guaranteed minimum payments. Prepaid royalties are amortized commencing upon the product release at the greater of the contractual royalty rate based on actual product sales, or the ratio of current revenues to total projected revenues. We evaluate the future recoverability of prepaid royalties on a quarterly basis and expense costs if and when they are deemed unrecoverable. We cannot assure you that the sales of products for which these royalties are paid or guaranteed payments are made will be sufficient to cover the amount of these required payments. Commencing upon product release, we amortize capitalized software development costs. We capitalize software development costs subsequent to establishing technological feasibility of a title. Technological feasibility is evaluated on a product-by-product basis. For products where proven game engine technology exists, this may be early in the development cycle. Prior to establishing technological feasibility, software development costs are expensed to research and development, and to cost of revenues subsequent to establishing technological feasibility. The following criteria is used to evaluate recoverability of software development costs: historical performance of comparable products; the commercial acceptance of prior products released on a given hardware platform; orders for a product prior to its release and actual development costs of a product as compared to forward-looking projections. Amortization of software development costs is based on the greater of the proportion of current revenues to total projected revenues or the straight-line method over the estimated product life, generally three to six months. We analyze all of our capitalized costs quarterly and we take write-offs when, based on our estimates, future individual product revenues will not be sufficient to recover our investment. -------------------------------------------------------------------------------- 23 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -------------------------------------------------------------------------------- Pursuant to a license agreement with Franchise Films, we are obligated to issue 68,738 shares of our common stock after the release of any film for which we elect to produce interactive entertainment software products, up to 10 films or 687,375 shares of common stock. To date, we have elected to produce titles for three films and have issued 68,738 shares under this agreement for an aggregate value of $746,000. We are required to issue these shares when the films are released and will then incur a non-cash charge. If the software product is released after the release of the film, we will amortize the non-cash charge over the life of the product, which is typically between three and six months. If the software product is released prior to the release of the film, we will at each interim period assess whether it is probable that the value of the shares issued is recoverable through future sales of the product to which it relates. If this is probable, the non-cash charge will be amortized to licensed costs over the life of the product. In the alternative, we will expense the non-cash charge at the time of the issuance of the shares if it is not probable that the value of the shares issued is recoverable through future sales of the product to which these shares relate. We cannot estimate the aggregate dollar amount of these future non-cash charges as they are based on our share price at a future point in time, but they may be substantial. The non-cash charges on the initial shares issued is expected to be incurred in the second and third quarters of fiscal 2002. In addition, in connection with the issuance of warrants pursuant to a license agreement with Spyglass Entertainment, we incurred a non-cash charge of $354,000, which will be amortized on a straight-line basis over five years. This amortization commenced in October 2000. In connection with these warrants, a further non-cash charge of $556,000 will be amortized over a period which is expected to be between three to six months, commencing on the release of the subject titles, expected to be the first or second fiscal quarter of 2003. In addition, pursuant to an August 2001 amendment to our master purchase order assignment agreement with an affiliate of Transcap Associates, Inc. and the execution of a $7.0 million factoring arrangement with an affiliate of Transcap, we issued Transcap a warrant to purchase 100,000 shares of our common stock at an exercise price equal to the initial public offering price. In connection with this issuance, we incurred a non-cash charge of $806,000. This charge is subject to remeasurement up to the date of this offering and is being amortized on a straight-line basis through March 2002, which is the remaining term of the agreement. Each of these charges will affect our gross margins and profitability. RESEARCH AND DEVELOPMENT Research and development expenses relate to the design and development of new interactive entertainment software products. These expenses generally consist of salaries, related expenses for engineering personnel and third-party development costs. We will continue to develop our products both internally and through third parties. In absolute dollars we expect to see increases in research and development expense as we expand our product offerings. SALES AND MARKETING Sales and marketing expenses consist primarily of salaries and related expenses for our direct sales force and marketing personnel, commissions to independent sales staff, marketing programs and advertising campaigns. In absolute dollars, we expect to see a significant increase in sales and marketing expense as revenues increase and we expand our product offerings and international presence. GENERAL AND ADMINISTRATIVE General and administrative expenses consist primarily of salaries and related expenses for finance and other administrative personnel, facilities and occupancy charges, professional fees and bad debt expense. We expect our general and administrative expenses to increase in absolute dollars as we expand our staff, build our infrastructure, grow our business and incur costs associated with being a public company. As a percentage of revenue, we expect to see a reduction in general and administrative expenses as our revenues increase. AMORTIZATION OF DEFERRED STOCK COMPENSATION Amortization of deferred stock compensation consists of deferred compensation expenses relating to stock option grants to employees. Deferred compensation represents the difference between the deemed fair market value of our common stock at the grant date and the exercise price of the related stock options. Deferred compensation is represented as a reduction of stockholders' equity and amortized, using a multiple option award valuation and -------------------------------------------------------------------------------- 24 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -------------------------------------------------------------------------------- amortization approach, over the vesting periods of the options, which is generally four years. We currently expect to amortize $1.3 million during fiscal 2002, $553,000 during fiscal 2003, $256,000 during fiscal 2004 and $61,000 during fiscal 2005. OTHER EXPENSE, NET Other expense, net consist mostly of interest expense net of interest income. We expect to be able to negotiate more favorable credit terms after this offering and therefore expect to see a net improvement in other expense, net in the future. REDEEMABLE CONVERTIBLE PREFERRED STOCK DIVIDEND Beneficial conversion charges arise in connection with financing arrangements where we have issued convertible redeemable preferred stock on which we have determined that there is a beneficial conversion feature, as they are convertible into shares of our common stock at a discount to the deemed fair market value of the common stock at the commitment date, which is generally the date of issuance. Depending on the nature and purpose of the arrangement, we value the beneficial conversion feature by subtracting the related effective conversion price from the deemed fair value of our common stock, and then multiplying the difference by the number of shares of common stock that would be issued upon conversion. The value of the beneficial conversion feature is limited to the relative fair value of the convertible instrument. We record as a deduction of stockholders' equity the value of the beneficial conversion feature and accretes this value over the expected period that the redeemable convertible preferred stock becomes convertible. In May 2001, we issued 245,659 shares of our Series C Preferred Stock for approximately $5.5 million. These shares are convertible into 1,154,597 shares of our common stock. Under the terms of our Series C Preferred Stock agreement, the redemption feature will terminate and the shares will convert into our common stock upon completion of this offering. In the quarter ended June 30, 2001, we recorded a non-cash charge of approximately $5.5 million relating to the beneficial conversion feature of these securities. This represents the difference between the aggregate deemed fair value of the common stock into which the Series C Preferred Stock is convertible of $13.2 million, and the aggregate purchase price paid for issued shares of Series C Preferred Stock of $5.5 million, or $7.7 million, limited to the gross purchase price paid for Series C Preferred Stock of $5.5 million in accordance with paragraph 6 of EITF 98-5 Accounting for Convertible Securities with Beneficial Conversion Features or Contingency Adjustable Conversion Ratios. -------------------------------------------------------------------------------- 25 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -------------------------------------------------------------------------------- RESULTS OF OPERATIONS The following table sets forth as a percentage of net revenues our consolidated statements of operations data for the periods indicated. The consolidated financial information for the year ended June 30, 2001 and for the period from October 7, 1999 (inception) through June 30, 2000 is derived from our audited consolidated financial statements. The consolidated financial information for the three month periods ended September 30, 2000 and 2001 is derived from our unaudited consolidated financial statements. Results for any interim period are not necessarily indicative of future operating results.
THREE MONTHS INCEPTION YEAR ENDED THROUGH ENDED SEPTEMBER 30, JUNE 30, JUNE 30, ------------- 2000 2001 2000 ------------------------------------------------------------------------------------------------ 2001 Net revenues................................................ 100.0% 100.0% 100% 100% ----- ----- ----- ---- Cost and expenses: Cost of revenues: Cost of goods sold...................................... 58.6 58.5 36.2 56.8 Royalties, software costs, license costs and project abandonment........................................... 18.0 11.4 25.5 14.3 ----- ----- ----- ---- Total cost of revenues............................. 76.6 69.9 61.7 71.1 Research and development (1).............................. 18.9 4.2 23.0 4.2 Sales and marketing (1)................................... 9.6 16.9 50.9 12.7 General and administrative (1)............................ 51.6 7.9 50.9 6.7 Amortization of deferred stock compensation............... -- 2.4 -- 3.3 ----- ----- ----- ---- Total costs and expenses........................... 156.7 101.3 186.5 98.0 ----- ----- ----- ---- Income (loss) from operations............................... (56.7) (1.4) (86.5) 2.0 Other expense, net.......................................... (1.6) (4.9) (1.4) (6.5) ----- ----- ----- ---- Net loss.................................................... (58.3) (6.3) (87.9) (4.5) Redeemable convertible preferred stock dividend............. -- (21.9) -- -- ----- ----- ----- ---- Net loss attributable to common stockholders................ (58.3)% (28.2)% (87.9)% (4.5)% ===== ===== ===== ====
(1) Excludes amortization of deferred stock compensation. THREE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED TO THREE MONTHS ENDED SEPTEMBER 30, 2000 NET REVENUES Net revenues were $10.8 million for the three months ended September 30, 2001 compared to $495,000 for the comparable period in 2000. This increase was primarily attributable to the fact that we released five new products during the three months ended September 30, 2001 compared to one new product in the comparable period of 2000. Our four largest customers collectively accounted for 59% of our net revenues for the three months ended September 30, 2001, compared to 75% for the comparable period in 2000. For the three months ended September 30, 2001, Toys "R" Us accounted for 19% of our net revenues, Kmart accounted for 19% of our net revenues, Ingram accounted for 11% of our net revenues and Electronics Boutique accounted for 10% of our net revenues. For the three months ended September 30, 2000, Toys "R" Us accounted for 27% of our net revenues, Babbages, Etc. accounted for 23% of our net revenues, Electronics Boutique accounted for 15% of our net revenues and KB Toys accounted for 10% of our net revenues. To date, a substantial portion of our revenues has been derived from sales of a limited number of products. Sales of our three DEXTER'S LABORATORY titles accounted for 36% of our net revenues for the three months ended September 30, 2001. Sales of our CONTENDER 2 title accounted for 64% of our net revenues for the comparable period in 2000. As we expand our product offerings in different periods, we expect that the percentage of total revenue from our largest product offerings will decrease. -------------------------------------------------------------------------------- 26 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -------------------------------------------------------------------------------- COST OF REVENUES Cost of goods sold was $6.2 million, or 57% of net revenues, for the three months ended September 30, 2001 as compared to $179,000, or 36% of net revenues, for the comparable period in 2000. The increase in absolute dollars was due to increased sales of product. The increase in cost of goods sold as a percentage of revenues was due primarily to a change in product mix and higher freight and distribution costs as a result of changed shipping channels. Financing costs associated with inventory acquisitions under financing arrangements are recorded as period costs and as such are classified as interest expense. The amount of interest expense associated with such financing arrangements and included in other expenses was $712,000 for the three months ended September 30, 2001. Royalties, software costs, license costs and project abandonment were $1.5 million, or 14% of net revenues, for the three months ended September 30, 2001 and $126,000, or 26% of net revenues, for the comparable period in 2000. The increase in absolute dollars was due to increased sales of products. The improvement in these costs as a percentage of revenues was due to a change in product mix. RESEARCH AND DEVELOPMENT Research and development expenses were $449,000, or 4% of net revenues, for the three months ended September 30, 2001, compared to $114,000, or 23% of net revenues, for the comparable period in 2000. The increase in absolute dollars was primarily because of the hiring of additional employees and expenses incurred at our internal development studio in London, England which opened in October 2000. SALES AND MARKETING Sales and marketing expenses were $1.4 million, or 13% of net revenues, for the three months ended September 30, 2001, compared to $252,000, or 51% of net revenues, for the comparable period in 2000. The increase in absolute dollars was primarily because of increased advertising and marketing activities on an increased number of product releases, along with increased sales commissions. GENERAL AND ADMINISTRATIVE General and administrative expenses were $729,000, or 7% of net revenues, for the three months ended September 30, 2001, compared to $252,000, or 51% of net revenues, for the comparable period in 2000. The increase in absolute dollars was primarily due to the hiring of additional personnel and increased professional fees and facilities costs. AMORTIZATION OF DEFERRED STOCK COMPENSATION Amortization of deferred stock compensation was $352,000, or 3% of net revenues, for the three months ended September 30, 2001, compared to zero for the comparable period in 2000. Amortization of deferred stock compensation resulted from using the accelerated amortization method to account for compensatory stock options granted to employees and directors primarily during the quarters ended June 30, 2001 and September 30, 2001. OTHER EXPENSE, NET Other expense, net was $708,000, or 7% of net revenues, for the three months ended September 30, 2001, compared to $7,000, or 1% of net revenues, for the comparable period in 2000. Interest income was $5,000 for the three months ended September 30, 2001, compared to $3,000 for the comparable period in 2000. Income interest in each period relates to interest earned on funds deposited in money market accounts. Interest expense was $712,000, or 7% of net revenues, for the three months ended September 30, 2001, compared to $10,000, or 2% of net revenues, for the comparable period in 2000. Interest expense arises through a purchase order funding arrangement with a finance company pursuant to which we are required to pay interest expense based on amounts advanced thereunder. A portion of the fees are dependent on the time it takes us to collect a portion of our -------------------------------------------------------------------------------- 27 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -------------------------------------------------------------------------------- accounts receivable. The increase in interest expense arose due to increased amounts advanced by the finance company due to the need to fund inventory required for increased sales during the three month period ended September 30, 2001. Other expense was $1,000 for the three months ended September 30, 2001, compared to zero for the comparable period in 2000. Other expense was comprised of exchange losses. YEAR ENDED JUNE 30, 2001 COMPARED TO THE PERIOD FROM OCTOBER 7, 1999 (INCEPTION) THROUGH JUNE 30, 2000 NET REVENUES Net revenues were $25.4 million for the year ended June 30, 2001 and $1.4 million for the period from our inception through June 30, 2000. Net revenues arose primarily from sales of new products released during those periods. Our three largest customers collectively accounted for 43% of net revenues for the year ended June 30, 2001 as compared to 75% the period from inception through June 30, 2000. Our three largest customers for the year ended June 30, 2001 were Toys "R" Us, which accounted for 17% of net revenues, Wal-Mart, which accounted for 14% of net revenues and Target, which accounted for 12% of net revenues. For the period from inception through June 30, 2000, Blockbuster accounted for 49% of net revenues, Wal-Mart accounted for 16% of net revenues and KB Toys accounted for 10% of net revenues. Sales of our three POWERPUFF GIRLS titles accounted for 66% of net revenues for the year ended June 30, 2001. Sales of our BEAST WARS title accounted for 100% of net revenues for the period from inception through June 30, 2000. COST OF REVENUES Cost of goods sold were $14.8 million, or 58% of net revenues, for the year ended June 30, 2001 and $807,000, or 59% of net revenues, for the period from our inception through June 30, 2000. Financing costs associated with inventory acquisitions under financing arrangements are recorded as period costs and as such are classified as interest expense. The amount of interest expense associated with such financing arrangements and included in other expense was $1.3 million for the year ended June 30, 2001. The increase in cost of goods sold was due to increased sales of product, and the improvement in cost of goods sold as a percentage of revenues was due primarily to a change in product mix, resulting in a higher percentage of sales of products which have lower contracted third-party royalty rates, offset by higher freight costs as a result of changed shipping channels. Royalties, software costs, license costs and project abandonment were $2.9 million, or 11% of net revenues, for the year ended June 30, 2001 and $248,000, or 18% of net revenues, for the period from our inception through June 30, 2000. The increase in costs was due to increased sales of product, and the improvement in costs as a percentage of revenues arose because of a change in product mix. RESEARCH AND DEVELOPMENT Research and development expenses were $1.1 million, or 4% of net revenues, for the year ended June 30, 2001 and $260,000, or 19% of net revenues, for the period from our inception through June 30, 2000. The increase was primarily the result of an increased headcount. In October 2000 we opened our internal development studio in London, England. Prior to opening this studio, all development was performed by third parties. SALES AND MARKETING Sales and marketing expenses were $4.3 million, or 17% of net revenues, for the year ended June 30, 2001 and $132,000, or 10% of net revenues, for the period from our inception through June 30, 2000. The increase was the result of increased advertising and marketing activities, along with an increase in commissions. -------------------------------------------------------------------------------- 28 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -------------------------------------------------------------------------------- GENERAL AND ADMINISTRATIVE General and administrative expenses were $2.0 million, or 8% of net revenues, for the year ended June 30, 2001 and $711,000, or 52% of net revenues, for the period from our inception through June 30, 2000. The increase was attributable to growth in headcount, professional fees, facility costs, bad debt expense and accounting fees. AMORTIZATION OF DEFERRED STOCK COMPENSATION Amortization of deferred stock compensation was $618,000, or 2% of revenues, for the year ended June 30, 2001 and zero for the period from our inception through June 30, 2000. Amortization of deferred stock compensation increased significantly in the quarter ended June 30, 2001 as a result of granting an increased number of stock options to employees and directors in the quarter and a subsequent revaluation of compensation expense related to such options granted. We did not grant any stock options prior to June 2000. OTHER EXPENSE, NET Other expense, net was $1.2 million for the year ended June 30, 2001 and $22,000 for the period from inception through June 30, 2000. Interest income was $58,000 for the year ended June 30, 2001 and $8,000 for the period from our inception through June 30, 2000. Interest income in each period relates to interest earned on funds deposited in money market accounts. Interest expense was $1.3 million, or 5% of net revenues, for the year ended June 30, 2001 and $39,000, or 3% of net revenues, for the period from our inception through June 30, 2000. Interest expense incurred during the period ended June 30, 2000 is comprised of interest incurred on promissory notes and through a purchase order funding arrangement with a finance company. The promissory notes were converted to redeemable convertible preferred stock in June 2000. Subsequent to this conversion, interest expense comprised primarily interest incurred through a purchase order funding arrangement with a finance company and through a commercial line of credit. The increase in interest expense for the year ended June 30, 2001 was due to increased amounts advanced by the finance company due to the need to fund inventory required for increased sales during the year. We had other income of $18,000 for the year ended June 30, 2001 and other income of $9,000 for the period from our inception through June 30, 2000. Other income for the year ended June 30, 2001 comprised exchange gains and for the period from inception to June 30, 2000 comprised rental income. REDEEMABLE CONVERTIBLE PREFERRED STOCK DIVIDEND In the quarter ended June 30, 2001, we recorded a non-cash charge of approximately $5.5 million relating to the beneficial conversion feature of shares of our Series C Preferred Stock issued in May 2001. -------------------------------------------------------------------------------- 29 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -------------------------------------------------------------------------------- QUARTERLY RESULTS OF OPERATIONS The following table presents our unaudited quarterly consolidated results of operations, in dollars and as a percentage of net revenues, for our seven most recent fiscal quarters and the period from our inception through December 31, 1999. In the opinion of management, this unaudited financial information has been prepared on the same basis as the audited financial information, and includes all adjustments, consisting only of normal recurring adjustments, necessary to present this information fairly when read in conjunction with our consolidated financial statements and the related notes contained elsewhere in this prospectus. These operating results are not necessarily indicative of results to be expected for any future period.
INCEPTION THREE MONTHS ENDED THROUGH ---------------------------------------------------------------------------- DEC. 31, MAR. 31, JUN. 30, DEC. 31, MAR. 31, JUN. 30, SEPT. 30, 1999 2000 2000 SEPT. 30, 2000 2001 2001 2001 CONSOLIDATED STATEMENT OF 2000 OPERATIONS DATA: (In thousands) ---------------------------------------------------------------------------------------------------------------------------- Net revenues...................... $ -- $ -- $1,377 $ 495 $10,717 $6,093 $ 8,046 1$0,827 ----- ----- ------ ----- ------- ------ ------- ----- Costs and expenses: Cost of revenues: Cost of goods sold............ -- -- 807 179 6,029 3,558 5,061 6,155 Royalties, software costs, license costs and project abandonment................. -- -- 248 126 1,113 789 870 1,548 ----- ----- ------ ----- ------- ------ ------- ----- Total cost of revenues... -- -- 1,055 305 7,142 4,347 5,931 7,703 Research and development (1).... 32 101 127 114 318 231 410 449 Sales and marketing (1)......... -- -- 132 252 1,844 1,138 1,058 1,375 General and administrative (1)............ 130 249 332 252 360 606 778 729 Amortization of deferred stock compensation.................. -- -- -- -- 9 10 599 352 ----- ----- ------ ----- ------- ------ ------- ----- Total costs and expenses............... 162 350 1,646 923 9,673 6,332 8,776 10,608 ----- ----- ------ ----- ------- ------ ------- ----- Income (loss) from operations..... (162) (350) (269) (428) 1,044 (239) (730) 219 Other expense, net................ (3) (2) (17) (7) (454) (491) (297) (708) ----- ----- ------ ----- ------- ------ ------- ----- Net income (loss)................. (165) (352) (286) (435) 590 (730) (1,027) (489) Redeemable convertible preferred stock dividend.................. -- -- -- -- -- -- (5,540) -- ----- ----- ------ ----- ------- ------ ------- ----- Net income (loss) attributable to common stockholders............. $(165) $(352) $ (286) $(435) $ 590 $ (730) $(6,567) $(489) ===== ===== ====== ===== ======= ====== ======= =====
(1) Excludes amortization of deferred stock compensation. -------------------------------------------------------------------------------- 30 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS --------------------------------------------------------------------------------
THREE MONTHS ENDED ----------------------------------------------------------------------------- JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30, AS A PERCENTAGE OF NET REVENUES (1) 2000 2000 2000 2001 2001 2001 ------------------------------------------------------------------------------------------------------------------------ Net revenues............................. 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% --------- ----------- --------- -------- --------- ----------- Costs and expenses: Cost of revenues: Cost of goods sold................... 58.6 36.2 56.3 58.4 62.9 56.8 Royalties, software costs, license costs and project abandonment...... 18.0 25.5 10.4 12.9 10.8 14.3 --------- ----------- --------- -------- --------- ----------- Total cost of revenues.......... 76.6 61.7 66.7 71.3 73.7 71.1 Research and development............... 9.2 23.0 3.0 3.8 5.1 4.2 Sales and marketing.................... 9.6 50.9 17.2 18.7 13.1 12.7 General and administrative............. 24.1 50.9 3.3 9.9 9.7 6.7 Amortization of deferred stock compensation......................... -- -- 0.1 0.2 7.4 3.3 --------- ----------- --------- -------- --------- ----------- Total costs and expenses........ 119.5 186.5 90.3 103.9 109.0 98.0 --------- ----------- --------- -------- --------- ----------- Income (loss) from operations............ (19.5) (86.5) 9.7 (3.9) (9.0) 2.0 Other expense, net....................... (1.2) (1.4) (4.2) (8.1) (3.7) (6.5) --------- ----------- --------- -------- --------- ----------- Net income (loss)........................ (20.7) (87.9) 5.5 (12.0) (12.7) (4.5) Redeemable convertible preferred stock dividend............................... -- -- -- -- (68.9) -- --------- ----------- --------- -------- --------- ----------- Net income (loss) attributable to common stockholders........................... (20.7)% (87.9)% 5.5% (12.0)% (81.6)% (4.5)% ========= =========== ========= ======== ========= ===========
(1) As we had no revenues for the period from inception through December 31, 1999 and for the three months ended March 31, 2000, these periods are not presented. NET REVENUES We sold our first product, BEAST WARS, in the quarter ended June 30, 2000. Our second product offering was not released until late in the quarter ended September 30, 2000 and this, combined with low seasonal demand, reduced quarterly net revenues for the quarter ended September 30, 2000. In the quarter ended December 31, 2000 we introduced six additional products, including two POWERPUFF GIRLS offerings which, in combination with holiday seasonal demand, resulted in significantly increased net revenues during the quarter. As expected, demand for product decreased in the quarter ended March 31, 2001, the quarter after the holiday season, resulting in reduced net revenues in the quarter. In the quarter ended June 30, 2001, we released three new products, and in the quarter ended September 30, 2001 we released five new titles, including our first two SPORTS ILLUSTRATED FOR KIDS titles. RESEARCH AND DEVELOPMENT Prior to the quarter ended December 31, 2000, we developed products solely through third parties. In the quarter ended December 31, 2000, we opened our internal development studio, resulting in an increase in research and development costs. In the quarter ended December 31, 2000, we incurred an expense of $125,000 relating to a performance bonus paid to a third-party developer. This expense was not repeated in the quarter ended March 31, 2001. Research and development expenses increased in the quarter ended June 30, 2001 and again in the quarter ended September 30, 2001 as a result of increased headcount and outside service costs. SALES AND MARKETING Sales commissions and marketing expenses grew significantly in the quarter ended December 31, 2000 as we actively promoted our products during the holiday season. Promotion decreased in the first and second calendar quarters of 2001 coinciding with reduced seasonal demand and sales and marketing expenses decreased accordingly. Sales and -------------------------------------------------------------------------------- 31 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -------------------------------------------------------------------------------- marketing expenses rose in the quarter ended September 30, 2001 due to the release of an increased number of new titles and incurred promotions ahead of the holiday season. GENERAL AND ADMINISTRATIVE Special professional and legal expenses were the cause of the increase in general and administrative costs in the quarter ended June 30, 2000. We do not expect to incur these costs again in the future. A portion of these expenses were accounting fees incurred in anticipation of our first year-end audit which was performed during this quarter. Additionally, we paid $81,000 to consultants who assisted us with an evaluation of financing possibilities that we ultimately did not pursue. With the exception of these special expenses, general and administrative expenses increased gradually over each quarter through the quarter ended June 30, 2001 as we expanded our infrastructure. General and administrative expenses decreased in the quarter ended September 30, 2001 compared to the quarter ended June 30, 2001 primarily due to reduced travel expenses. AMORTIZATION OF DEFERRED STOCK COMPENSATION Amortization of deferred stock compensation commenced in the quarter ended June 30, 2001 as a result of granting an increased number of stock options to employees and directors in the quarter including options that vested fully on grant and a subsequent revaluation of compensation expense related to such options granted. Amortization of deferred stock compensation decreased in the quarter ended September 30, 2001 compared to the quarter ended June 30, 2001 primarily as a result of the application of the multiple option award valuation and amortization approach. OTHER EXPENSE, NET Significant purchase order funding charges were the cause of the significant expense increase in other expense, net in the quarters ended December 31, 2000, March 31, 2001 and September 30, 2001. REDEEMABLE CONVERTIBLE PREFERRED STOCK DIVIDEND In the quarter ended June 30, 2001, we recorded a non-cash charge of approximately $5.5 million relating to the beneficial conversion feature of shares of our Series C Preferred Stock issued in May 2001. LIQUIDITY AND CAPITAL RESOURCES From inception we have financed our operations primarily through the private sale of equity securities, cash generated from the sale of our products, a product financing arrangement with a finance company, the issuance of promissory notes to stockholders, a commercial line of credit and short-term liabilities. Net cash used in operating activities was $2.7 million for the three months ended September 30, 2001, $10.3 million for the year ended June 30, 2001 and $1.7 million for the period from our inception through June 30, 2000. For these periods, net cash used in operating activities was the result of net losses and increases in operating assets. Net cash used in investing activities was $893,000 for the three months ended September 30, 2001, $2.2 million for the year ended June 30, 2001 and $91,000 for the period from our inception through June 30, 2000. Net cash used in investing activities during the three months ended September 30, 2001 and year ended June 30, 2001 consisted primarily of issuance costs in connection with this offering and purchases of property and equipment. Net cash used in investing activities during the period from our inception through June 30, 2000 consisted of the purchase of property and equipment. Net cash provided by financing activities was $1.9 million for the three months ended September 30, 2001, $13.7 million for the year ended June 30, 2001 and $2.7 million for the period from our inception through June 30, 2000. Financing for the three months ended September 30, 2001 consisted primarily of net borrowings under a finance agreement with a finance company, but also included the sale of common stock upon exercise of stock options. Financing for the year ended June 30, 2001 consisted primarily of the sale of redeemable convertible -------------------------------------------------------------------------------- 32 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -------------------------------------------------------------------------------- preferred stock, net borrowings on finance agreements and a line of credit with our bankers. Financing for the period from our inception through June 30, 2000, consisted primarily of the sale of common stock, redeemable convertible preferred stock, promissory notes and net borrowings on finance agreements. In October 1999, we issued 580,962 shares of common stock to our principal stockholder at a price of $0.001 per share. Also, in October 1999, we issued 274,950 shares of common stock at $0.11 per share to consultants in exchange for services performed valued at approximately $30,000. In each of November 1999 and January 2000, we issued our principal stockholder convertible promissory notes in the principal amount of $500,000, and in May 2000 issued him an additional convertible promissory note in the principal amount of $47,000 for operating capital. Each note bore interest at 7% per annum with principal and accrued interest due on demand after one year from the date of issuance. Each note was automatically convertible into shares of our Series A Preferred Stock upon the initial closing of our Series A Preferred Stock financing. In June 2000, the notes were converted and our principal stockholder was issued 482,625 shares of our Series A Preferred Stock for $1.0 million; these shares are convertible into 2,268,338 shares of our common stock. In June 2000, inclusive of shares issued to our principal stockholder upon the conversion, we sold and issued 976,220 shares of our Series A Preferred Stock for $2.1 million; these shares are convertible into 4,588,234 shares of our common stock. In addition, at the same time we issued the Series A Preferred Stock, we issued 614,060 shares of our common stock at $0.11 per share for $59,000 in cash and for services valued at $7,000. In December 2000, we sold and issued 294,620 shares of our Series B Preferred Stock for $5.2 million; these shares are convertible into 1,384,714 shares of our common stock. In May 2001, we sold and issued 245,659 shares of our Series C Preferred Stock for $5.5 million; these shares are convertible into 1,154,597 shares of our common stock. In February 2000, we entered into a master purchase order assignment agreement with Transcap Associates, Inc., whereby we assign customer purchase orders to Transcap and request that Transcap purchase finished goods to fulfill such customer purchase orders. Our obligations under the agreement are secured by our assets and purchase order accounts receivable, and guaranteed by our President and Chief Executive Officer. Under the agreement, we assign purchase orders to Transcap as collateral. The agreement required a security deposit of $90,000 to be made by us to Transcap and specified that Transcap's funding commitment with respect to a purchase order shall not exceed 60% of the retail purchase order price. We are required to pay Transcap's expenses under the contract, a deal fee comprising a transaction and initiation fee equal to 5% of the face amounts of letters of credits issued or other funds advanced by the finance company, a daily maintenance fee of 0.067%, a materials advance fee at prime rate plus 4%, and a late payment fee where applicable. Outstanding borrowings under the agreement are collateralized by our inventory, accounts receivable, fixed assets and intangible assets. Under the initial terms of the agreement, Transcap's aggregate outstanding funding was limited to $1.0 million and the term of the agreement was 12 months, ending on February 25, 2001. In September 2000, the agreement was amended increasing the maximum outstanding funding to $5.0 million. In December 2000, the agreement was further amended extending the term to March 31, 2002. In August 2001, the agreement was amended again to increase the maximum outstanding funding to $10 million. As of September 30, 2001, the aggregate amount outstanding under this agreement was $6.1 million. In August 2001, the agreement was further amended, decreasing the initiation fee to 3% until the earlier of the termination of the agreement or December 31, 2001 if this offering has not occurred by that date. At such time, we also entered into a $7.0 million factoring arrangement with an affiliate of Transcap pursuant to which we are entitled to sell to the factor eligible accounts receivable. During the period of time that the account receivable remains unpaid, we are obligated to pay the factor interest on the unpaid amount at the prime rate plus 4%, plus a daily maintenance fee of 0.067%. If an eligible account purchased by the factor is not paid in full within the earlier of 75 days after the date of purchase by the factor or 15 days following the invoice due date, we are required to repurchase the eligible account. The repurchase price is equal to the unpaid invoice amount plus interest at the prime rate plus 4% for the period from the date of purchase by the factor to date of repurchase by us, plus a daily maintenance fee of 0.067%. All amounts due under the factoring arrangement are guaranteed by our President and Chief Executive Officer. In connection with these August transactions we issued Transcap a warrant to purchase 100,000 shares of our common stock at an exercise price equal to the initial public offering price. There were no amounts outstanding under the factoring arrangement as of September 30, 2001. -------------------------------------------------------------------------------- 33 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -------------------------------------------------------------------------------- In November 2000, we entered into an agreement with our bankers whereby they would provide us with a $1.0 million commercial line of credit, repayable on demand. The interest rate on amounts drawn down was at the bank's prime interest rate plus 3% and was payable monthly. The line of credit was secured by restricted cash being held in a money market account with the same bank. In May 2001, all sums borrowed were repaid and the line of credit was terminated. As of September 30, 2001 we had cash and cash equivalents of $474,000. As of June 30, 2001, we had cash and cash equivalents of $2.2 million. As of June 30, 2000, we had cash and cash equivalents of $908,000. Capital expenditures were $324,000 for the three months ended September 30, 2001, $421,000 for the year ended June 30, 2001, and $91,000 for the period from our inception through June 30, 2000. We did not have any material commitments for capital expenditures at any of those dates. Our principal commitments at September 30, 2001 were comprised of operating leases, guaranteed royalty payments and contractual marketing commitments. At September 30, 2001, we had commitments to spend $778,000 under operating leases, prepay $1.1 million for royalties under agreements with various content providers and spend $4.1 million in advertising on the networks and websites of these content providers. Of these amounts, $2.8 million must be paid no later than September 30, 2002. Guaranteed royalty payments will be applied against any royalties that may become payable to the content providers. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK We are exposed to various market risks, including changes in foreign exchange rates and interest rates. Market risk is the potential loss arising from changes in market rates and prices. FOREIGN CURRENCY EXCHANGE RATE RISK Currently, 90% of our net revenues and 85% of our operating expenses are denominated in U.S. dollars. Remaining expenses are mostly denominated in British pounds or the Euro and consequently we are currently exposed to fluctuations in the U.S. dollar to British pound and Euro exchange rates. We estimate that a 10% change in foreign exchange rates would impact reported operating results by less than $250,000. Accordingly, we have not entered into any hedging arrangements. As we expand our international operations, revenues will be generated and more operating expenses will be incurred in currencies other than the US dollar, which will increase potential exchange rate risk. We anticipate we will enter into customary hedging arrangements to reduce this risk. INTEREST RATE RISK We do not consider our cash and cash equivalents to be subject to interest rate risk due to the short maturities of the instruments in which we have invested. We are currently exposed to interest rate risk on our product financing arrangement with a finance company. We do not enter into derivatives or other financial instruments for trading or speculative purposes. We estimate that a 10% increase in interest rates would impact our results of operations by $70,000 for the three month period ended September 30, 2001, $130,000 for the year ended June 30, 2001 and $2,000 for the period from inception through June 30, 2000. INFLATION Inflation has not had a material adverse effect on our results of operations; however, our results of operations may be materially and adversely affected by inflation in the future. RECENT ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard No. 133 ("SFAS No. 133"), "Accounting for Derivative Instruments and Hedging Activities." This statement requires companies to record derivatives on the balance sheet as assets and liabilities, measured at fair value. Gains -------------------------------------------------------------------------------- 34 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -------------------------------------------------------------------------------- and losses resulting from changes in the values of those derivatives would be accounted for depending on the use of the derivative and whether it qualifies for hedge accounting. SFAS No. 133 was effective for us beginning in the first quarter of fiscal 2001 and did not have a significant impact on our consolidated financial statements. In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial Statements." SAB 101 summarizes certain of the staff's views in applying generally accepted accounting principles in the United States to revenue recognition in financial statements and provides interpretations regarding the application of generally accepted accounting principles to revenue recognition where there is an absence of authoritative literature addressing a specific arrangement or a specific industry. SAB 101 was effective for our company in the fourth quarter of fiscal 2001. The adoption of the revenue recognition practices prescribed by the guidance in SAB 101 did not have a material effect on our consolidated financial statements. In March 2000, the FASB issued Financial Accounting Standards Board Interpretation No. 44, Accounting for Certain Transactions Involving Stock Compensation ("FIN 44"), an interpretation of Accounting Principles Board Opinion No. 25 ("APB No. 25"). FIN 44 clarifies the application of APB No. 25 for various issues, specifically: + The definition of an employee, + The criteria for determining whether a plan qualifies as a noncompensatory plan, + The accounting consequence of various modifications to the terms of a previously fixed stock option or award, and + The accounting for an exchange of stock compensation awards in a business combination. FIN No. 44 was effective July 1, 2000, but certain conclusions cover specific events that occur after either December 15, 1998 or January 12, 2000. The impact of FIN 44 did not have a material effect on our consolidated financial statements. In June 2001, the FASB issued SFAS No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 requires that all business combinations initiated after June 30, 2001 be accounted for under the purchase method and addresses the initial recognition and measurement of goodwill and other intangible assets acquired in a business combination. SFAS No. 142 addresses the initial recognition and measurement of intangible assets acquired outside of a business combination and the accounting for goodwill and other intangible assets subsequent to their acquisition. SFAS No. 142 requires that intangible assets with finite useful lives be amortized and that goodwill and intangible assets with indefinite lives not be amortized, but instead be tested at least annually for impairment. SFAS No. 142 was effective for us beginning in the first quarter of fiscal 2002 and is not expected to have a significant impact on our consolidated financial statements because we did not carry any goodwill or other intangibles on our balance sheet as of June 30, 2001. In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. While SFAS No. 144 supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, it retains many of the fundamental provisions of SFAS No. 121. SFAS No. 144 also supersedes the accounting and reporting provisions of APB No. 30, Reporting the Results of Operations--Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions, for the disposal of a segment of a business. However, it retains the requirement in APB No. 30 to report separately discontinued operations and extends that reporting to a component of an entity that either has been disposed of (by sale, abandonment, or in a distribution to owners) or is classified as held for sale. SFAS No. 144 is effective for fiscal years beginning after December 15, 2001 and interim periods within those fiscal years. We do not expect the adoption of SFAS No. 144 to have a material impact on our consolidated financial statements. -------------------------------------------------------------------------------- 35 -------------------------------------------------------------------------------- Business COMPANY OVERVIEW We are a rapidly emerging developer and publisher of interactive entertainment software. We license properties from a wide variety of sources including entertainment and media companies and we publish interactive entertainment software based on their motion picture, sports and television properties. We currently publish interactive entertainment software for many of the most popular hardware platforms, such as Sony's PlayStation, Nintendo 64 and Nintendo's Game Boy Color and Game Boy Advance, as well as for portable handheld devices manufactured by Palm and Handspring and for personal computers. We plan to develop and publish interactive entertainment software for next generation hardware platforms such as Sony's PlayStation 2, NINTENDO GAMECUBE and Microsoft's Xbox, as well as for other portable handheld devices. Our interactive entertainment software is primarily based on properties that have consumer recognition and appeal. We have secured license agreements with AOL Time Warner's Cartoon Network and Sports Illustrated for Kids, Spyglass Entertainment Group and Franchise Films, as well as other entertainment and media property owners, and are developing titles based on their popular entertainment and media properties for targeted age groups. We develop titles that can be leveraged through sequels and extensions and across multiple hardware platforms. We sell our products to mass merchandisers such as Toys "R" Us, Target, Kmart, Wal-Mart and Best Buy, and specialty chains such as Babbages, Etc. and Electronics Boutique and independent distributors. INDUSTRY BACKGROUND According to Euromonitor, worldwide sales of consoles, console games and PC games grew from $17.0 billion in 1996 to $26.9 billion in 2000. Forrester predicts that, in the United States alone, interactive entertainment console manufacturers and software publishers will generate $29.4 billion in revenues in 2005. Of that $29.4 billion, Forrester estimates that $12.8 billion will be generated by sales of console game software alone. According to International Data Corporation, or IDC, the majority of video game households own more than one video game system. For additional information regarding these statistical sources and International Development Group, or IDG, see "-- Sources of Statistical Data." The interactive entertainment industry includes three distinct forms of hardware systems: + portable handheld devices, such as Nintendo's Game Boy and its recently released Game Boy Advance; + in-home television connected hardware platforms, such as Nintendo's Super Nintendo Entertainment System and Nintendo 64 and Sony's PlayStation and PlayStation 2 and announced consoles such as NINTENDO GAMECUBE and Microsoft's Xbox; and + personal computers. According to IDG, 15.7% of all interactive entertainment software dollar sales for 2000 were attributable to products for portable handheld devices, 59.5% for in-home hardware platforms and 24.8% for PCs. Historically, the interactive entertainment industry has experienced significant transitions every four to five years. The hardware platform and video game console market has evolved from 8- and 16-bit technology in the early 1980s to 32- and 64-bit technology in the past few years. The terms 8-, 16-, 32- or 64-bit technology means that the central processing unit, or chip, on which the software operates is capable of processing data in 8-, 16-, 32- or 64-bit units. Larger per bit capacity translates into a faster and potentially more realistic game experience. The transition to 128-bit, or next generation, hardware platforms has already begun with the recent introduction of Sony's PlayStation 2. -------------------------------------------------------------------------------- 36 BUSINESS -------------------------------------------------------------------------------- INDUSTRY TRENDS Currently, there are a number of trends affecting the interactive entertainment industry. We believe that the following should result in increased opportunities for interactive entertainment software developers and publishers: + Hardware platform technology evolution. Consoles that employ 128-bit technology will provide faster and more complex images and more lifelike animation and sound than their 32- and 64-bit predecessors. Additionally, most handheld devices will employ 32-bit technology instead of 8-bit technology. Titles published for these new hardware platforms should appeal to the core population of video game players and attract new players. The transition to 128-bit hardware platforms is expected to drive demand for titles published for these next generation systems. Historically, during hardware transition periods, consumer demand for titles compatible with next generation hardware systems is high and the supply of such titles is low. In addition, licensors and third-party developers look for new and additional partners to develop titles. We believe that experienced software developers and publishers having access to popular properties are well positioned to take advantage of these opportunities. + Introduction of next generation hardware platforms drives software demand. Historically, as next generation hardware platforms have been introduced, the number of software units sold per hardware platform sold has increased. This ratio is known as the tie ratio. Increasing tie ratios represent an upward trend in units of software products purchased for each successive generation of hardware platforms. According to IDG, these ratios had steadily increased from approximately 6:1 for 16-bit hardware platforms to approximately 9:1 for the 32-bit Sony PlayStation in North America. If historical patterns are indicative of future tie ratios, interactive entertainment software developers and publishers should see an increasing demand for their products as new 128-bit next generation hardware platforms are introduced and gain wider acceptance. + Many next generation hardware platforms are DVD compatible and can access the Internet. Many of the 128-bit hardware platforms, such as Sony's PlayStation 2 and Microsoft's Xbox, will utilize a DVD software format and have the potential to serve as multi-purpose entertainment centers by doubling as a player for DVD movies and compact discs. Moreover, some next generation hardware platforms are expected to have online capability that will allow users to access the Internet. We believe these new systems will have cross-over appeal to a segment of the market that might not otherwise be inclined to purchase hardware platforms for game use alone, which will drive additional hardware and software sales. + Development of hardware platforms utilizing a disk-based software format. The increased use of disk-based software for new hardware platforms is expected to result in shortened order lead times, reduced inventory risk and gross margins that are typically greater than those achievable with cartridge-based systems. Quicker product manufacturing and greater pricing flexibility will allow software producers to adjust to market demands and introduce products to the marketplace more rapidly. In addition, the memory capacity of disks generally exceeds cartridges, allowing for enhanced graphic capabilities and more realistic game play. + Backward compatibility. Sony's PlayStation 2 and Nintendo's Game Boy Advance are both backward compatible, meaning that titles produced for the earlier version of the hardware platform may be used on the new hardware platform. We believe that backward compatibility may result in a smoother revenue transition for interactive entertainment software developers and publishers because the lag in consumer demand for products for existing hardware platforms that typically precedes the release of a next generation hardware platform may be diminished. + Broadening demographic appeal. According to IDC, a pattern has emerged in which male gamers appear to be slowly migrating away as the primary gamers of older platforms. Other household members -- in particular, females and younger children -- transition to become that platform's primary gamers. IDC reports that the percentages of households where the primary gamer is female for PlayStation, Nintendo 64 and Super Nintendo Entertainment System grew from 17.2%, 15.3%, and 22.6% in 1999 to 18.1%, 15.8%, 29.8% in 2000. According to Interactive Digital Software Association, or IDSA, 58% of all Americans who play video games most frequently are over the age of 18 and 43% of Americans who play video games are female. This demographic -------------------------------------------------------------------------------- 37 BUSINESS -------------------------------------------------------------------------------- expansion broadens opportunities for interactive entertainment software developers to produce titles with content focused on a specific sex or targeted age group. INDUSTRY CHALLENGES As the transition to next generation hardware platforms begins and the number of titles continues to rise, differentiation among developers and publishers will become increasingly important. This need is heightened by the fact that the market for interactive entertainment software products tends to be dominated by a limited number of successful titles that are typically based on popular properties with brand name recognition. In order to succeed in this market environment, we believe interactive entertainment software developers and publishers will need to: + identify and license brand name properties from a wide variety of sources; + develop a network of relationships with hardware platform manufacturers, mass merchandisers and other industry participants; + develop creative software both internally and using third-party interactive entertainment software developers with a proven track record of developing successful titles; + aggressively market and sell titles to retailers and through traditional and emerging distribution channels in both domestic and international markets; and + develop compelling titles for multiple hardware platforms. OUR APPROACH We develop and publish interactive entertainment software for multiple hardware platforms. We believe our ability to license popular properties, develop content with internal and third-party developers and distribute titles through our broad distribution channels provides us with significant opportunities. The following are the key elements of our business approach, which we believe address many of the challenges facing the interactive entertainment software industry. Development and promotion of titles based on properties with existing brand recognition. Since the best selling titles are often based on popular properties and existing brands, we strive to secure license agreements with the owners of popular entertainment and media properties. We have agreements to utilize properties from AOL Time Warner's Cartoon Network and Time Inc.'s Sports Illustrated For Kids, Spyglass Entertainment Group, Franchise Films and other entertainment and media property owners. We believe that developing interactive entertainment software titles with brand name recognition and sustainable consumer appeal may allow us to promote titles over an extended period of time through the release of sequels and extensions and to re-release products at different price points. We work closely with the property owners to develop follow-on products based on both existing and new brands with the potential to become successful titles. We focus on developing titles that target specific segments of the interactive entertainment industry. We identify popular properties that have the potential to become successful titles, evaluate the demographic segment that the titles are most likely to appeal to and begin the development process. In this manner, we are able to develop titles with brand name recognition that appeal to specific segments of the interactive entertainment software market. We are currently developing titles in the following categories: + Adventure. We target game players ages 10 and under, with titles based on properties that appeal to this demographic segment. We have developed and are developing titles based on the popular television cartoons POWERPUFF GIRLS and DEXTER'S LABORATORY distributed by AOL Time Warner's Cartoon Network. We coordinate product release and promotion with the Cartoon Network and selected mass merchandisers to enhance consumer acceptance; -------------------------------------------------------------------------------- 38 BUSINESS -------------------------------------------------------------------------------- + Sports. We target game players age nine to 14, as well as the casual sports fan. We believe that existing sports games appeal more to the older core video game playing and sports audiences than the younger game player. With AOL Time Warner's Sports Illustrated for Kids, we are developing a line of sports-based titles that we believe will appeal to this audience; and + Action. We target the mass market with titles based on content originated by film production companies. We have entered into agreements with Spyglass Entertainment Group, producer of the upcoming motion picture REIGN OF FIRE, and Franchise Films, producer of the recent Warner Bros. motion picture DRIVEN, to create games based on these films. We work with our film company content providers early in the development process to produce titles closely aligned with the film's plot and endeavor to coordinate product release concurrently with that of the film. Management experience. Our executive management team has substantial experience in the interactive entertainment software industry. Key members of our management team have been founders and executives of other interactive entertainment software companies and in their current and past service have successfully identified and secured licenses for popular properties, established relationships with key third-party product developers and successfully negotiated distribution arrangements with multiple retail channels. In addition, our team has developed strong working relationships with hardware platform manufacturers, which we believe provide substantial benefits in the product approval and development process. We believe that established relationships with retailers and a track record for publishing top-selling titles are important factors that affect our ability to gain access to highly competitive shelf space. We believe our executive management team has the necessary experience to capitalize on opportunities afforded by the industry transition to next generation hardware platforms. Strategic management of product development. To maintain our position in the competitive interactive entertainment software industry, we devote significant resources to the internal development of products and to securing relationships with third-party interactive entertainment software developers with proven track records of developing successful titles. Product design and development is a joint effort among our producers and our marketing and sales groups. Members of each group have unique expertise, which allows for the creation of ideas that combine the latest technologies, current and future trends, and consumer and retailer demands. We believe this enables us to better manage our internal and external production efforts thereby allowing for greater efficiency and improved predictability in the development process. Broad distribution channels. Our sales and marketing efforts are designed to broaden product distribution and increase the penetration of our products in domestic and international markets. We further seek to leverage and expand our channels of distribution in order to reach a larger number of consumers in the retail, direct and online markets, both domestically and internationally. We sell our products to mass merchandisers such as Toys "R" Us, Target, Kmart, Wal- Mart and Best Buy, specialty chains such as Babbages, Etc. and Electronics Boutique and independent distributors. Hardware platform flexibility. While we have the ability to develop products for all current hardware platforms, our development efforts focus on specific hardware platforms for specific demographics. For example, our initial titles targeted at the 14 and under audience have primarily focused on the Nintendo Game Boy Color hardware platform since this audience primarily uses that platform. In contrast, games under development for the mass market will be offered on a wider range of hardware platforms since we believe there will be a widespread demographic appeal for these products. In addition, we leverage our more popular titles across multiple hardware platforms that have sufficient installed bases and appropriate demographics for development to be successful. For example, we released additional titles for POWERPUFF GIRLS and DEXTER'S LABORATORY for the PC in September 2001 and follow-on products for POWERPUFF GIRLS, scheduled for release in 2002 and 2003, will be developed for NINTENDO GAMECUBE and Sony's PlayStation 2, as well as for PCs. We believe this approach reduces both our reliance on any one hardware platform and the risks associated with product development. -------------------------------------------------------------------------------- 39 BUSINESS -------------------------------------------------------------------------------- STRATEGY Our objective is to enhance our position as a developer and publisher of interactive entertainment software. In pursuing our business strategy we intend to: Focus on next-generation hardware platforms to increase market share. We continue to develop products for hardware platforms that have or we expect will have large installed bases. We assess the potential acceptance and success of emerging hardware platforms and the anticipated continued viability of existing hardware platforms based on many factors, including the number of competing titles, the tie ratio, the current and potential installed base, the rate of sales and the cost and timing of developing titles for that hardware platform. We work with hardware companies to coordinate the release of our new titles with the launch of the next generation hardware platforms for which those titles are designed. In June 2001 we began the introduction of titles for Nintendo's Game Boy Advance and over the next 12 to 24 months, we plan to release additional titles for Nintendo's Game Boy Advance, and for NINTENDO GAMECUBE, Sony's PlayStation 2 and Microsoft's Xbox. Continue to develop relationships with owners of popular content properties. We will continue to pursue licensing relationships with a wide variety of sources for well-known properties. We also plan to continue to work closely with licensors to engage in efficient marketing efforts that capitalize on promotional campaigns that precede the launch of our titles. We believe that we are an attractive partner for licensors as evidenced by our recent agreement with Time Inc.'s Sports Illustrated For Kids. We seek to license popular content to produce titles with appeal among a wide range of demographics for use with a variety of existing and next generation hardware platforms. Expand international distribution. We believe we can further expand our presence in foreign markets. We have leased space for our office in Bath, England to enhance our international presence. We plan to increase our penetration in international markets by licensing our titles to publishers in these markets, entering into distribution agreements and establishing direct distribution capabilities. To further grow in global markets, we may also develop titles that are customized for consumer preferences in these foreign markets. Continue to build internal and external development capabilities. We intend to continue to devote significant resources to expanding existing relationships and securing new relationships with interactive entertainment software developers with proven track records of developing successful titles. We believe that our success as a publisher of well known titles will help us to continue to attract and retain dependable, creative and innovative developers to enhance product design creativity and reduce risks associated with dependence on a limited number of developers. -------------------------------------------------------------------------------- 40 BUSINESS -------------------------------------------------------------------------------- PRODUCTS The following tables set forth our existing titles and those anticipated to be released in the next 12 months. We cannot assure you that any of the titles anticipated for release in the next 12 months will be released when scheduled, if ever. EXISTING TITLES
--------------------------------------------------------------------------------------------------------------- TITLE GENRE HARDWARE PLATFORM DATE OF RELEASE --------------------------------------------------------------------------------------------------------------- Beast Wars Action Nintendo 64/PlayStation June 2000 Contender 2 Action PlayStation October 2000 Jimmy White's Cueball 2 Sports PlayStation October 2000 Bad Mojo Jojo (Powerpuff Girls) Adventure Game Boy Color November 2000 Paint the Townsville Green (Powerpuff Girls) Adventure Game Boy Color November 2000 Sgt. Rock Action Game Boy Color November 2000 Dexter's Laboratory: Robot Revenge Adventure Game Boy Color December 2000 Yogi Bear Adventure Game Boy Color December 2000 Battle Him (Powerpuff Girls) Adventure Game Boy Color February 2001 Xtreme Wheels Sports Game Boy Color April 2001 Fire Pro Wrestling Sports Game Boy Advance June 2001 Hot Potato Puzzle Game Boy Advance June 2001 Strike it Rich Trivia Palm/Handspring July 2001 CardTopia Card Palm/Handspring July 2001 Dexter's Laboratory: Deesaster Strikes Adventure Game Boy Advance September 2001 Dexter's Laboratory: Science Ain't Fair Adventure PC September 2001 Mojo Jojo A-Go-Go (Powerpuff Girls) Adventure PC September 2001 Sports Illustrated for Kids: Baseball Sports Game Boy Advance September 2001 Sports Illustrated for Kids: Football Sports Game Boy Advance September 2001 ---------------------------------------------------------------------------------------------------------------
ANTICIPATED TITLES
----------------------------------------------------------------------------------------------------------------- TITLE GENRE HARDWARE PLATFORM ----------------------------------------------------------------------------------------------------------------- Chase Action XBox Dexter's Laboratory Adventure PlayStation Driven Action PlayStation 2/Game Boy Advance/NINTENDO GAMECUBE Ecks v. Sever Action Game Boy Advance Kong Adventure Game Boy Advance Mage Action Game Boy Advance Powerpuff Girls Adventure Game Boy Advance/PlayStation/Nintendo 64 Reign of Fire Action Game Boy Advance/Playstation 2/XBox Riding Spirits Sports PlayStation 2 Sports Illustrated For Kids: Baseball Sports NINTENDO GAMECUBE Sports Illustrated For Kids: Basketball Sports Game Boy Advance/NINTENDO GAMECUBE Sports Illustrated For Kids: Football Sports NINTENDO GAMECUBE Star Fighter Action Game Boy Advance Stone Monkey Action Game Boy Advance Sound of Thunder Action PlayStation 2 3D Pro Wrestling Sports PlayStation 2 -----------------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------- 41 BUSINESS -------------------------------------------------------------------------------- STRATEGIC RELATIONSHIPS We have entered into strategic relationships with entertainment and media companies that have developed well-known characters and brands and that are producing popular properties that are expected to form the basis of future products. The Cartoon Network. Between March 2000 and October 2000, we entered into three non-exclusive license agreements that give us the right to develop and distribute interactive entertainment software based on Warner Bros.' POWERPUFF GIRLS, DEXTER'S LABORATORY and YOGI BEAR properties on a multi-national basis. The POWERPUFF GIRLS, DEXTER'S LABORATORY and YOGI BEAR television shows are aired on AOL Time Warner's Cartoon Network. Under these agreements, we are obligated to pay royalties based on a percentage of net sales of the titles and are obligated to advertise and promote the titles on the Cartoon Network. We believe that the Cartoon Network has significant brand awareness among six to 11 year olds. According to the Cartoon Network, their programs are viewed in 69 million homes around the world. We participate in promotional programs with the Cartoon Network and certain retailers who advertise on the Cartoon Network in connection with the release of our products. For example, our POWERPUFF GIRLS Game Boy Color series of titles were co-promoted with on-air advertisements sponsored in part by the Cartoon Network and in-store displays with Toys "R" Us, Target, Best Buy, Sears, Circuit City, Electronics Boutique and Babbages, Etc. We believe this promotional campaign has helped us sell over 700,000 units of our three POWERPUFF GIRLS Game Boy Color titles since their initial launch in the fourth calendar quarter of 2000. In addition, in September 2001 we released titles based on the POWERPUFF GIRLS and DEXTER'S LABORATORY for the PC and are developing additional titles based on these properties for existing and new hardware platforms. Franchise Films. In April 2000, we entered into a strategic arrangement with Franchise Films, Inc. Our agreement gives us the exclusive, first look right to review screenplays acquired by the studio, develop titles based on films produced from those screenplays and distribute them worldwide. Our agreement expires upon the later of three years or the theatrical release of the tenth film on which we base a product. Franchise Films has also agreed to provide us with free access to any publicity and advertising materials it prepares and granted us the right to use these materials to promote and advertise our products. Under the agreement, we agreed to pay Franchise Films royalties based on the net sales of the titles based on the films we select and issue 68,738 shares of our common stock following the theatrical release of each film for which we have developed a title, up to a maximum of 687,375 shares. Our title based upon the movie DRIVEN, which is the first property subject to the arrangement, is currently in production for Sony's PlayStation 2, Microsoft's Xbox and Nintendo's Game Boy Advance. DRIVEN, directed by Renny Harlin, the director of films such as DIE HARD 2 and DEEP BLUE SEA, is based on the CART racing circuit and has a cast that includes Sylvester Stallone, who also wrote the screenplay, and Burt Reynolds. Warner Bros. released DRIVEN in April 2001 and we plan a Fall 2001 release for our related title. Spyglass Entertainment Group. In October 2000, we entered into a strategic arrangement with Spyglass Entertainment Group, L.P., the studio that produced the film THE SIXTH SENSE. Our five-year agreement gives us an exclusive right of first refusal to develop titles based on films produced by the studio and to distribute them worldwide. In addition, Spyglass Entertainment Group has agreed to provide us with free access to any publicity and advertising materials it prepares and the right to use these materials to promote and advertise our titles. Under the agreement, we granted Spyglass Entertainment Group a warrant to purchase up to 470,000 shares of our common stock and agreed to pay the studio royalties based on the net sales of titles based on its films. We have commenced development on the first Spyglass Entertainment Group title, REIGN OF FIRE, for Sony's PlayStation 2 and Microsoft's Xbox. REIGN OF FIRE, scheduled for release in 2002, is being directed by Rob Bowman, who also directed AIRBORNE and THE X-FILES, and will star Christian Bale, Matthew McConaughey and Izabella Scorupco. Sports Illustrated For Kids. In May 2000, we signed a strategic arrangement with Time, Inc. for the development of titles utilizing the Sports Illustrated For Kids brand name. Our four-year, non-exclusive license gives us the right to publish titles based on popular sports that are appropriate for children ages seven to 17 and to distribute those titles -------------------------------------------------------------------------------- 42 BUSINESS -------------------------------------------------------------------------------- on a multi-national basis. Our agreement gives us the right to access a portion of their subscriber base for market research purposes. Under the agreement, we are obligated to pay a royalty based on the gross wholesale price of the titles and advertise and promote the titles in the magazine. We believe that Sports Illustrated For Kids has significant brand awareness, especially for boys ages 10 to 14. According to Phillips Business Information, Sports Illustrated For Kids has a subscription base of 950,000 readers and a circulation of over one million. We are currently developing the first three titles under this collaboration for Nintendo's Game Boy Advance. The targeted sports are football, basketball and baseball. We released our football and baseball titles for Nintendo's Game Boy Advance in September 2001 and we plan to release versions for Nintendo GAMECUBE and our basketball title between Fall 2001 and Fall 2002. SOFTWARE PRODUCT DESIGN AND DEVELOPMENT We believe our success will depend in large part on our ability to design and develop innovative interactive entertainment software based on popular content, design and develop sequels to our more popular products and offer previously released products on additional hardware platforms. We pair members of our internal production staff with internal and external software developers who have varying design and development capabilities, which we believe provides us with flexibility to develop titles in a timely, cost-effective manner. Our software producers take responsibility for the selection of the title concept, evaluation of the capabilities of the software developer who will prepare the graphics, artwork and computer code for the title, and the publication, marketing and distribution of the completed title. The internal and external software developers are responsible for the completion of technical milestones such as creation of particular graphics, artwork and sound designs. TITLE PRODUCTION AND DEVELOPMENT Our in-house production staff includes eight software producers who are responsible for monitoring the progress of our 21 internal software developers as well as the independent third-party software developers with whom we contract to create titles. Our production staff evaluates the work of each of the internal and external software developers through design review, progress evaluation, milestone review and quality checks. Each milestone submission is reviewed by our in-house production staff to ensure compliance with the product's design specifications. Members of our in-house production staff and internal software development team currently work at our offices in San Jose, California and Bath, England, as well as at our internal software development studio in London, England. INTERNAL PRODUCT DEVELOPMENT Members of our internal production and development staff are organized into teams led by a producer and staffed with software developers who are responsible for such functions as game design, software programming, art design and sound design. We believe that this team approach promotes the creative and cooperative environment necessary to develop innovative and successful titles. To create a title internally, our software production staff first prepares a schedule and budget. Our internal software developers then complete the initial design and concept layout, computer graphic design, two-dimensional and three- dimensional artwork, programming, prototype testing, sound engineering and quality control. To successfully complete the production and development of our interactive entertainment titles, our internal software development team utilizes a variety of advanced hardware and software development tools, including sound compression utilities, clay modeling and video compression. When the development of the title is complete, and our internal production staff has confirmed that each design milestone has been met, we publish and ship the title to our distributors. We believe that the development process for an original, internally-developed product for a next generation hardware platform, typically takes 12 to 24 months. This process is shorter for existing products currently used on 32-bit and 64-bit hardware platforms. We believe that it takes approximately six to 12 months to develop an existing title as a product for a different hardware platform. -------------------------------------------------------------------------------- 43 BUSINESS -------------------------------------------------------------------------------- EXTERNAL PRODUCT DEVELOPMENT When we elect to develop a concept or property externally, we contract with an independent third-party software developer to develop the title under the supervision of our internal software production staff. When we develop a title with an independent software developer, we select a title concept and then evaluate whether the independent developer has sufficient expertise to create the software code, animation and graphics for that title. After we evaluate the independent developer's capabilities and decide to produce that title with the developer, our production team prepares a budget, list of development milestones and a sales and marketing plan. The independent developer then begins to prepare the software code, graphics and animation for the title. When the final milestone has been met and our production staff is satisfied that the title is ready for publication, we publish, distribute and market the title. Our production staff also works with independent software developers to modify, or port, existing titles for distribution in a certain country or across additional platforms. When we decide to port an existing title in this manner, our internal production staff prepares a list of development milestones and a budget and marketing plan for the title. Our internal production staff then works with the independent software developer to ensure that the milestones are met and the title is ported to a new platform or readied for distribution to a new country. Our agreements with independent software developers are typically entered into on a title-by-title basis and provide for the payment of the greater of a fixed amount or royalties based on actual sales. We generally pay independent software developers installments of the fixed advance based on the achievement of specific development milestones established by our production staff at the outset of the development process. Royalties in excess of the fixed advance are generally based on a fixed amount per unit sold. We generally obtain ownership of the software code and related documentation from our independent software developers. In instances where we do not retain sole ownership of the source code, the owner may use or license the code for development of other software products that may compete directly with our products and we may not have sufficient rights in the source code to produce derivative products. Upon completion of the development process, each title is play-tested by us and sent to the manufacturer for its testing, review and approval. Related artwork, user instructions, warranty information, brochures and packaging designs are also developed by third parties under our supervision. MARKETING, SALES AND DISTRIBUTION Our marketing, sales and distribution efforts are designed to broaden product distribution and increase the penetration of our products in domestic and international markets. We rely in part on the name recognition of the motion picture, sports and television cartoon properties on which our products are based to attract consumers and obtain shelf space from mass merchandisers. We supplement our domestic direct efforts with third-party distributors, and in the last year, we have increased our marketing, sales and distribution efforts in international markets through licensing and third-party distribution strategies. As of September 30, 2001, our sales and marketing staff consisted of nine employees, five of whom work in our San Jose, California headquarters and four of whom work in our Bath, England office. DOMESTIC ACTIVITIES Our domestic sales and marketing activities are directed by our Vice President of Sales and Marketing, who maintains contact with major retail accounts, manages the activities of our marketing department and oversees our independent regional sales representatives. Our domestic marketing department consists of two employees who develop and implement marketing programs and campaigns for each of our titles. In preparation for a product launch, our marketing activities may include print and cooperative retail advertising campaigns, game reviews in consumer and trade publications, pre-release giveaways, and retail in-store promotions including demonstrations, videos, over-size displays and posters. We have selectively included in our marketing efforts radio, television and Internet advertising campaigns. We also budget a portion of each of our product's sales and marketing budget for cooperative advertising and market development with retailers. -------------------------------------------------------------------------------- 44 BUSINESS -------------------------------------------------------------------------------- Many of our titles are launched with a multi-tiered marketing campaign that is developed on an individual basis to promote product awareness and customer pre-orders. We sell our products primarily to mass merchandisers and, to a lesser extent, to third-party distributors. Our principal customers include Toys "R" Us, Target, Best Buy, Wal-Mart, Kmart, Babbages, Etc. and Electronics Boutique. Revenues from our three largest customers collectively accounted for approximately 49% of our net revenue for the three months ended September 30, 2001 as compared to 43% from our three largest customers for the year ended June 30, 2001 and 75% from our three largest customers for the period from inception through June 30, 2000. Our largest customers for the three months ended September 30, 2001 were Toys "R" Us, which accounted for 19% of our net revenues, K-Mart, which accounted for 19% of our net revenues, Ingram, which accounted for 11% of our net revenue, and Electronics Boutique, which accounted for 10% of our net revenues year ended June 30, 2001 were Toys "R" Us, which accounted for 17% of our net revenues, Wal-Mart, which accounted for 14% of our net revenues and Target, which accounted for 12% of our net revenues. For the period from inception through June 30, 2000, Blockbuster accounted for 49% of our net revenues, Wal-Mart accounted for 16% of our net revenues and KB Toys accounted for 10% of our net revenues. We do not have any written agreements or other understandings with any of our customers that relate to future purchases, so our customers could reduce or terminate their purchases from us at any time. We sell our products to retailers and distributors through 59 independent regional sales representatives who operate on a commission basis. The sales staff is largely responsible for generating retail demand for our products by presenting new products to our customers in advance of the products' scheduled release dates. They do this by providing technical advice with respect to the products and by working closely with retailers and distributors to sell the products. We typically ship our products within a short period of time after acceptance of purchase orders from distributors and other customers. Accordingly, we do not have a material backlog of unfilled orders and net sales in any quarter are substantially dependent on orders booked in that quarter. We seek to extend the life cycle and financial return of many of our products by marketing those products differently throughout the product's life. Although the product life cycle for each title varies based on a number of factors, including the quality of the title, the number and quality of competing titles, and in certain instances seasonality, we typically consider a title as back catalog six months after its initial release. We utilize marketing programs appropriate for the particular title, which generally includes progressive price reductions over time to increase the product's longevity in the retail channel as we shift advertising support to newer releases. We believe that we provide terms of sale comparable to competitors in our industry. In addition, we provide technical support for our products through our customer support department. To date we have not experienced any material warranty claims. We utilize an electronic data interchange with most of our major domestic customers to efficiently receive, process and ship customer product orders and to accurately track and forecast sell-through of our products to consumers in order to determine whether to order additional products from manufacturers. INTERNATIONAL ACTIVITIES Our international sales and marketing activities are currently conducted from our office located in Bath, England. Our international marketing activities are planned to include television advertising and publicity campaigns in interactive entertainment publications, magazines and newspapers. Our first four international titles were introduced in the quarter ended June 30, 2001 and we intend to continue to pursue our international sales by localizing our products for various international markets and releasing localized versions of many of our products simultaneously with the commercial release of corresponding titles in North America. We are also engaged in software development and production at our internal development studio in London, England. Although our international product development efforts have, to date, primarily consisted of the localization of existing products, we are currently designing and developing original products at our internal development studio. -------------------------------------------------------------------------------- 45 BUSINESS -------------------------------------------------------------------------------- In February 2001, we entered into a two-year exclusive license agreement with Ubi Soft Entertainment S.A. ("Ubi Soft"), a French distributor of entertainment and educational multimedia, to distribute, market, and sell certain of our interactive software products in the Nintendo Game Boy Color format on a multi-national basis. The agreement also obligates Ubi Soft to make minimum purchases at a set price per title. In July 2001, we expanded our relationship with Ubi Soft and signed a distribution agreement establishing them as the exclusive distributor of all of our interactive entertainment software products across all hardware platform formats in France, Germany, Italy, Spain, Belgium, Luxembourg, the Netherlands, Austria, Switzerland, Finland, Norway, Denmark and Sweden. Under this agreement, we are obligated to pay a distribution fee based on a percentage of the net revenues from sales of all products in the territory. MANUFACTURING Nintendo and Sony are the sole manufacturers of the software products sold for use on their respective hardware platforms. We begin the manufacturing process by placing a purchase order for the manufacture of our products with Nintendo or Sony and opening either a letter of credit in favor of the manufacturer or utilizing our line of credit with the manufacturer. We then send software code and a prototype of the product to the manufacturer, together with related artwork, user instructions, warranty information, brochures and packaging designs for approval, defect testing and manufacture. Microsoft appoints approved third-party manufacturers to manufacture software for its hardware platform. Microsoft also offers us the opportunity to enter into one or more kit licenses, pursuant to which Microsoft would license software development tools and hardware to assist us in the development of titles prior to sending these titles to authorized third-party manufacturers for replication. The amounts charged by the manufacturers include a manufacturing, printing and packaging fee, as well as a royalty for the use of the manufacturer's name, proprietary information and technology. All of these fees are subject to adjustment by the manufacturers at their discretion. Nintendo charges us a fixed amount for each cartridge that includes the royalty. This amount varies based, in part, on the memory capacity of the cartridges. Sony charges us a royalty for every disk manufactured. The manufacturers have the right to review, evaluate and approve a prototype of each title and the title's packaging and marketing materials. COMPETITION The interactive entertainment software industry is intensely competitive and is characterized by the frequent introduction of new hardware platforms and titles. Our competitors vary in size from small companies to large corporations, including the manufacturers of the hardware platforms. We must obtain a license from and compete with the hardware platform manufacturers in order to develop and sell titles for their respective hardware platforms, with each such manufacturer being the largest publisher and seller of software products for its own hardware platforms. As a result of their commanding positions in the interactive entertainment industry as the manufacturers of hardware platforms and publishers of titles for their own hardware platforms, these manufacturers generally have better bargaining positions with respect to retail pricing, shelf space and purchases than do any of their licensees. In addition to the hardware platform manufacturers, we compete with other interactive entertainment software companies. Significant competitors include Acclaim Entertainment, Inc., Activision, Inc., Bandai America Incorporated, Capcom USA, Inc., Eidos PLC, Electronic Arts Inc., Infogrames, Inc., Interplay Entertainment Corp., Konami Corporation of America, Inc., Midway Games Inc., Namco Ltd., Sega Enterprises, Inc. (USA), Take-Two Interactive Software, Inc., THQ, Inc., Ubi Soft Entertainment, Vivendi Universal S.A. and The 3DO Company. Many of these competitors are large corporations that have significantly greater financial, marketing, personnel and product development resources than us. Due to these greater resources, certain of these competitors are able to undertake more extensive marketing campaigns, adopt more aggressive pricing policies, pay higher fees to licensors of desirable motion picture, television, sports and character properties and pay more to third-party software developers than we -------------------------------------------------------------------------------- 46 BUSINESS -------------------------------------------------------------------------------- can. We believe that we are able to successfully compete with regard to the principal factors of the interactive entertainment software industry, including + product features; + brand name recognition; + rights to properties; + access to distribution channels; + product quality and ease of use; + price; + marketing support; + reviews received from independent reviewers; and + quality of customer service. However, any significant increase in the development, marketing and sales efforts of our competitors could harm our business. INTELLECTUAL PROPERTY Our business relies on the hardware platform manufacturers and our non-exclusive licenses with them to publish titles and manufacture our products for their hardware platforms. Our existing hardware platform licenses for Nintendo's Game Boy Color and Game Boy Advance, Nintendo 64, Sony's PlayStation and PlayStation 2, Sega's Dreamcast and Microsoft's Xbox and our pending license for NINTENDO GAMECUBE grant us the right to develop, publish and distribute titles for use on the respective hardware platforms. Each of these hardware platform licenses requires that we obtain approval for the publication of new titles on a title-by-title basis and licenses with Nintendo and Sony require that our titles be manufactured solely by the respective manufacturer and licenses with Microsoft require that we use certain approved third party manufacturers. License agreements relating to these rights generally extend for a term of two to three years. The agreements are terminable upon the occurrence of a number of factors, including: (1) breach of the agreement by us; (2) our bankruptcy or insolvency; or (3) our entry into a relationship with, or acquisition by, a competitor of the manufacturer. We cannot assure you that we will be able to obtain new or maintain existing licenses on acceptable terms, or at all. Upon termination of a hardware platform license for any reason other than our breach or default, the manufacturer has the right to purchase from us, at the price paid by us, any product inventory manufactured by such manufacturer that remains unsold for a specified period after termination. We must destroy any such inventory not purchased by the manufacturer. Upon termination as a result of our breach or default, we must destroy any remaining inventory, subject to the right of any of our institutional lenders to sell such inventory for a specified period. We hold copyrights on our products, product literature and advertising and other materials. We rely on common law trademark rights to our name and our logo. We do not currently hold any patents. We outsource some of our product development to third-party developers and typically retain all intellectual property rights related to such projects. No third-party developer has challenged our ownership interest in the intellectual property rights to projects we have outsourced, but it is always possible that a third-party developer could issue such a challenge and prevail. We also license products developed by third parties and pay royalties on such products. We regard our products as proprietary and rely primarily on a combination of copyright, trademark and trade secret laws, confidentiality and nondisclosure agreements and other methods to protect our proprietary rights. We require our employees, consultants and other outside individuals and entities, including employees of third-party developers, to execute confidentiality and nondisclosure agreements upon the start of employment, consulting or other contractual relationships with us. These agreements provide that all confidential information developed or made known to the individual or entity during the course of the relationship is to be kept confidential and not disclosed to third -------------------------------------------------------------------------------- 47 BUSINESS -------------------------------------------------------------------------------- parties except in specific circumstances. However, our ability to police these individuals and entities and enforce these agreements is costly and uncertain. We also rely on existing copyright laws to prevent unauthorized distribution of our products. However, existing copyright laws afford only limited protection. Policing unauthorized use of our products is difficult and software piracy can be a persistent problem, especially in certain international markets. We are aware that unauthorized copying occurs within our industry and if a significant amount of unauthorized copying of our interactive entertainment software products were to occur, our business would be harmed. In addition, the laws of some countries in which our products are or may be distributed either do not protect our products and intellectual property rights to the same extent as the laws of the United States, or these laws are weakly enforced. Legal protection of our rights may be ineffective in these countries, and as we leverage our products using emerging technologies, such as the Internet and online services, our ability to protect our intellectual property rights, and to avoid infringing the intellectual property rights of others, becomes more difficult. In addition, intellectual property laws are less clear with respect to such emerging technologies. Accordingly, existing intellectual property laws may not provide adequate protection to our products that are developed in connection with emerging technologies. As the number of titles in the interactive entertainment software industry increases and the features and content of these titles further overlap, interactive entertainment software developers may increasingly become subject to infringement claims. Although we make reasonable efforts to ensure that our products do not violate the intellectual property rights of others, we cannot assure you that claims of infringement will not be made. Any such claims, with or without merit, can be time consuming and expensive to defend and we cannot assure you that infringement claims against us will not result in costly litigation or require us to license the intellectual property rights of third parties, either of which could harm us. We may also be subject to legal proceedings and claims from time to time in the ordinary course of business, including claims of alleged infringement of the trademarks and other intellectual property rights of third parties. For example, we have recently become aware that other parties are utilizing the "BAM" mark, or marks that incorporate the letters "BAM," in businesses similar to ours, and those parties may have rights to such mark that are superior to ours. These parties could challenge our rights to use the name "BAM" in their markets. In this event, we could be required to stop using the name in particular markets or to obtain a license from these parties to use it in such markets. In addition, in May 2001, Nintendo of America, Inc. and Spike Co., Ltd. received a letter from counsel to World Wrestling Federation Entertainment, Inc. claiming a game violated certain of the World Wrestling Federation Entertainment, Inc.'s intellectual property rights and demanding that each of them cease the United States distribution of the game. We hold the rights to the United States version of the game. We believe that the game sold in the United States does not violate the World Wrestling Federation Entertainment, Inc.'s rights because we believe that the United States version does not contain references to the characters, moves or wrestling organizations mentioned in the letter. However, in the event it is determined that the game distributed in the United States violates the World Wrestling Federation Entertainment, Inc.'s intellectual property rights, we may be liable for damages and/or could be enjoined from further distributing the game, which would negatively affect our net revenues. Our agreements with third-party software developers and property licensors typically provide for us to be indemnified with respect to certain matters. However, if any claim is brought by a hardware manufacturer or other party against us, our software developers or property licensors may not have sufficient resources to, in turn, indemnify us. In addition, these parties' indemnification of us may not cover the matter that gives rise to the original claim, and in either case, our business could be harmed. LEGAL PROCEEDINGS From time to time, we may be involved in litigation relating to claims arising out of our operations in the normal course of business. As of the date of this prospectus, we are not a party to any material legal proceedings. -------------------------------------------------------------------------------- 48 BUSINESS -------------------------------------------------------------------------------- EMPLOYEES As of September 30, 2001, we had 47 full time employees, including 29 in product development, nine in sales and marketing and nine in finance, general and administrative. Of these employees, 20 work in our London, England studio, 12 are working at our Bath, England office, 14 are working in our San Jose, California office and one works from a satellite office in Seattle, Washington. We intend to hire additional employees as needed at each of our facilities. We also retain independent contractors to provide various services, primarily in connection with our software development and sales activities. We are not subject to any collective bargaining agreements and we believe that our relationship with our employees is good. FACILITIES Our headquarters are located in San Jose, California, where we occupy approximately 4,855 square feet of office space under a lease which expires in July 2004. We currently lease approximately 1,000 square feet in London, England for our development studio. This lease expires in 2002. We currently lease approximately 1,800 square feet for our office in Bath, England. This lease expires in 2008 although we have the right to terminate the lease at our option in 2004. We believe that our facilities are adequate for our current needs and suitable additional or substitute space will be available in the future to replace our existing facilities, if necessary, or accommodate expansion of our operations. SOURCES OF STATISTICAL DATA This prospectus contains statistical data regarding internet usage and other industry estimates that we obtained from reports generated by Euromonitor, Forrester, the Interactive Digital Software Association, the International Development Group and International Data Corporation. A description of these sources is provided as follows: Euromonitor. Euromonitor International was established in 1972 and conducts research and interpretation of numerous industries, producing reports, business reference titles and electronic data systems. Euromonitor maintains analysts in London, Chicago and Singapore. Forrester. Forrester Research, Inc. is a research firm that analyzes the future of technology change and its impact on businesses, consumers, and society. Forrester is based in Cambridge, Massachusetts with research offices in Toronto, Amsterdam and San Francisco. Interactive Digital Software Association. The Interactive Digital Software Association, or IDSA, is based in Washington, D.C. and offers a range of services to interactive entertainment software publishers, including generating business and consumer research on interactive entertainment software industry issues. International Development Group. International Development Group, or IDG, was founded in 1984 and provides companies with a range of consulting services in marketing, sales and distribution, strategic planning, mergers and acquisitions, business development and licensing. IDG provides analysis on the multimedia markets in Asia/Pacific, Europe, North America and Latin America. IDG is based in San Francisco, California. International Data Corporation. International Data Corporation, or IDC, provides information technology research, market data, and industry analysis on the future of electronic business, technology and the Internet. IDC, which is a division of International Data Group, is headquartered in Framingham, Massachusetts and has offices in North America, South America, Europe, Asia, the Middle East and Africa. -------------------------------------------------------------------------------- 49 -------------------------------------------------------------------------------- Management EXECUTIVE OFFICERS, DIRECTORS AND KEY EMPLOYEES Set forth below is information concerning our current directors, executive officers and other key employees.
NAME AGE POSITION ------------------------------------------------------------------------------------------------------------------------ Robert W. Holmes, Jr....................................... 48 Chairman of the Board of Directors Anthony R. Williams........................................ 43 Vice Chairman of the Board of Directors Raymond C. Musci........................................... 40 Chief Executive Officer, President and Director Stephen M. Ambler.......................................... 42 Chief Financial Officer and Vice President of Finance Joseph P. Morici........................................... 46 Vice President of Sales and Marketing Aaron H. Endo.............................................. 36 Director of Business Development George M. Sundheim, III.................................... 48 Secretary and Director Mark Dyne.................................................. 40 Director David E. Tobin (1)(2)...................................... 30 Director Anthony G. Williams (1)(2)................................. 42 Director Steven J. Massarsky (1).................................... 53 Director Robert T. Slezak (2)....................................... 44 Director
(1) Member of our compensation committee. (2) Member of our audit committee. Robert W. Holmes, Jr. has served as our Chairman since May 2001 and as a member of our board of directors since October 1999. From March 1998 to the present, Mr. Holmes has pursued independent investment and consulting opportunities. In April 1987, Mr. Holmes co-founded Acclaim Entertainment, Inc. (NASDAQ:AKLM), a developer, publisher and distributor of interactive entertainment software, where he was a General Manager, Senior Vice President, and Director. He became Chief Operating Officer of Acclaim in March 1989 and President in January 1990. He served as President until October 1996, and as a Director until February 1997, after which time he remained as Special Consultant to the Chairman until August 1999. Prior to Acclaim, Mr. Holmes was Senior Vice President of Marketing for Activision, Inc. (NASDAQ:ATVI), a software company. Prior to Activision, he held a variety of management and marketing positions with Seagram Co., Epicure Associates and Hilton Hotels, Mr. Holmes was also a teacher in the Business college of Western Michigan University. Mr. Holmes earned a B.A. in Romance Languages from Wesleyan University and his M.B.A. from Western Michigan University. Anthony R. Williams has served as our Vice Chairman since May 2001 and as our Co-Chairman of the board of directors from July 2000 to April 2001. Mr. Williams served as our Chief Executive Officer from July 2000 to May 2001 and as our Chief Financial Officer from July 2000 to March 2001. From February 1998 to July 2000, Mr. Williams served as the Co-Chairman and Chief Operating Officer of Take-Two Interactive Software, Inc. (NASDAQ:TTWO), a developer, publisher and distributor of interactive entertainment software. From April 1988 to February 1998, Mr. Williams was employed in various executive positions at Acclaim Entertainment, Inc. Mr. Williams currently serves as a director of the Near East Foundation, a private, nonprofit development agency dedicated to assisting people in the Middle East and Africa. Mr. Williams earned a B.A. in Economics from Cambridge University. In 2000, Mr. Williams and the staff of the Securities and Exchange Commission, or SEC, agreed to settle a proposed administrative proceeding relating to a press release issued by Acclaim in October 1995. Under the settlement, Acclaim and Mr. Williams, without admitting or denying the findings and conclusions of the SEC, have agreed to cease and desist from future violations of Sections 10(b) and 13(b) of the Securities and Exchange Act of 1934. Raymond C. Musci is our founder and has served as our Chief Executive Officer since May 2001, as our Chief Operating Officer and Co-Chairman of the Board from July 2000 to April 2001 and as our President and a member of our board of directors since October 1999. From October 1999 to July 2000, Mr. Musci served as our Chief -------------------------------------------------------------------------------- 50 MANAGEMENT -------------------------------------------------------------------------------- Financial Officer and Secretary. From May 1996 through July 1999, Mr. Musci was President, Chief Executive Officer and a member of the board of directors of the US division of Infogrames Entertainment, S.A., a developer, publisher and distributor of interactive entertainment software. From September 1994 to July 1996, Mr. Musci served as a director of Ocean International, Ltd., the holding company of Ocean of America. From 1990 until its merger with Infogrames Entertainment (Paris Bourse:5257), in May 1996, Mr. Musci was co-founder, President, and Chief Operating Officer of Ocean of America, a private developer, publisher and distributor of interactive entertainment software. From October 1996 to the present, Mr. Musci is a member of the board of directors of Brilliant Digital Entertainment, Inc., a developer, publisher and distributor of interactive entertainment software (AMEX:BDE), where he is a member of the audit and compensation committees. Mr. Musci earned a B.A. in Criminal Justice from Western New Mexico University. Stephen M. Ambler has served as our Chief Financial Officer and Vice President of Finance since April 2001. From April 1994 to March 2001, Mr. Ambler served in various executive capacities, including Chief Financial Officer, Secretary and Senior Vice President Finance, at Insignia Solutions PLC (NASDAQ:INSG), a software developer. Mr. Ambler received his diploma in Accounting Studies, with distinction, from Oxford Polytechnic, and he is a member of the Institute of Chartered Accountants in England and Wales. Joseph P. Morici has served as our Vice President of Sales and Marketing since March 2000. From November 1998 through March 2000, Mr. Morici was the Executive Vice President of Metro3D, Inc., developer, publisher and distributor of interactive entertainment software. From November 1996 through November 1998, Mr. Morici was Vice President of Fujitsu Interactive, a producer of interactive CD-ROMs for children. From January 1995 through November 1996, Mr. Morici served as a consultant to Simply Interactive, Inc., Titus Interactive, S.A. and Gametek Inc. Mr. Morici earned a B.S. in Economics from Santa Clara University. Aaron H. Endo has served as our Director of Business Development since November 1999. From December 1997 through November 1999, Mr. Endo was the Business Development Manager at Warner Bros. Interactive Entertainment, a division of AOL Time Warner (NYSE:AOL). From March 1997 through December 1997, Mr. Endo was an independent consultant. From July 1996 through March 1997, Mr. Endo was a senior financial analyst at Macromedia, Inc. (NASDAQ:MACR). Mr. Endo earned a B.S. in Mechanical Engineering from Northwestern University and an M.B.A. from the University of North Carolina. George M. Sundheim III has served as our Secretary since July 2000 and as a member of our board of directors since October 1999. From April 1986 to the present, Mr. Sundheim has been a partner of the law firm of Doty Sundheim & Gilmore, a professional corporation. Mr. Sundheim earned a B.A. in Economics from Stanford University and a J.D. from Northwestern University. Mark Dyne has served on our board of directors since July 2000. From October 1996 to the present, Mr. Dyne has served as Chairman of the Board and Chief Executive Officer at Brilliant Digital Entertainment, Inc. From September 1997 to the present, Mr. Dyne has also served as the Chairman of the Board of Tag-It Pacific, Inc. (ASE:TAG), a specialty printing and packaging company for the garment, accessories and related market areas. Additionally, from October 1998 though January 2000, Mr. Dyne was Chairman and Chief Executive Officer of Virgin Interactive Entertainment Ltd., a distributor of software programs and video games that is based in London, England. From June 1995 to October 1996, Mr. Dyne served as Co-Chief Executive Officer of Sega Enterprises, a theme park developer. Mr. Dyne is a founder and a director of Ozisoft Pty Ltd., a leading distributor of entertainment software in Australia and New Zealand. Mr. Dyne attended the University of California, Los Angeles. David E. Tobin has served on our board of directors since December 2000. From April 1996 to the present, Mr. Tobin has served as a Vice President at PAR Capital Management, Inc., an investment management firm in Boston, MA. Pursuant to the Series B Preferred Stock Purchase Agreement dated December 28, 2000, Mr. Tobin is the designee of PAR Capital Management, Inc. elected to our board of directors and appointed to our compensation committee. Mr. Tobin earned a B.A. in Finance from Saint Anselm College. -------------------------------------------------------------------------------- 51 MANAGEMENT -------------------------------------------------------------------------------- Anthony G. Williams has served on our board of directors since April 2001. From July 2000 to the present, Dr. Williams has been pursuing independent investment opportunities and non-commercial activities. From November 1994 to July 2000, Dr. Williams served in various Director positions as a partner at Goldman Sachs & Co., London, including Global Co-Head Swaps 2000, Global Head of FICC Risk, and Global Head of Fixed Income Arbitrage. Dr. Williams earned a B.A., M.A., and Ph.D. in Physics from Cambridge University. Steven J. Massarsky has served on our board of directors since May 2001. From February 1999 to the present, Mr. Massarsky has served as the Chief Executive Officer of The Business Incubation Group, a business incubator. From May 1997 to January 1999, Mr. Massarsky pursued independent investment opportunities and personal interests. From May 1996 to April 1997, Mr. Massarsky was the President of Acclaim Comics, Inc., a comic book publishing company. Earlier in his career, Mr. Massarsky operated an entertainment law practice; his clientele included The Wailers, the Psychedelic Furs, Aerosmith and Willie Mays. Prior to his law practice, Mr. Massarsky owned and operated an artist management company and managed the careers of artists such as The Allman Brothers Band, The Wailers and Cyndi Lauper. Mr. Massarsky earned a B.A. in political science from Brown University and a J.D. from Rutgers University. Robert T. Slezak has served on our board of directors since June 2001. From November 1999 to the present, Mr. Slezak has worked as an independent management consultant. From October 1989 through November 1999, Mr. Slezak served as the Chief Financial Officer of Ameritrade Holding Corporation, an online brokerage firm (NASDAQ:AMTD) and is currently a member of their board of directors. Mr. Slezak earned a B.S. in business administration from the University of Nebraska at Omaha and an M.B.A. from Creighton University. Our board of directors currently consists of nine members. Our board of directors is divided into three classes, each serving staggered three-year terms. Robert W. Holmes, Jr., Anthony R. Williams and Raymond C. Musci have been designated Class I Directors whose terms expire at the 2004 annual meeting of stockholders. George M. Sundheim, III, David E. Tobin and Mark Dyne have been designated Class II Directors, whose terms expire at the 2002 annual meeting of the stockholders. Anthony G. Williams, Steven Massarsky and Robert T. Slezak have been designated Class III Directors, whose terms expire at the 2003 annual meeting of stockholders. This classification of our board of directors may delay or prevent a change in control of our company or our management. Subject to existing employment agreements, our board of directors appoints our executive officers on an annual basis to serve until their successors have been duly elected and qualified. There are no family relationships among any of our directors or officers. BOARD COMMITTEES + AUDIT COMMITTEE -- In April 2001, our board of directors established an audit committee composed of three independent directors, who are currently David E. Tobin, Robert T. Slezak and Anthony G. Williams. The audit committee will generally meet with and consider suggestions from members of management and our internal accounting personnel, as well as our independent accountants, concerning our financial operations. The audit committee will also have the responsibility to: - review the audit committee charter at least annually and recommend any changes to our board of directors; - review our annual financial statements and any other relevant reports or other financial information; - review the regular internal financial reports prepared by management and any internal auditing department; - recommend to the board of directors the selection of the independent accountants and approve the fees and other compensation to be paid to the independent accountants; - review and discuss with the accountants all significant relationships the accountants have with us to determine the accountants' independence; -------------------------------------------------------------------------------- 52 MANAGEMENT -------------------------------------------------------------------------------- - review the performance of the independent accountants and approve any proposed discharge of the independent accountants when circumstances warrant; - review separately with the independent accountants, the internal auditing department, if any, and management, following completion of the annual audit, any significant difficulties encountered during the course of the audit; and - review the independence of each member of the committee. + COMPENSATION COMMITTEE -- In April 2001, our board of directors established a compensation committee composed of three directors, who are currently Steven J. Massarsky, Anthony G. Williams and David E. Tobin. The compensation committee is responsible for the design, review, recommendation and approval of compensation arrangements for our directors, executive officers and key employees, and for the administration of our 2000 Stock Incentive Plan, including the approval of grants under such plan to our employees, consultants and directors. Our board of directors may establish other committees to facilitate the management of our business. DIRECTOR COMPENSATION We provide annual compensation of $10,000 to each of our non-employee directors for serving on our board of directors and for attendance at meetings of the board of directors and the committees of the board of directors on which they serve. Non-employee directors are reimbursed for reasonable travel and other out-of-pocket expenses incurred in connection with attendance at meetings of the board of directors and committees of the board of directors. Employee directors are eligible to receive option grants and direct stock issuances under our 2000 Stock Incentive Plan. Non-employee directors will each receive, from time to time, grants of options to purchase a number of shares of our common stock determined by our board of directors. During the fiscal year ended June 30, 2001, Robert W. Holmes was granted options to purchase 178,600 shares at a weighted average exercise price of $6.49 per share, George M. Sundheim III was granted options to purchase 37,600 shares at a weighted average exercise price of $2.63 per share, Mark Dyne was granted options to purchase 84,600 shares at a weighted average exercise price of $3.83 per share, and each of Steven J. Massarsky, Robert T. Slezak and Anthony G. Williams was granted options to purchase 18,800 shares at an exercise price of $4.79 per share. In August 2001, David E. Tobin was granted options to purchase 18,800 shares at an exercise price of $4.79 per share. Except for options granted to Mr. Holmes to purchase 47,000 shares that vested immediately, and options to purchase an additional 47,000 shares that vest upon the earlier of this offering or December 31, 2001, these options vest 25% on the first anniversary of the date of grant and the balance vests over the three years that follow. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION We did not have a compensation committee or other board committee performing equivalent functions until April 2001. All members of our board of directors, some of whom were executive officers, participated in deliberations concerning executive officer compensation. No interlocking relationship exists between our board of directors and the board of directors or compensation committee of any other company other than Mr. Musci who serves on the board of directors and compensation committee of Brilliant Digital Entertainment, Inc., a company of which Mr. Dyne is the Chairman of the Board. -------------------------------------------------------------------------------- 53 MANAGEMENT -------------------------------------------------------------------------------- EXECUTIVE COMPENSATION SUMMARY OF CASH AND OTHER COMPENSATION FOR FISCAL YEAR ENDED JUNE 30, 2001 The following summary compensation table indicates the cash and non-cash compensation earned by our Chief Executive Officer and employees whose earnings during the fiscal year ended June 30, 2001 exceeded $100,000 (the "Named Executive Officers").
EXECUTIVE COMPENSATION TABLE (FISCAL YEAR ENDED JUNE 30, 2001) ------------------------------------------------------------------------------------------------------------------------- LONG-TERM COMPENSATION SECURITIES BASE OTHER ANNUAL UNDERLYING ALL OTHER NAME AND PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION OPTIONS/SAR COMPENSATION ------------------------------------------------------------------------------------------------------------------------- Raymond C. Musci................................ 2001 $225,000 -- -- -- -- Chief Executive Officer, President and Director (1) Anthony R. Williams............................. 2001 $225,000 -- -- -- -- Vice Chairman and Former Chief Executive Officer (2) Joseph P. Morici................................ 2001 $123,600 -- -- 23,500 -- Vice President of Sales and Marketing
--------------- (1) Mr. Musci previously served as our Chief Operating Officer, Chief Financial Officer and Secretary. (2) Mr. Williams served as our Chief Executive Officer until May 2001. OPTIONS GRANTED IN FISCAL YEAR ENDED JUNE 30, 2001 The following table sets forth information regarding options granted to our Named Executive Officers during the fiscal year ended June 30, 2001. Options were granted at an exercise price equal to the fair market value of our common stock at the date of the grant. In determining the fair market value of our common stock, the board of directors considered various factors, including our financial condition and business prospects, operating results, the absence of a market for the common stock and risks normally associated with investments in companies engaged in similar businesses.
--------------------------------------------------------------------------------------------------------------------- INDIVIDUAL GRANTS -------------------------------------------------------------- NUMBER OF POTENTIAL REALIZABLE VALUE SHARES OF % OF TOTAL AT ASSUMED COMMON OPTIONS ANNUAL RATES OF STOCK GRANTED TO STOCK PRICE APPRECIATION UNDERLYING EMPLOYEES EXERCISE PRICE FOR OPTION TERM OPTIONS IN FISCAL PER SHARE EXPIRATION -------------------------- NAME GRANTED (#) YEAR 2001(%) ($/SHARE) DATE 5% ($) 10% ($) --------------------------------------------------------------------------------------------------------------------- Joseph P. Morici......... 23,500(1) 3.7 0.46 7/10/10 326,903 520,538
--------------- (1) On the first anniversary of the date of the grant, 25% of the options vest and the balance vests over the three years that follow. During the fiscal year ended June 30, 2001, we granted options to purchase 833,075 shares of our common stock, which included options granted to our employees to purchase 635,675 shares and options granted to our non-employee directors to purchase 197,400 shares. The term of each option granted is generally 10 years from the date of the grant. Options may terminate before their expiration dates, if the optionee's status as an employee is terminated or upon the optionee's death or disability. Potential realizable values are based on an assumed initial public offering price of $9.00 and are net of exercise price, but before the payment of taxes associated with exercise. Amounts represent hypothetical gains that could be achieved for the respective options if exercised at the end of the -------------------------------------------------------------------------------- 54 MANAGEMENT -------------------------------------------------------------------------------- option term. The 5% and 10% assumed annual rates of compounded stock price appreciation are mandated by rules of the Securities and Exchange Commission and do not represent our estimate or projection of our future common stock prices. These amounts represent assumed rates of appreciation in the value of the common stock from the fair market value on the date of grant. Actual gains, if any, on stock option exercises are dependent on the future performance of our common stock and overall stock market conditions. The amounts reflected in the table may not necessarily be achieved. AGGREGATE OPTION EXERCISES IN FISCAL YEAR 2001 AND VALUES AT JUNE 30, 2001 The following table sets forth the number and value of unexercised options held by our Named Executive Officers at June 30, 2001. There was no public trading market for our common stock as of June 30, 2001. Accordingly, the value of unexercised options has been calculated by subtracting the exercise price from the fair market value of our common stock on June 30, 2001, using the assumed initial public offering price of $9.00 per share as the fair market value, multiplied by the number of shares underlying the option. None of our Named Executive Officers exercised options in the fiscal year ended June 30, 2001.
---------------------------------------------------------------------------------------------------------------------------- NUMBER OF SHARES OF COMMON STOCK UNDERLYING VALUE OF UNEXERCISED UNEXERCISED OPTIONS AT IN-THE-MONEY OPTIONS AT JUNE 30, 2001 JUNE 30, 2001 ------------------------------------- ------------------------------------- NAME EXERCISABLE (#) UNEXERCISABLE (#) EXERCISABLE ($) UNEXERCISABLE ($) ---------------------------------------------------------------------------------------------------------------------------- Joseph P. Morici.............................. -- 23,500 -- 200,690
2000 STOCK INCENTIVE PLAN Our Amended and Restated 2000 Stock Incentive Plan (the "2000 Stock Incentive Plan") provides for the grant of qualified incentive stock options that meet the requirements of Section 422 of the Internal Revenue Code (the "Code"), nonqualified stock options and restricted stock awards. Our board of directors adopted our 2000 Stock Incentive Plan in July 2000 and our stockholders approved it in July 2000. The 2000 Stock Incentive Plan was amended and restated in each of May and August 2001. We have reserved a total of 1,527,500 shares of our common stock for issuance under our 2000 Stock Incentive Plan, which is subject to anti-dilution provisions for stock splits, reverse stock splits, stock dividends, combinations, reclassifications and similar events. Our 2000 Stock Incentive Plan may be administered by our board of directors or a committee or subcommittee of a committee designated by our board of directors. The administrator of our 2000 Stock Incentive Plan has the power to select participants among eligible people and to determine the terms of options or awards. Under current law, incentive stock options may only be granted to a person who is an employee or officer of ours or of any future subsidiary of ours. The exercise price of an award under the 2000 Stock Incentive Plan is payable in full in cash, by promissory note with recourse approved by the administrator of the plan, by surrender of shares of common stock owned equal to the aggregate exercise price, withholding whole shares of common stock then issuable upon the exercise of an option or any combination of the foregoing. In the event of a change of control, all stock option and restricted stock awards will terminate unless the award is assumed by our successor corporation and there will be no acceleration of vesting or exercisability of an award unless an individual's award agreement provides otherwise. A change of control is defined in our 2000 Stock Incentive Plan as (i) a merger or consolidation where we are not the successor entity; (ii) the sale or disposition of substantially all of our assets; (iii) a reverse merger where we are the surviving entity but the holders of our common stock prior to the merger do not possess more than 50% of the total control voting power of the surviving entity's outstanding securities after the merger; or (iv) if any person obtains beneficial ownership of 50% or more of the combined voting power of our outstanding securities. -------------------------------------------------------------------------------- 55 MANAGEMENT -------------------------------------------------------------------------------- Incentive stock options and restricted stock awards generally may not be transferred, although non-qualified stock options may be transferred pursuant to California Code of Regulations Section 260.140.41 or by will or intestacy. Our board of directors may from time to time amend, suspend or terminate our 2000 Stock Incentive Plan unless stockholder approval is required. As of September 30, 2001, no shares of restricted stock had been issued and options to purchase 966,056 shares of our common stock were outstanding under our 2000 Stock Incentive Plan at exercise prices ranging between $0.46 and $13.00 per share. 2001 STOCK INCENTIVE PLAN (UK PART) In August 2001 when the 2000 Stock Incentive Plan was amended and restated as described above, our board of directors adopted the 2001 Stock Incentive Plan (UK Part) (the "UK Plan") as Schedule A to the 2000 Stock Incentive Plan. The UK Plan provides for the grant of stock options to our employees who satisfy certain criteria as set forth in our 2000 Stock Incentive Plan. The UK Plan contains restrictions intended to comply with UK taxation laws, including restrictions on exercise, limitations on the size of option grants, requirements with respect to changes in capitalization and other matters. The UK Plan is administered by our board of directors or a committee of our board of directors (the "Administrator"). The Administrator has the authority to determine the terms of options granted under the UK Plan, including the number of shares subject to the option, exercise price, term and exercisability. Payment of the exercise price must be made in cash. An option may not be transferred by the optionee. Options granted under the UK Plan must generally be exercised at the end of the optionee's employment with us; or within 12 months after such optionee's termination by retirement, disability or death, but in no event after the ten year term of the option. In the event of a change in control, optionees under the UK Plan have the right to exercise or substitute their options for a period of six months from the date of the change in control. The Administrator has the authority to alter the UK Plan as long as such action does not adversely affect any outstanding option, subject to approval of the Board of Inland Revenue. 2001 EMPLOYEE STOCK PURCHASE PLAN Our 2001 Employee Stock Purchase Plan (the "2001 Purchase Plan") was adopted by the board of directors and the stockholders in August 2001. The 2001 Purchase Plan, which is intended to qualify under Section 423 of the Code, contains consecutive six month offering periods. The offering periods generally start on the first trading day on or after March 1 and September 1 of each year. The initial offering period will commence on the first trading day after this Registration Statement is declared effective by the Securities and Exchange Commission. A total of 705,000 shares of common stock have been reserved for issuance under the 2001 Purchase Plan. Employees are eligible to participate if they are employed by us or any designated subsidiary for at least 20 hours per week and more than five months in any calendar year. No employee shall be granted an option under the 2001 Purchase Plan (1) to the extent that, immediately after the grant, such employee (or any other person whose stock would be attributed to such employee pursuant to Section 424(d) of the Code) would own our capital stock and/or hold outstanding options to purchase such stock possessing five percent (5%) or more of the total combined voting power or value of all classes of our capital stock, or (2) to the extent that his or her rights to purchase stock under all of our employee stock purchase plans accrues at a rate which exceeds $25,000 worth of stock (determined at the fair market value of the shares at the time such option is granted) for each calendar year in which such option is outstanding at any time. The 2001 Purchase Plan permits participants to purchase common stock through payroll deductions of up to 15.0% of the participant's compensation. Compensation is defined as the participant's base straight time gross earnings, -------------------------------------------------------------------------------- 56 MANAGEMENT -------------------------------------------------------------------------------- including commissions, payment for overtime, incentive bonuses and performance bonuses. Amounts deducted and accumulated by the participant are used to purchase shares of our common stock at the end of each purchase period. The price of stock purchased under the 2001 Purchase Plan is 85.0% of the lower of the fair market value of the common stock at the beginning of the offering period or at the end of the purchase period. The maximum number of shares a participant may purchase during a single offering period is determined by dividing $25,000 by the fair market value of a share of our common stock on the first day of the offering period. Participants may end their participation at any time during an offering period and they will be paid their payroll deductions to date. Participation ends automatically upon termination of employment with us. Rights granted under the 2001 Purchase Plan are not transferable by a participant other than by will, the laws of descent and distribution, or as otherwise provided under the 2001 Purchase Plan. The 2001 Purchase Plan provides that, in the event we merge with or into another corporation or sell all or substantially all of our assets, each outstanding option may be assumed or substituted for by the successor corporation. If the successor corporation refuses to assume or substitute for the outstanding options, the offering period then in progress will be shortened and a new purchase date will be set so that shares of our common stock are purchased with the participant's accumulated payroll deductions prior to the effective date of such transaction. Our board of directors has the authority to amend or terminate the 2001 Purchase Plan, except that no such action may adversely affect any options previously granted under the 2001 Purchase Plan, provided that the board of directors may terminate an offering period on any exercise date if the board of directors determines that the termination of the 2001 Purchase Plan is in our best interest or the best interests of our stockholders. Additionally, without stockholder consent and without regard to whether any participant rights may be considered to have been adversely affected, the board of directors shall be entitled to change the offering periods, limit the frequency and/or number of changes in the amount withheld during an offering period, establish the exchange ratio applicable to amounts withheld in a currency other than U.S. dollars, permit payroll withholding in excess of the amount designated by a participant in order to adjust for delays or mistakes in our processing of properly completed withholding elections, establish reasonable waiting and adjustment periods and/or accounting and crediting procedures to ensure that amounts applied toward the purchase of our common stock for each participant properly correspond with amounts withheld from the participant's compensation, and establish such other limitations or procedures as the board of directors determines in its sole discretion advisable which are consistent with the 2001 Purchase Plan. Notwithstanding anything to the contrary, the board of directors may in its sole discretion amend the 2001 Purchase Plan to the extent necessary and desirable to avoid unfavorable financial accounting consequences by altering the purchase price for any offering period, shortening any offering period or allocating remaining shares among the participants. Unless sooner terminated by the Board of Directors, the 2001 Purchase Plan will terminate on August 8, 2011. 401(k) RETIREMENT PLAN We have in place a contributory retirement plan, or 401(k) plan, for employees age 21 and older. Our 401(k) plan is designed to be tax deferred in accordance with the provisions of Section 401(k) of the Internal Revenue Code of 1986, as amended. Under our 401(k) Plan, employees may elect to enroll as of the first day of the month coinciding with or following the date on which the employee meets the eligibility requirements. Our 401(k) plan provides that each participant may contribute up to the maximum amount per year allowed by federal law, and we may contribute to the participant's plan account at the end of each plan year a percentage of salary contributed by the participant. We may make such matching contributions in our sole discretion. Subject to the rules for maintaining the tax status of our 401(k) plan, we may make an additional contribution in our sole discretion that vests upon the employees' number of years of service, and this contribution is divided among eligible employees on a pro-rata share based on the amount of total compensation each eligible employee receives in comparison to all eligible employees. Total contributions to our 401(k) plan were $15,000 for the three months -------------------------------------------------------------------------------- 57 MANAGEMENT -------------------------------------------------------------------------------- ended September 30, 2001, $41,000 for the year ended June 30, 2001 and $6,500 for the period from October 7, 1999 (inception) through June 30, 2000. INDEMNIFICATION OF DIRECTORS AND OFFICERS We have included in our certificate of incorporation a provision that, to the extent permitted by Delaware General Corporation Law, our directors will not be personally liable to us or our stockholders for monetary damages for breach of fiduciary duty as directors, except for liability: + for any breach of the director's duty of loyalty to us or our stockholders; + for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law; + under Section 174 of the General Corporation Law of the State of Delaware, which relates to unlawful dividends; or + for any transaction from which the director derived an improper personal benefit. Our bylaws provide for the indemnification of our directors to the fullest extent permitted by the Delaware General Corporation Law. Our bylaws further provide that our board of directors has sole discretion to indemnify our officers and other employees. We may limit the extent of such indemnification by individual contracts with our directors and executive officers, but have not done so. We are not, however, required to indemnify any director or executive officer in connection with any proceeding initiated by us and approved by a majority of our board of directors, that alleges (a) unlawful misappropriation of corporate assets, (b) disclosure of confidential information or (c) any other willful breach of such director or executive officer's duty to us or our stockholders. We are required to advance, prior to the final disposition of any proceeding, promptly on request, all expenses incurred by any director or executive officer in connection with that proceeding on receipt of an undertaking by, or on behalf of, that director or executive officer to repay those amounts if it should be determined ultimately that he or she is not entitled to be indemnified under our bylaws or otherwise. We have entered into agreements with our directors and executive officers containing provisions specifying that the Company will indemnify and defend these directors and officers against any liability incurred in performance of services in their capacity as directors and officers to the fullest extent authorized by our certificate of incorporation, bylaws and applicable law. EMPLOYMENT AGREEMENTS In October 1999 we entered into a two year employment agreement with Raymond C. Musci, our Chief Executive Officer and President. In July 2000 we entered into a two year employment agreement with Anthony R. Williams, our Vice Chairman, which was subsequently amended to reflect his change in title. Messrs. Musci and Williams are each entitled to an annual base salary of $225,000 and are both eligible for any bonus program or plan established for our employees. The employment agreements entitle the employees to receive stock options or other equity rights to be determined in the sole discretion of our Compensation Committee and to receive certain insurance and other employee plans and benefits established for our employees. If the employment agreement of either Messrs. Musci or Williams is terminated for any reason, except for disability or cause, or if either of Messrs. Musci or Williams resign for good cause, he shall receive severance in an amount equal to 24 months of his then-current base salary, with 50% payable within 60 days of the termination date and 50% payable as salary continuing for 12 months following the termination date. In addition, they will receive 12 months of insurance coverage following the termination date. The employment agreements of Messrs. Musci and Williams automatically renew for an additional one year term if notice is not provided ninety days before the termination of the original term. -------------------------------------------------------------------------------- 58 MANAGEMENT -------------------------------------------------------------------------------- Effective June 2001 we entered into a one year agreement with Robert W. Holmes, Jr., the chairman of our board of directors. Pursuant to the terms of the agreement, Mr. Holmes will receive a fee of $100,000 per year, and was issued stock options to purchase 47,000 shares of our common stock at an exercise price of $4.79 per share, all of which are fully vested, and stock options to purchase 47,000 shares of our common stock at an exercise price equal to the initial public offering price, unless this offering has not occurred by December 31, 2001, in which case the exercise price shall be the fair market value of our common stock on that date, which options shall be fully vested commencing on the earlier of this offering or December 31, 2001. In the event of a change of control or the removal of Mr. Holmes as a director without cause, all of Mr. Holmes' unvested options shall vest immediately. Mr. Holmes may be removed or resign at any time as the chairman of our board of directors. If Mr. Holmes resigns or is removed as a director, his agreement will terminate and we will be obligated to pay him all compensation and benefits which have accrued through the date of termination. -------------------------------------------------------------------------------- 59 -------------------------------------------------------------------------------- Related party transactions In October 1999, Raymond C. Musci, our Chief Executive Officer and President, purchased 580,962 shares of our common stock for $1,000. In October 1999, each of Robert W. Holmes, Jr., our Chairman of the Board, and D&S Partners, whose general partner, Mr. George Sundheim, III is our Secretary and a director, purchased 45,825 shares of our common stock for $0.11 per share, or an aggregate purchase price of $5,000. In each of November 1999 and January 2000, we issued Mr. Musci a convertible promissory note each in the principal amount of $500,000, and in May 2000 we issued him an additional convertible promissory note in the principal amount of $47,000. Each note bore interest at 7% per annum with principal and accrued interest due on demand after one year from the date of issuance. Each note was automatically convertible into shares of our Series A Preferred Stock upon the initial closing of our Series A Preferred Stock financing. In June 2000, the notes were converted and Mr. Musci was issued 482,625 shares of our Series A Preferred Stock for $1.0 million; these shares are convertible into 2,268,338 shares of common stock. In February 2000, we entered into an agreement with Transcap Trade Finance to have Transcap finance the purchase of materials required to produce our products. As a condition of this agreement, Mr. Musci entered into a separate agreement with Transcap to guarantee our obligations under the agreement. In June 2000, we sold and issued 976,220 shares of our Series A Preferred Stock for $2.1 million; these shares are convertible into 4,588,234 shares of our common stock. In addition, at this time, we sold shares of our common stock at a price of $0.11 per share to certain purchasers of our Series A Preferred Stock. In addition to Mr. Musci, who converted promissory notes into 482,625 shares of Series A Preferred Stock, purchasers included the following officers, directors and entities affiliated with them:
SHARES OF COMMON STOCK SHARES OF SHARES OF SERIES A ISSUABLE UPON COMMON STOCK PREFERRED STOCK CONVERSION OF PURCHASER PURCHASED PURCHASED SERIES A PREFERRED ----------------------------------------------------------------------------------------------- STOCK PURCHASED Anthony R. Williams (1)..................................... 422,516 351,000 1,649,700 Robert W. Holmes, Jr. ...................................... 105,628 87,750 412,425 Mark Dyne................................................... 17,183 10,969 51,554 FIMAS, L.P.................................................. 17,183 10,969 51,554
(1) Mr. Williams' shares of Series A Preferred Stock are currently held in an irrevocable trust administered by Breams Trust Limited. Although Breams Trust Limited has the power to dispose of trust property, Mr. Williams has the right to appoint new or additional trustees and to require any trustee to resign. Mr. Williams is our Vice Chairman, Mr. Dyne is a director and Mr. Sundheim, one of our directors, is a general partner of FIMAS, L.P. In October 2000, we issued to Spyglass Entertainment Group, L.P. a warrant with a six year term to purchase 470,000 shares of our common stock at an exercise price of $1.06 per share in connection with our strategic arrangement with Spyglass Entertainment Group. In November 2000, we entered into an agreement with Comerica Bank-California to have Comerica provide a revolving note for an amount of up to $1 million. As consideration for providing the note, Comerica was given a security interest in a money market account in the name of Anthony R. Williams maintained at the bank. In addition, as a condition of this agreement, Mr. Musci entered into a separate agreement with Comerica to guarantee our -------------------------------------------------------------------------------- 60 RELATED PARTY TRANSACTIONS -------------------------------------------------------------------------------- obligations under the agreement. Both guarantees lapsed in December 2000, when the revolving note became secured by restricted cash held in a money market account with the same bank. In December 2000, we sold 294,620 shares of our Series B Preferred Stock for $5.2 million; these shares are convertible into 1,384,714 shares of our common stock. Purchasers included the following officers, directors and 5% stockholders:
SHARES OF COMMON STOCK SHARES OF SERIES B ISSUABLE UPON CONVERSION OF PURCHASER PREFERRED STOCK PURCHASED SERIES B PREFERRED STOCK PURCHASED ------------------------------------------------------------------------------------------------------------------------ PAR Investment Partners, L.P........................... 198,301 932,015 Raymond C. Musci....................................... 28,329 133,146 Anthony R. Williams (1)................................ 28,329 133,146 Merchant Bankers, Inc. (2)............................. 28,329 133,146 Robert W. Holmes, Jr................................... 11,332 53,260
(1) Mr. Williams' shares of Series B Preferred Stock are currently held in an irrevocable trust administered by Breams Trust Limited. Although Breams Trust Limited has the power to dispose of trust property, Mr. Williams has the right to appoint new or additional trustees and to require any trustee to resign. (2) Merchant Bankers, Inc. is the general partner of Morgan Keegan Early Stage Fund, L.P., which purchased 22,092 shares of Series B Preferred Stock (convertible into 103,832 shares of our common stock), and Morgan Keegan Employee Investment Fund, L.P., which purchased 6,237 shares of Series B Preferred Stock (convertible into 29,319 shares of our common stock). Merchant Bankers, Inc. is deemed to beneficially own these shares. Merchant Bankers, Inc. is a wholly-owned subsidiary of Morgan Keegan & Company, Inc. In connection with the sale of the Series B Preferred Stock, we paid placement agent fees of $253,000 to Morgan Keegan & Company, Inc. Mr. Tobin, a director, is a Vice President of PAR Capital Management, Inc ("PAR Capital"). A three year warrant for 141,000 shares of our common stock has also been issued to PAR Investment Partners, L.P. ("PIP") at an exercise price of $3.76 per share. PAR Capital is a Delaware S Corporation and the sole general partner of PAR Group, L.P. ("PAR Group"). The principal business of PAR Capital is to act as the general partner of PAR Group. PAR Group is a Delaware limited partnership and the sole general partner of PIP. The principal business of PAR Group is that of a private investment partnership engaging in the purchase and sale of securities for its own account. PIP is a Delaware limited partnership and its principal business is that of a private investment partnership engaging in the purchase and sale of securities for its own account. Mr. Sundheim is a partner of the law firm Doty, Sundheim & Gilmore, a professional corporation, which provides legal services to us. For the year ended June 30, 2001, we paid Doty, Sundheim & Gilmore $195,000 for legal services rendered and $9,000 for the period from our inception through June 30, 2000. We had accrued but unpaid legal fees to Doty, Sundheim & Gilmore of $84,000 as of September 30, 2001. -------------------------------------------------------------------------------- 61 RELATED PARTY TRANSACTIONS -------------------------------------------------------------------------------- In May 2001, we sold 245,659 shares of our Series C Preferred Stock for $5.5 million; these shares are convertible into 1,154,597 shares of our common stock. Purchasers included the following officers, directors and 5% stockholders.
SHARES OF COMMON STOCK SHARES OF SERIES C ISSUABLE UPON CONVERSION OF PURCHASER PREFERRED STOCK PURCHASED SERIES C PREFERRED STOCK PURCHASED ------------------------------------------------------------------------------------------------------------------------ Merchant Bankers, Inc. (1)............................. 88,680 416,796 PAR Investment Partners, L.P........................... 88,680 416,796 Anthony R. Williams.................................... 13,302 62,519 Raymond C. Musci....................................... 13,302 62,519 Robert W. Holmes, Jr................................... 6,651 31,260 Mark Dyne.............................................. 4,434 20,840 Steven J. Massarsky(2)................................. 2,217 10,420 Stephen M. Ambler (3).................................. 1,109 5,212 FIMAS, L.P. ........................................... 900 4,230 Joseph P. Morici (4)................................... 887 4,169
(1) Merchant Bankers, Inc. is the general partner of Morgan Keegan Opportunity Fund, L.P., which purchased 70,944 (convertible into 333,437 shares of our common stock) shares of Series C Preferred Stock, and Morgan Keegan Employee Investment Fund, L.P., which purchased 17,736 (convertible into 83,359 shares of our common stock) shares of Series C Preferred Stock. Merchant Bankers, Inc. is deemed to beneficially own these shares. (2) Mr. Massarsky is one of our directors. (3) Mr. Ambler is our Chief Financial Officer and Vice President of Finance. (4) Mr. Morici is our Vice President of Sales and Marketing. In connection with the sale of the Series C Preferred Stock, we paid placement agent fees of $200,000 and issued a five-year warrant to purchase 16,450 shares of common stock at a per share exercise price of $4.80 to Morgan Keegan & Company, Inc. In May 2001, Franchise Films and its president assigned 68,738 shares of our common stock, 21,937 shares of our Series A Preferred Stock (convertible into 103,104 shares of our common stock) and the right to be issued up to 599,838 shares of our common stock to Selected Ventures, LLC, a Delaware limited liability company. Mark Dyne owns 25% of Selected Ventures, LLC. Anthony R. Williams has accrued approximately $113,000 in salary that has not yet been paid to him. Mr. Musci has accrued approximately $281,000 in salary that has not yet been paid to him. These amounts will be paid with a portion of the proceeds of this offering. -------------------------------------------------------------------------------- 62 -------------------------------------------------------------------------------- Principal stockholders The following table sets forth information regarding the beneficial ownership of our common stock and redeemable convertible preferred stock on an as converted basis as of October 1, 2001 for each of the following persons: + all executive officers, including the Named Executive Officers; + all directors; and + each person who is known by us to beneficially own prior to this offering 5% or more of our common stock. Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission. In computing the number of shares beneficially owned by a person and the percentage of ownership of that person, shares of common stock subject to options or warrants held by that person that are currently exercisable or become exercisable within 60 days of October 1, 2001 are included. Those shares, however, are not deemed outstanding for the purpose of computing the percentage ownership of any other person. Each stockholder's percentage of ownership in the following table is based upon 8,678,984 shares of common stock and redeemable convertible preferred stock on an as converted basis outstanding as of October 1, 2001. Unless otherwise indicated in the table, the persons and entities named in the table have sole voting and sole investment power with respect to the shares set forth opposite the stockholder's name. All share numbers and percentages assume no exercise of the underwriters over-allotment option. Unless otherwise indicated, the address of each beneficial owner listed below is c/o: BAM! Entertainment, Inc., 333 West Santa Clara Street, Suite 716, San Jose, California 95113.
PERCENTAGE OF SHARES BENEFICIALLY OWNED NUMBER OF SHARES -------------------- BENEFICIALLY BEFORE AFTER NAME OF BENEFICIAL OWNER OWNED OFFERING OFFERING ------------------------------------------------------------------------------------------------------ Raymond C. Musci............................................ 3,044,966 35.1% 24.0% Anthony R. Williams (1)..................................... 2,267,882 26.1 17.9 PAR Investment Partners, L.P. (2)........................... 1,489,811 16.9 11.6 David E. Tobin One Financial Center, Suite 1600 Boston, MA 02111 Robert W. Holmes, Jr. (3)................................... 701,665 8.0 5.5 Merchant Bankers, Inc. (4).................................. 549,942 6.3 4.3 50 North Front Street, 19th Floor Memphis, TN 38103 Spyglass Entertainment Group, L.P. (5)...................... 470,000 5.1 3.6 500 S. Buena Vista Street Burbank, CA 91521-1855 George M. Sundheim III (6).................................. 125,060 1.4 1.0 Mark Dyne (7)............................................... 95,844 1.1 * Joseph P. Morici(8)......................................... 12,003 * * Steven J. Massarsky......................................... 10,420 * * Stephen M. Ambler........................................... 5,212 * * Robert T. Slezak............................................ -- -- -- Anthony G. Williams......................................... -- -- -- All directors and executive officers as a group (10 persons) (1)(2)(3)(6)(7)(8)............................... 7,752,863 87.2% 60.1%
* Less than 1%. (1) Mr. Williams' shares of common stock and Series A and Series B Preferred Stock are currently held in an irrevocable trust administered by Breams Trust Limited. Although Breams Trustees Limited has the power to dispose of trust property, Mr. Williams has the right to appoint new or additional trustees and to require any trustee to resign. -------------------------------------------------------------------------------- 63 PRINCIPAL STOCKHOLDERS -------------------------------------------------------------------------------- (2) Includes 141,000 shares of our common stock issuable upon exercise of a warrant exercisable within 60 days held by PAR Investment Partners, L.P. PAR Group, L.P. is a Delaware limited partnership and the sole general partner of PAR Investment Partners, L.P. PAR Capital Management, Inc. is a Delaware S corporation and the sole general partner of PAR Group, L.P. Messrs. Paul A. Reeder, III, Frederick S. Downs, Jr., Arthur G. Epker, III and Edward L. Shapiro are deemed to be controlling shareholders of PAR Capital Management, Inc. and exercise voting and/or dispositive power over PAR Investment Partners, L.P. Mr. Tobin is a Vice President of PAR Capital Management, Inc. and disclaims beneficial ownership of the shares held by this entity except to the extent of his pecuniary interest in the shares. (3) Includes 53,267 options exercisable within 60 days. (4) Merchant Bankers, Inc. is the general partner of Morgan Keegan Early Stage Fund, L.P., which holds 22,092 shares of our Series B Preferred Stock (convertible into 103,832 shares of our common stock), Morgan Keegan Employee Investment Fund, L.P., which holds 6,237 shares of Series B Preferred Stock (convertible into 29,314 shares of our common stock) and 17,736 shares of our Series C Preferred Stock (convertible into 83,359 shares of our common stock) and Morgan Keegan Opportunity Fund L.P., which holds 70,944 shares of our Series C Preferred Stock (convertible into 333,437 shares of our common stock). Merchant Bankers, Inc. is deemed to beneficially own these shares. Merchant Bankers, Inc. is a wholly-owned subsidiary of Morgan Keegan & Company, Inc. Excludes 16,450 shares of common stock issuable upon exercise of a warrant exercisable within 60 days held by Morgan Keegan & Company, Inc., of which Merchant Bankers, Inc. disclaims beneficial ownership. (5) Represents shares of our common stock issuable upon exercise of warrants exercisable within 60 days. (6) Includes 45,825 shares of common stock held by D&S Partners, and 17,183 shares of our common stock, 10,969 shares of our Series A Preferred Stock (convertible into 51,554 shares of our common stock) and 900 shares of our Series C Preferred Stock (convertible into 4,230 shares of our common stock) held by FIMAS, L.P., of which Mr. Sundheim is a general partner. Mr. Sundheim disclaims beneficial ownership of the shares held by these entities except to the extent of his pecuniary interest in these shares. Also includes 6,267 options exercisable within 60 days. (7) Includes 6,267 options exercisable within 60 days. Excludes 103,104 shares of common stock, 21,938 shares of Series A Preferred Stock (convertible into 103,109 shares of our common stock) and the right to be issued up to 618,637 shares of common stock held by Selected Ventures, LLC which is 25% owned by Mr. Dyne and as to which he disclaims beneficial ownership. (8) Includes 7,833 options exercisable within 60 days. -------------------------------------------------------------------------------- 64 -------------------------------------------------------------------------------- Description of capital stock The following information describes our common stock and preferred stock, as well as options to purchase our common stock, and provisions of our certificate of incorporation and our bylaws, all as will be in effect upon the completion of this offering. This description is only a summary. You should also refer to our certificate of incorporation and bylaws which have been filed with the Securities and Exchange Commission as exhibits to our registration statement, of which this prospectus forms a part. The descriptions of the common stock and preferred stock, as well as options to purchase our common stock, reflect changes to our capital structure that will occur upon the completion of this offering in accordance with the terms of the certificate of incorporation. As of September 30, 2001, all outstanding shares of our capital stock were held of record by 27 stockholders. Our authorized capital stock consists of 100,000,000 shares of common stock, par value $0.001 per share and 10,000,000 shares of authorized preferred stock, par value $0.001 per share. COMMON STOCK We are authorized to issue 100,000,000 shares of common stock, par value $0.001 per share. As of September 30, 2001, options to purchase an aggregate of 984,856 shares of our common stock, and warrants to purchase 774,450 shares of our common stock and a contractual obligation to issue 618,637 shares of our common stock were outstanding. There will be 12,678,984 shares of our common stock outstanding after giving effect to the sale of the shares offered in this offering. + Voting rights -- The holders of our common stock are entitled to one vote for each share held of record. + Dividends -- Holders of record of shares of our common stock are entitled to receive dividends when, if and as may be declared by the board of directors out of funds legally available for such purposes, subject to the rights of preferred stockholders. We presently intend to retain future earnings, if any, for use in the operation and expansion of our business and do not anticipate paying cash dividends in the foreseeable future. + Liquidation rights -- Upon our liquidation, dissolution or winding-up, the holders of our common stock are entitled to share ratably in all assets available for distributions after payment in full to creditors and holders of preferred stock. + Other provisions -- The holders of our common stock are not entitled to cumulative voting, preemptive rights, subscription rights or the right to convert their common stock into any other securities. There are no redemption or sinking fund provisions applicable to the common stock. All outstanding shares are, and the shares of our common stock sold in the offering will be validly issued, fully paid and nonassessable. PREFERRED STOCK Upon the closing of this offering, all outstanding shares of our redeemable convertible preferred stock will be automatically converted into 4.7 shares of our common stock. Thereafter, our board of directors has the authority, without action by our stockholders, to issue up to 10,000,000 shares of preferred stock in one or more series and to designate the rights, preferences and privileges of each series, any or all of which may be greater than the rights of the common stock. The effect of the issuance of any shares of preferred stock upon the rights of holders of the common stock may include diluting the voting power of the common stock, impairing the liquidation rights of the common stock and delaying or preventing a change in control of our company without further action by the stockholders. -------------------------------------------------------------------------------- 65 DESCRIPTION OF CAPITAL STOCK -------------------------------------------------------------------------------- OPTIONS As of September 30, 2001, options to purchase a total of 984,856 shares of common stock were outstanding at prices ranging from $0.46 to $13.00. Of these options 966,056 were granted under our 2000 Stock Incentive Plan and 18,800 were granted outside of our 2000 Stock Incentive Plan. Additional options to purchase a total of 561,444 shares of common stock may be granted under our 2000 Stock Incentive Plan. See "Management -- 2000 Stock Incentive Plan." WARRANTS As of September 30, 2001, warrants to purchase a total of 774,450 shares of common stock were outstanding. Of these, warrants to purchase 674,450 shares had per share exercise prices ranging from $1.06 to $4.80 and a warrant to purchase 100,000 shares has a per share exercise price equal to the initial public offering price. The latter warrant is exercisable six months following the closing of this offering and the right to exercise that warrant terminates on August 30, 2004 or on December 31, 2001 if this offering has not occurred by that date. CONTINGENT ISSUANCES OF COMMON STOCK We are obligated to issue up to 687,375 shares of our common stock pursuant to a license agreement with a production studio. Pursuant to the terms of that license agreement, we have agreed to issue 68,738 shares of our common stock following the theatrical release of each film for which we have developed a software title, up to ten films. To date, we have issued 68,738 shares under this agreement. AUTHORIZED BUT UNISSUED CAPITAL STOCK Following the completion of this offering, there will be 87,321,016 shares of authorized but unissued common stock, or 86,721,016 if the underwriters' over-allotment option is exercised in full. Of this amount, 1,514,771 shares of common stock are reserved for issuance upon exercise of options outstanding or available for future grant under our 2000 Stock Incentive Plan. A total of 774,450 shares of common stock are also issuable upon the exercise of warrants that were outstanding as of June 30, 2001. In addition, following the completion of this offering, there will be 10,000,000 shares of authorized preferred stock. Delaware law does not require stockholder approval for the issuance of authorized shares. However, the listing requirements of The Nasdaq Stock Market, Inc., which apply so long as the common stock remains included in that inter-dealer quotation system, require prior stockholder approval of specified issuances, including certain issuances of shares at a price less than the greater of book or market value bearing voting power equal to or exceeding 20% of the pre-issuance outstanding voting power or pre-issuance outstanding number of shares of common stock. These additional shares could be used for a variety of corporate purposes, including, but not limited to, facilitating corporate acquisitions. One of the effects of the unissued and unreserved common stock and preferred stock may be to enable our board of directors to issue shares to persons who may agree or be inclined to vote in concert with current management on issues put to consideration of stockholders, which issuance could render more difficult or discourage an attempt to obtain control of us by means of a merger, tender offer, proxy contest or otherwise, and protect the continuity of our management and possibly deprive our stockholders of the opportunity to sell their shares of common stock at prices higher than prevailing market prices. DELAWARE ANTI-TAKEOVER LAW AND CHARTER AND BYLAW PROVISIONS We are subject to the provisions of Section 203 of the Delaware General Corporation Law. In general, this statute prohibits a publicly-held Delaware corporation from engaging in a "business combination" with an "interested stockholder" for a period of three years after the date that the person became an interested stockholder unless, with certain exceptions, the business combination or the transaction in which the person became an interested stockholder -------------------------------------------------------------------------------- 66 DESCRIPTION OF CAPITAL STOCK -------------------------------------------------------------------------------- is approved in a prescribed manner. Generally, a "business combination" includes a merger, asset or stock sale, or other transaction resulting in a financial benefit to the stockholder. Generally, an "interested stockholder" is a person who, together with affiliates and associates, owns or within three years prior, did own 15% or more of the corporation's voting stock. These provisions may have the effect of delaying, deferring or preventing a change in control of us without further action by our stockholders. Our certificate of incorporation and bylaws contain provisions that could have the effect of discouraging potential acquisition proposals or making a tender offer or delaying or preventing a change in control of our company, including changes a stockholder might consider favorable. In particular, our certificate of incorporation and bylaws, as applicable, among other things, will: + provide our board of directors with the ability to alter our bylaws without stockholder approval; + provide that special meetings of stockholders can only be called by our president or secretary at the request in writing of a majority of the members of our board of directors or holders of at least 10% of the total voting power of all outstanding shares of stock entitled to vote. In addition, the business permitted to be conducted at any special meeting of stockholders is limited to the business brought before the meeting by our board of directors or the stockholders; + provide for an advance notice procedure with regard to the nomination, other than by or at the direction of the board of directors, of candidates for election as directors and with regard to business to be brought before a meeting of stockholders; + provide that vacancies on our board of directors may be filled by a majority of directors in office, although less than a quorum; and + allow us to issue up to 10,000,000 shares of preferred stock with rights senior to those of the common stock and that otherwise could adversely affect the rights and powers, including voting rights, of the holders of common stock. In some circumstances, this issuance could have the effect of decreasing the market price of our common stock, as well as having the anti-takeover effects discussed above. Such provisions may have the effect of discouraging a third-party from acquiring us, even if doing so would be beneficial to our stockholders. These provisions are intended to enhance the likelihood of continuity and stability in the composition of our board of directors and in the policies formulated by them, and to discourage some types of transactions that may involve an actual or threatened change in control of our company. These provisions are designed to reduce our vulnerability to an unsolicited acquisition proposal and to discourage some tactics that may be used in proxy fights. We believe that the benefits of increased protection of our potential ability to negotiate with the proponent of an unfriendly or unsolicited proposal to acquire or restructure our company outweigh the disadvantages of discouraging such proposals because, among other things, negotiation of such proposals could result in an improvement of their terms. However, these provisions could have the effect of discouraging others from making tender offers for our shares that could result from actual or rumored takeover attempts. These provisions also may have the effect of preventing changes in our management. TRANSFER AGENT AND REGISTRAR The transfer agent and registrar for our common stock is American Stock Transfer Corporation, New York, New York. -------------------------------------------------------------------------------- 67 -------------------------------------------------------------------------------- Shares eligible for future sale Prior to this offering, there has been no market for our common stock. Future sales of substantial amounts of our common stock in the public market could adversely affect prevailing market prices. Furthermore, only a limited number of shares will be available for sale shortly after this offering because of contractual and legal restrictions on resale (as described below), sales of substantial amounts of our common stock in the public market after the restrictions lapse could adversely affect the prevailing market price and our ability to raise equity capital in the future. Upon completion of this offering, we will have outstanding 12,678,984 shares of our common stock. Of these shares, the 4,000,000 shares sold in the offering, plus any shares issued upon exercise of the underwriters' over-allotment option, will be freely tradable without restriction under the Securities Act, unless purchased by our "affiliates" as that term is defined in Rule 144 under the Securities Act, which generally would be our officers, directors and 10% stockholders. The remaining 8,678,984 shares outstanding are "restricted securities" within the meaning of Rule 144 under the Securities Act. Restricted securities may be sold in the public market only if registered or if they qualify for an exemption from registration, such as the exemption provided under Rules 144 or 701 promulgated under the Securities Act, which are summarized below. Sales of the restricted securities in the public market, or the availability of such shares for sale, could adversely affect the market price of the common stock. All of our securityholders have entered into lock-up agreements providing that they will not offer, sell, contract to sell or grant any option to purchase or otherwise dispose of our common stock or any securities exercisable for or convertible into our common stock owned by them for a period of 180 days after the effective date of the registration statement filed pursuant to this offering without the prior written consent of Jefferies & Company, Inc. In addition to the foregoing contractual lock-up agreements, pursuant to Rule 2710 of the NASD Conduct Rules, Merchant Bankers, Inc., as general partner of the Morgan Keegan Opportunity Fund, L.P., Morgan Keegan Employee Investment Fund, L.P., and Morgan Keegan & Company, Inc. have agreed that they will not cause or permit either of those partnerships to offer, sell, contract to sell or grant any option to purchase or otherwise dispose of 131,965 shares of common stock that will be held by the Morgan Keegan Opportunity Fund, L.P. and the Morgan Keegan Employee Investment Fund, L.P. for a period of one year after the effective date of the registration statement. Morgan Keegan & Company, Inc. has further agreed that it will not offer, sell, contract to sell or grant any option to purchase or otherwise dispose of 16,450 shares of common stock that it may acquire pursuant to the exercise of warrants for a period of one year after the effective date of the registration statement. As a result of these contractual restrictions, notwithstanding possible earlier eligibility for sale under an effective registration statement or an exemption from registration, shares subject to lock-up agreements may not be sold until such agreements expire or are waived by Jefferies & Company, Inc. Among the factors that Jefferies & Company, Inc. may consider in consenting to an early release of such shares are the condition of the securities markets in general and the market price and trading activity of our common stock and the personal requirements of the subject stockholder in particular. Jefferies & Company, Inc. has advised us that it has no present intention to release any of the shares subject to the lock-up agreements prior to the expiration of the lock-up period. Taking into account the lock-up agreements, and assuming Jefferies & Company, Inc. does not release stockholders from these agreements, the following shares will be eligible for sale in the public market at the following times: + beginning on the effective date of the offering, only the shares sold in this offering will be immediately available for sale in the public market; + 7,442,920 shares will become eligible for sale pursuant to Rule 144 beginning 180 days after the date of this prospectus, 68,738 shares will be eligible for sale in April 2002 and 1,022,632 shares will be eligible for sale in May 2002, 12,729 shares will be eligible for sale in August 2002 and 131,965 shares will be eligible for sale beginning one year after the date of this prospectus. Shares eligible to be sold by affiliates pursuant to Rule 144 are subject to volume restrictions as described below; -------------------------------------------------------------------------------- 68 SHARES ELIGIBLE FOR FUTURE SALE -------------------------------------------------------------------------------- + 774,450 shares issuable upon exercise of outstanding warrants and 618,637 shares issuable pursuant to a contractual arrangement will be eligible for sale one year after issuance. In general, under Rule 144 currently in effect, and beginning after the expiration of the lock-up agreements, a person, or persons whose shares are aggregated, who has beneficially owned restricted shares for at least one year would be entitled to sell within any three-month period a number of shares that does not exceed the greater of: + 1% of the number of shares of common stock then outstanding, which will equal approximately 126,790 shares immediately after the offering; or + the average weekly trading volume of the common stock on the Nasdaq National Market during the four calendar weeks preceding the sale. Sales under Rule 144 are also subject to manner of sale provisions and notice requirements and to the availability of current public information about us. Under Rule 144(k), a person who is not deemed to have been an affiliate of us at any time during the three months preceding a sale, and who has beneficially owned the shares proposed to be sold for at least two years, is entitled to sell shares without complying with the manner of sale, public information, volume limitation or notice provisions of Rule 144. Beginning 90 days after the effective date, any employee, officer or director of or consultant to us who purchased shares pursuant to a written compensatory plan or contract may be entitled to rely on the resale provisions of Rule 701. Rule 701 permits affiliates to sell their Rule 701 shares under Rule 144 without complying with the holding period requirements of Rule 144. Rule 701 further provides that non-affiliates may sell such shares in reliance on Rule 144 without having to comply with the holding period, public information, volume limitation or notice provisions of Rule 144. In addition, we intend to file registration statements under the Securities Act as promptly as possible after the effective date to register shares to be issued pursuant to our employee benefit plans. As a result, any options exercised under our 2000 Stock Incentive Plan or any of our other benefit plans after the effectiveness of such registration statement will also be freely tradable in the public market following the expiration of the 180-day lock-up period, except that shares held by affiliates will still be subject to the volume limitation, manner of sale, notice and public information requirements of Rule 144 unless otherwise resalable under Rule 701. The sale of a significant number of these shares could cause the price of our common stock to decline. -------------------------------------------------------------------------------- 69 -------------------------------------------------------------------------------- Underwriting We and the underwriters for the offering named below have entered into an underwriting agreement concerning the shares being offered. Subject to conditions, each underwriter has severally agreed to purchase the number of shares indicated in the following table. Jefferies & Company, Inc. and Morgan Keegan & Company, Inc. are the representatives of the underwriters.
NUMBER UNDERWRITER OF SHARES ----------------------------------------------------------------------- Jefferies & Company, Inc. .................................. Morgan Keegan & Company, Inc. .............................. --------- Total....................................................... 4,000,000 =========
If the underwriters sell more shares than the total number set forth in the table above, the underwriters have a 30-day option to buy from us up to an additional 600,000 shares at the initial public offering price less the underwriting discounts and commissions to cover these sales. If any shares are purchased under this option, the underwriters will severally purchase shares in approximately the same proportion as set forth in the table above. The following table shows the per share and total underwriting discounts and commissions we will pay to the underwriters. These amounts are shown assuming both no exercise and full exercise of the underwriters' option to purchase up to an additional 600,000 shares.
NO EXERCISE FULL EXERCISE ----------------------------------------------------------------------------------------- Per share................................................... $ $ Total....................................................... $ $
We have agreed with the underwriters that the fees and expenses of their legal counsel and certain travel costs, in the maximum aggregate amount of $300,000, will be paid by us. We estimate that the total expenses of the offering payable by us, including the fees and expenses of counsel to the underwriters and certain travel costs but excluding underwriting discounts and commissions, will be approximately $3,300,000. This offering is made in accordance with the conflict of interest rules governing underwriters' conduct, as set forth in Rule 2720 of the NASD Manual. Morgan Keegan & Company, Inc. is a member of the underwriting syndicate, but because affiliates of Morgan Keegan & Company, Inc. own 28,329 shares of our Series B Preferred Stock, 88,680 shares of our Series C Preferred Stock, and a five-year warrant to purchase 16,450 shares of our common stock (see Related Party Transactions), Morgan Keegan & Company, Inc. is presumed to have a conflict of interest. Jefferies & Company, Inc. will therefore act as Qualified Independent Underwriter, as defined in Rule 2720(b)(15), in connection with pricing the offering and conducting due diligence. Shares sold by the underwriters to the public will initially be offered at the initial public offering price, as determined by Jefferies & Company, Inc., the qualified independent underwriter, set forth on the cover of this prospectus. Any shares sold by the underwriters to securities dealers may be sold at a discount of up to $ per share from the initial public offering price. Any of these securities dealers may resell any shares purchased from the underwriters to other brokers or dealers at a discount of up to $ per share from the initial public offering price. If all the shares are not sold at the initial public offering price, Jefferies & Company, Inc. may change the offering price and the selling terms. The underwriters have informed us that they do not expect discretionary sales to exceed % of the shares of common stock to be offered. All of our securityholders have agreed with the underwriters not to offer, sell, contract to sell, hedge or otherwise dispose of, directly or indirectly, or file with the SEC a registration statement under the Securities Act relating to, any shares of our common stock or securities convertible into or exchangeable for shares of common stock during the period from the date of this prospectus continuing through the date 180 days after the date of this prospectus, -------------------------------------------------------------------------------- 70 UNDERWRITING -------------------------------------------------------------------------------- without the prior written consent of Jefferies & Company, Inc. Among the factors that Jefferies & Company, Inc. may consider in consenting to an early release of such shares are the condition of the securities markets in general and the market price and trading activity of our common stock and the personal requirements of the subject stockholder in particular. Jefferies & Company, Inc. has advised us that it has no present intention to release any of the shares subject to the lock-up agreements prior to the expiration of the lock-up period. In addition to the foregoing contractual lock-up agreements, pursuant to Rule 2710 of the NASD Conduct Rules, Merchant Bankers, Inc., as general partner of the Morgan Keegan Opportunity Fund, L.P., Morgan Keegan Employee Investment Fund, L.P., and Morgan Keegan & Company, Inc. have agreed that they will not cause or permit either of those partnerships to offer, sell, contract to sell or grant any option to purchase or otherwise dispose of 131,965 shares of common stock that will be held by the Morgan Keegan Opportunity Fund, L.P. and the Morgan Keegan Employee Investment Fund, L.P. for a period of one year after the effective date of the registration statement. Morgan Keegan & Company, Inc. has further agreed that it will not offer, sell, contract to sell or grant any option to purchase or otherwise dispose of 16,450 shares of common stock that it may acquire pursuant to the exercise of warrants for a period of one year after the effective date of the registration statement. The underwriters have reserved for sale, at the initial public offering price, shares of our common stock being offered for sale to our customers and business partners. At the discretion of our management, other parties, including our employees, may participate in this reserved shares program. The number of shares available for sale to the general public in the offering will be reduced to the extent these persons purchase reserved shares. Any reserved shares not so purchased will be offered by the underwriters to the general public on the same terms as the other shares. Prior to this offering, there has been no public market for our common stock. The initial public offering price will be negotiated by us and Jefferies & Company, Inc., the qualified independent underwriter. The principal factors to be considered in determining the initial public offering price will include: + the information set forth in this prospectus and otherwise available to the representatives; + the history and the prospects for the industry in which we compete; + the abilities of our management; + our prospects for future earnings, the present state of our development and our current financial position; + the general condition of the securities markets at the time of this offering; and + recent market prices of, and demand for, publicly traded common stock of comparable companies. In connection with the offering, the underwriters may purchase and sell shares of our common stock in the open market. These transactions may include short sales, stabilizing transactions and purchases to cover positions created by short sales. Short sales involve the sale by the underwriters of a greater number of shares than they are required to purchase in the offering. "Covered" short sales are sales made in an amount not greater than the underwriters' option to purchase additional shares from us in the offering. The underwriters may close out any covered short position by either exercising their option to purchase additional shares or purchasing shares in the open market. In determining the source of shares to close out the covered short position, the underwriters will consider, among other things, the price of shares available for purchase in the open market as compared to the price at which they may purchase shares through the overallotment option. "Naked" short sales are any sales in excess of the overallotment option. The underwriters must close out any naked short position by purchasing shares in the open market. A naked short position is more likely to be created if the underwriters are concerned that there may be downward pressure on the price of the common stock in the open market after pricing that could adversely affect investors who purchase in the offering. Stabilizing transactions consist of bids or purchases made for the purpose of preventing or retarding a decline in the market price of our common stock while the offering is in progress. The underwriters also may impose a penalty bid. This occurs when a particular underwriter repays to the underwriters a portion of the underwriting discount received -------------------------------------------------------------------------------- 71 UNDERWRITING -------------------------------------------------------------------------------- by it because the representatives have repurchased shares sold by or for the account of that underwriter in stabilizing or short covering transactions. These activities by the underwriters may stabilize, maintain or otherwise affect the market price of our common stock. As a result, the price of our common stock may be higher than the price that otherwise might exist in the open market. If these activities are commenced, they may be discontinued by the underwriters at any time. These transactions may be effected on the Nasdaq National Market, in the over-the-counter market or otherwise. We have agreed to indemnify the several underwriters against liabilities, including liabilities under the Securities Act and to contribute to payments that the underwriters may be required to make in respect thereof. -------------------------------------------------------------------------------- 72 -------------------------------------------------------------------------------- Legal matters Kirkpatrick & Lockhart LLP, Los Angeles, California, will pass for us on the validity of the common stock offered hereby. Brobeck, Phleger & Harrison LLP, Palo Alto, California, is acting as counsel for the underwriters in connection with selected legal matters. An affiliate of Kirkpatrick & Lockhart LLP owns 1,109 shares of our Series C Preferred Stock (convertible into 5,212 shares of our common stock) and holds a warrant to purchase 47,000 shares of our common stock at an exercise price of $4.80 per share. Experts The consolidated financial statements as of June 30, 2000 and 2001 and for the period from October 7, 1999 (inception) through June 30, 2000 and for the year ended June 30, 2001 included in this prospectus and the related consolidated financial statement schedule included elsewhere in the registration statement have been audited by Deloitte & Touche LLP, independent auditors, as stated in their reports appearing herein and elsewhere in the registration statement, and have been so included in reliance upon the reports of such firm given upon their authority as experts in accounting and auditing. Where you can find additional information We filed a registration statement on Form S-1 under the Securities Act with the SEC to register the shares of our common stock offered by this prospectus. This prospectus does not contain all of the information set forth in the registration statement and the exhibits to the registration statement. You should refer to the registration statement and the exhibits and schedules to the registration statement for more information about us and our common stock. Our statements in this prospectus concerning the contents of any document are not necessarily complete, and in each instance, we refer you to the copy of the document filed as an exhibit to the registration statement. Each statement about those documents is qualified in its entirety by this reference. Following this offering, we will become subject to the reporting requirements of the Securities Exchange Act of 1934. In accordance with that law, we will be required to file reports and other information with the SEC. The registration statement and exhibits, as well as those reports and other information when we file them, may be inspected without charge at the public reference facilities maintained by the SEC at 450 Fifth Street, N.W., Washington, D.C. 20549, and at the regional office of the SEC located at the Northwestern Atrium Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661. Please call the SEC at 1-800-SEC-0330 for further information on the operation of the public reference facilities. Copies of all or any part of the registration statement may be obtained from the SEC's offices upon payment of fees prescribed by the SEC. The SEC maintains a World Wide Web site that contains reports, proxy and information statements and other information regarding registrants that file electronically with the SEC. The address of the site is http://www.sec.gov. We will furnish to our stockholders annual reports and unaudited quarterly reports for the first three quarters of each fiscal year. Annual reports will include audited consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America. The consolidated financial statements included in those annual reports will be audited and reported upon, with an opinion expressed, by our independent auditors. -------------------------------------------------------------------------------- 73 BAM! ENTERTAINMENT, INC. AND SUBSIDIARIES -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- Index to Consolidated Financial Statements
PAGE ------------------------------------------------------------------- Independent Auditors' Report................................ F-2 Consolidated Balance Sheets as of June 30, 2000 and 2001 and September 30, 2001 (unaudited)............................ F-3 Consolidated Statements of Operations for the period from October 7, 1999 (inception) through June 30, 2000, the year ended June 30, 2001 and the three month periods ended September 30, 2000 and 2001 (unaudited)................... F-4 Consolidated Statements of Stockholders' Equity (Deficit) and Comprehensive Loss for the period from October 7, 1999 (inception) through June 30, 2000, the year ended June 30, 2001 and the three month period ended September 30, 2001 (unaudited)............................................... F-5 Consolidated Statements of Cash Flows for the period from October 7, 1999 (inception) through June 30, 2000, the year ended June 30, 2001 and the three month periods ended September 30, 2000 and 2001 (unaudited)................... F-6 Notes to Consolidated Financial Statements.................. F-7
-------------------------------------------------------------------------------- F- 1 -------------------------------------------------------------------------------- INDEPENDENT AUDITORS' REPORT To the Board of Directors and Stockholders of BAM! Entertainment, Inc.: We have audited the accompanying consolidated balance sheets of BAM! Entertainment, Inc. and its subsidiaries (the "Company") as of June 30, 2000 and 2001, and the related consolidated statements of operations, stockholders' equity (deficit) and comprehensive loss, and cash flows for the period from October 7, 1999 (inception) through June 30, 2000 and the year ended June 30, 2001. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of June 30, 2000 and 2001, and the results of its operations and its cash flows for the period from October 7, 1999 (inception) through June 30, 2000 and for the year ended June 30, 2001 in conformity with accounting principles generally accepted in the United States of America. DELOITTE & TOUCHE LLP San Jose, California August 15, 2001 (August 31, 2001 as to the last two paragraphs of Note 15) -------------------------------------------------------------------------------- F- 2 BAM! ENTERTAINMENT, INC. AND SUBSIDIARIES -------------------------------------------------------------------------------- CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
PRO FORMA JUNE 30, SEPTEMBER 30, SEPTEMBER 30, ---------------- 2001 2001 2000 2001 (UNAUDITED) (UNAUDITED) -------------------------------------------------------------------------------------------------------------- ASSETS Current assets: Cash and cash equivalents................................. $ 908 $ 2,170 $ 474 Accounts receivable, net of allowance of $77 as of June 30, 2000, $1,163 as of June 30, 2001, and $1,617 as of September 30, 2001...................................... 1,299 7,372 10,855 Inventories............................................... 6 1,463 2,299 Prepaid royalties, capitalized software costs and licensed assets.................................................. 368 5,924 7,886 Prepaid expenses and other................................ 52 393 2,812 ------ ------- ------- Total current assets............................... 2,633 17,322 24,326 Prepaid royalties, capitalized software and licensed assets, net of current portion.................................... -- 1,545 1,385 Property and equipment, net................................. 79 395 662 Other assets................................................ -- 1,730 2,299 ------ ------- ------- Total assets....................................... $2,712 $20,992 $28,672 ====== ======= ======= LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (DEFICIT) Current liabilities: Accounts payable -- trade................................. $ 118 $ 1,489 $ 4,197 Short-term borrowings..................................... 610 4,164 6,075 Royalties payable......................................... 248 310 499 Accrued compensation and related benefits................. 221 1,026 1,401 Accrued software costs.................................... -- 781 1,456 Accrued expenses -- other................................. 118 562 1,593 ------ ------- ------- Total current liabilities.......................... 1,315 8,332 15,221 Redeemable convertible preferred stock; $0.001 par value; shares authorized: 10,000,000; shares issued and outstanding: 976,220, 1,516,499 and 1,516,499 as of June 30, 2000 and 2001 and September 30, 2001, respectively, none issued and outstanding on a pro forma basis.......... 2,103 17,329 17,329 Stockholders' equity (deficit): Common stock, $0.001 par value; shares authorized: 100,000,000; shares issued and outstanding: 1,469,972, 1,538,710 and 1,551,439 as of June 30, 2000 and 2001 and September 30, 2001, respectively, 8,678,984 issued and outstanding on a pro forma basis........................ 1 1 1 $ 9 Additional paid-in capital................................ 97 5,375 6,337 23,658 Receivable from stockholder............................... (1) -- -- -- Deferred stock compensation............................... -- (2,096) (1,833) (1,833) Accumulated deficit....................................... (803) (7,945) (8,434) (8,434) Accumulated other comprehensive income (loss)............. -- (4) 51 51 ------ ------- ------- ------- Total stockholders' equity (deficit)........................ (706) (4,669) (3,878) $13,451 ------ ------- ------- ======= Total liabilities and stockholders' equity (deficit)........................................ $2,712 $20,992 $28,672 ====== ======= =======
See notes to consolidated financial statements -------------------------------------------------------------------------------- F- 3 BAM! ENTERTAINMENT, INC. AND SUBSIDIARIES -------------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
PERIOD FROM OCTOBER 7, 1999 THREE MONTHS (INCEPTION) YEAR ENDED THROUGH ENDED SEPTEMBER 30, JUNE 30, JUNE 30, ----------------- 2000 2001 2000 2001 (Unaudited) --------------------------------------------------------------------------------------------------------- Net revenues................................................ $ 1,377 $25,351 $ 495 $10,827 Costs and expenses: Cost of revenues: Cost of goods sold...................................... 807 14,827 179 6,155 Royalties, software costs, license costs and project abandonment........................................... 248 2,898 126 1,548 ----------- ------- ------ ------- Total cost of revenues............................. 1,055 17,725 305 7,703 Research and development (exclusive of amortization of deferred stock compensation)............................ 260 1,073 114 449 Sales and marketing (exclusive of amortization of deferred stock compensation)..................................... 132 4,292 252 1,375 General and administrative (exclusive of amortization of deferred stock compensation)............................ 711 1,996 252 729 Amortization of deferred stock compensation*.............. -- 618 -- 352 ----------- ------- ------ ------- Total costs and expenses........................... 2,158 25,704 923 10,608 ----------- ------- ------ ------- Income (loss) from operations............................... (781) (353) (428) 219 Interest income............................................. 8 58 3 5 Interest expense............................................ (39) (1,325) (10) (712) Other income (expense)...................................... 9 18 -- (1) ----------- ------- ------ ------- Net loss.................................................... (803) (1,602) (435) (489) Redeemable convertible preferred stock dividend............. -- (5,540) -- -- ----------- ------- ------ ------- Net loss attributable to common stockholders................ $ (803) $(7,142) $ (435) $ (489) =========== ======= ====== ======= Net loss per share: Basic and diluted......................................... $ (0.96) $ (4.82) $(0.30) $(0.32) =========== ======= ====== ======= Shares used in computation: Basic and diluted......................................... 834 1,482 1,470 1,544 =========== ======= ====== ======= Pro forma net loss per share (Note 1): Basic and diluted (unaudited)............................. $ (1.04) $(0.06) ======= ======= Shares used in pro forma computation (Note 1): Basic and diluted (unaudited)............................. 6,898 8,672 ======= ======= * Amortization of deferred stock compensation: Research and development.................................. $ -- $ 72 $ -- $ 58 Sales and marketing....................................... -- 28 -- 25 General and administrative................................ -- 518 -- 269 ----------- ------- ------ ------- $ -- $ 618 $ -- $ 352 =========== ======= ====== =======
See notes to consolidated financial statements -------------------------------------------------------------------------------- F- 4 BAM! ENTERTAINMENT, INC. AND SUBSIDIARIES -------------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) AND COMPREHENSIVE LOSS (IN THOUSANDS, EXCEPT SHARE AMOUNTS)
ACCUMULATED COMMON STOCK ADDITIONAL RECEIVABLE DEFERRED OTHER --------------------- PAID-IN FROM STOCK ACCUMULATED COMPREHENSIVE SHARES AMOUNT CAPITAL STOCKHOLDER COMPENSATION DEFICIT INCOME (LOSS) ------------------------------------------------------------------------------------------------- Issuance of common stock for note receivable................ 580,962 $ -- $ 1 $ (1) $ -- $ -- $-- Issuance of common stock for services....................... 343,683 -- 37 -- -- -- -- Sale of common stock............ 545,327 1 59 -- -- -- -- Net loss and comprehensive loss........................... -- -- -- -- -- (803) -- --------- --------- --------- --------- ---------- ---------- --- Balance, June 30, 2000.......... 1,469,972 1 97 (1) -- (803) -- Issuance of common stock in connection with a license agreement...................... 68,738 -- 746 -- -- -- -- Issuance of common stock warrants in connection with a license agreement.............. -- -- 910 -- -- -- -- Issuance of common stock warrants to a service provider in connection with Series B redeemable convertible preferred stock................ -- -- 283 -- -- -- -- Issuance of common stock warrants to a service provider in connection with Series C redeemable convertible preferred stock................ -- -- 159 -- -- -- -- Issuance of common stock warrants to a service provider in connection with a proposed initial public offering........ -- -- 456 -- -- -- -- Issuance of stock options to consultant..................... -- -- 10 -- -- -- Deferred stock compensation..... -- -- 2,714 -- (2,714) -- -- Collection of note receivable from stockholder............... -- -- -- 1 -- -- -- Amortization of deferred stock compensation................... -- -- -- -- 618 -- -- Net loss........................ -- -- -- -- -- (1,602) -- Redeemable convertible preferred stock dividend................. -- -- -- -- -- (5,540) -- Change in accumulated other comprehensive income (loss).... -- -- -- -- -- -- (4) Comprehensive loss.............. -- -- -- -- -- -- -- --------- --------- --------- --------- ---------- ---------- --- Balance, June 30, 2001.......... 1,538,710 $ 1 $ 5,375 $ -- $ (2,096) $ (7,945) $(4) Exercise of stock options*...... 12,729 -- 5 -- -- -- -- Issuance of stock options to consultant*.................... -- -- 62 -- -- -- -- Deferred stock compensation*.... -- -- 89 -- (89) -- -- Amortization of deferred stock compensation*.................. -- -- -- -- 352 -- -- Issuance of common stock warrants to a service provider in connection with a finance agreement*..................... -- -- 806 -- -- -- -- Net loss*....................... -- -- -- -- -- (489) -- Change in accumulated other comprehensive income (loss)*... -- -- -- -- -- -- 55 Comprehensive loss*............. --------- --------- --------- --------- ---------- ---------- --- Balance, September 30, 2001*.... 1,551,439 $ 1 $ 6,337 $ -- $ (1,833) $ (8,434) $51 ========= ========= ========= ========= ========== ========== === TOTAL STOCKHOLDERS' EQUITY TOTAL (DEFICIT) COMPREHENSIVE -------------------------------- LOSS Issuance of common stock for note receivable................ $ -- Issuance of common stock for services....................... 37 Sale of common stock............ 60 Net loss and comprehensive loss........................... (803) ---------- Balance, June 30, 2000.......... (706) Issuance of common stock in connection with a license agreement...................... 746 Issuance of common stock warrants in connection with a license agreement.............. 910 Issuance of common stock warrants to a service provider in connection with Series B redeemable convertible preferred stock................ 283 Issuance of common stock warrants to a service provider in connection with Series C redeemable convertible preferred stock................ 159 Issuance of common stock warrants to a service provider in connection with a proposed initial public offering........ 456 Issuance of stock options to consultant..................... 10 Deferred stock compensation..... -- Collection of note receivable from stockholder............... 1 Amortization of deferred stock compensation................... 618 Net loss........................ (1,602) $ (1,602) Redeemable convertible preferred stock dividend................. (5,540) -- Change in accumulated other comprehensive income (loss).... (4) (4) ---------- Comprehensive loss.............. -- $ (1,606) ---------- ========== Balance, June 30, 2001.......... $ (4,669) Exercise of stock options*...... 5 Issuance of stock options to consultant*.................... 62 Deferred stock compensation*.... -- Amortization of deferred stock compensation*.................. 352 Issuance of common stock warrants to a service provider in connection with a finance agreement*..................... 806 Net loss*....................... (489) $ (489) Change in accumulated other comprehensive income (loss)*... 55 55 ---------- Comprehensive loss*............. $ (434) ---------- ========== Balance, September 30, 2001*.... $ (3,878) ==========
* Unaudited See notes to consolidated financial statements -------------------------------------------------------------------------------- F- 5 BAM! ENTERTAINMENT, INC. AND SUBSIDIARIES -------------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
PERIOD FROM OCTOBER 7, THREE MONTHS 1999 ENDED (INCEPTION) THROUGH YEAR ENDED SEPTEMBER 30, JUNE 30, JUNE 30, 2000 2001 2000 2001 (UNAUDITED) -------------------------------------------------------------------------------------------------------------------- Cash flows from operating activities: Net loss.................................................... $ (803) $(1,602) $(435) $ (489) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization............................. 12 1,859 8 1,668 Provision for bad debts and price protection.............. 77 1,989 62 1,131 Consulting services performed in exchange for common stock and options............................................. 37 10 10 62 Consulting services performed in exchange for redeemable convertible preferred stock............................. 96 -- -- -- Other..................................................... -- (4) -- 55 Changes in operating assets and liabilities: Accounts receivable..................................... (1,376) (8,062) 804 (4,614) Inventories............................................. (6) (1,457) (56) (836) Prepaid expenses and other.............................. (52) 115 (106) (1,728) Prepaid royalties, capitalized software costs and licensed assets....................................... (368) (6,581) (768) (2,946) Accounts payable - trade................................ 118 1,371 264 2,708 Royalties payable....................................... 248 62 (122) 189 Accrued compensation and related benefits............... 221 805 103 375 Accrued software costs.................................. -- 781 -- 675 Accrued expenses - other................................ 118 444 (53) 1,031 ------- ------ ----- ------- Net cash used in operating activities................. (1,678) (10,270) (289) (2,719) ------- ------ ----- ------- Cash flows from investing activities: Purchase of property and equipment........................ (91) (421) (2) (324) Increase in other assets.................................. -- (1,730) -- (569) ------- ------ ----- ------- Net cash used in investing activities................. (91) (2,151) (2) (893) ------- ------ ----- ------- Cash flows from financing activities: Net proceeds from issuance of promissory notes............ 1,047 -- -- -- Advances under short-term borrowings...................... 610 14,912 361 6,779 Repayments of short-term borrowings....................... -- (11,358) (828) (4,868) Net proceeds from issuance of common stock................ 60 -- -- 5 Collection of note receivable from stockholder............ -- 1 -- -- Net proceeds from issuance of redeemable convertible preferred stock......................................... 960 10,128 -- -- ------- ------ ----- ------- Net cash provided by (used in) financing activities... 2,677 13,683 (467) 1,916 ------- ------ ----- ------- Net increase (decrease) in cash and cash equivalents........ 908 1,262 (758) (1,696) Cash and cash equivalents, beginning of period.............. -- 908 908 2,170 ------- ------ ----- ------- Cash and cash equivalents, end of period.................... $ 908 $2,170 $ 150 $ 474 ======= ====== ===== ======= Noncash investing and financing activities: Conversion of promissory notes to redeemable convertible preferred stock......................................... $ 1,047 $ -- $ -- $ -- ======= ====== ===== ======= Issuance of common stock for promissory notes............. $ 1 $ -- $ -- $ -- ======= ====== ===== ======= Issuance of common stock in connection with license agreement............................................... $ -- $ 746 $ -- $ -- ======= ====== ===== ======= Issuance of common stock warrants in connection with license agreement....................................... $ -- $ 910 $ -- $ -- ======= ====== ===== ======= Issuance of common stock warrants in connection with a finance agreement....................................... $ -- $ -- $ -- $ 806 ======= ====== ===== ======= Issuance of common stock warrants to a service provider in connection with a proposed initial public offering...... $ -- $ 456 $ -- $ -- ======= ====== ===== ======= Issuance of common stock warrants in connection with redeemable convertible preferred stock.................. $ -- $ 442 $ -- $ -- ======= ====== ===== ======= Deferred stock compensation............................... $ -- $2,714 $ -- $ 89 ======= ====== ===== =======
See notes to consolidated financial statements -------------------------------------------------------------------------------- F- 6 BAM! ENTERTAINMENT, INC. AND SUBSIDIARIES -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS PERIOD FROM OCTOBER 7, 1999 (INCEPTION) THROUGH JUNE 30, 2000, AND YEAR ENDED JUNE 30, 2001 (ALL INFORMATION AS OF SEPTEMBER 30, 2001 AND FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2000 AND 2001 IS UNAUDITED) 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Organization and Business -- BAM! Entertainment, Inc. and subsidiaries (the "Company") is a developer and publisher of interactive entertainment software products for popular interactive entertainment hardware platforms and personal computers. The Company licenses popular properties that have consumer recognition and appeal from a wide variety of sources and publishes software based on their motion picture, television, sports and cartoon character properties. The Company sells its software to mass merchandisers and independent distributors. Principles of Consolidation -- The consolidated financial statements include the Company and its wholly-owned subsidiaries in the United Kingdom. All intercompany transactions and balances have been eliminated in consolidation. Stock Split -- In May 2000, the Company effected a reverse common stock split of 0.195 to one with an adjusted par value of $0.001. On August 15, 2001, the Company effected a common stock split of 4.7 to one with an adjusted par value of $0.001 and increased the number of authorized shares of common stock to 100,000,000 shares and preferred stock to 10,000,000 shares. All common share and per share amounts in these consolidated financial statements have been adjusted to give effect to these stock splits. Foreign Currency Translation -- The functional currency for the Company's foreign operations is the applicable local currency. The translation of the applicable foreign currencies into U.S. dollars is performed for balance sheet accounts using exchange rates in effect at the balance sheet date and for revenue and expense accounts using a weighted-average exchange rate during the period. The gains or losses resulting from such translation are reported as a separate component of equity as accumulated other comprehensive loss, whereas gains or losses resulting from foreign currency transactions are included in results of operations. Use of Estimates -- The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Such estimates include, but are not limited to: allowances for price protection, uncollectible accounts receivable and sales returns; inventory valuations; recoverability of prepaid royalties, capitalized software costs and licensed assets; depreciation and amortization; taxes and contingencies. Actual results could differ from those estimates. Certain Significant Risks and Uncertainties -- Financial instruments which potentially subject the Company to concentrations of credit risk consist primarily of cash and cash equivalents and accounts receivable. Cash and cash equivalents are held with one financial institution and consist primarily of cash in bank accounts. The Company generates revenue primarily from large retailers in the United States and generally does not require its customers to provide collateral or other security to support accounts receivable. To reduce credit risk, management performs ongoing credit evaluations of its customers' financial condition and maintains allowances for estimated potential bad debt losses. The Company participates in a dynamic high-technology industry and believes that changes in any of the following areas could have a material adverse effect on the Company's future financial position, results of operations or cash flows: ability to obtain future financing; advances and trends in new technologies and industry standards; competitive pressures in the form of new and more popular products by competitors; changes in the overall demand by customers and consumers for products offered by the Company; unexpected quantities of product returns and mark-down allowances; changes in certain strategic relationships or customer relationships; the loss of significant customers; litigation or claims against the Company based on intellectual property, patent, product, regulatory or other factors; the inability to procure the necessary third-party licenses or proprietary software needed to develop its products; risks -------------------------------------------------------------------------------- F- 7 BAM! ENTERTAINMENT, INC. AND SUBSIDIARIES -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) associated with changes in domestic and international economic and/or political conditions or regulations; risks associated with regulation within the industry; availability of necessary product components; the Company's ability to attract and retain employees necessary to support its growth; the Company's reliance on senior management; the Company's limited operating history; inability to manage the growth of the business; delays and cost overruns on products under development; risks associated with development of products by third-party developers; failure to anticipate changing consumer preferences; dependence on hardware manufacturers for the provision of the platforms necessary to generate revenue; the Company's inability to protect its proprietary rights or to avoid claims from other companies; short product life cycles; and the reliance on platform manufacturers in manufacturing the Company's products. Cash and Cash Equivalents -- The Company considers all highly liquid debt instruments purchased with maturities at the date of purchase of three months or less to be cash equivalents. The recorded carrying amounts of the Company's cash and cash equivalents approximate their fair market value due to their short maturities. Inventories -- Inventories, which consist of finished goods, are stated at the lower of cost (based upon the first-in, first-out method) or market value. The Company estimates the net realizable value of slow moving inventories on a product-by-product basis and charges the excess of cost over net realizable value to cost of revenues. Property and Equipment -- Property and equipment are stated at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the assets of three years. Prepaid Royalties, Capitalized Software Costs and Licensed Assets -- Advance royalty payments for intellectual property licenses are capitalized and recorded as prepaid royalties. Royalty payments for intellectual property licenses are classified as current assets to the extent they relate to anticipated sales during the subsequent year and long-term assets if the sales are anticipated after one year. Royalty payments are based on sales and royalties are generally payable on a quarterly basis. Prepaid royalties are amortized to cost of revenues commencing upon the product release at the greater of the contractual royalty rate based on actual product sales, or the ratio of current revenues to total projected revenues. The Company evaluates the future recoverability of prepaid royalties on a quarterly basis and expenses them to costs of revenue if and when they are deemed unrecoverable. The Company utilizes both independent software developers (who are paid advances against future royalties) and internal development teams to develop its software. The Company accounts for prepaid royalties relating to development agreements and capitalized software costs in accordance with Statement of Financial Accounting Standards ("SFAS") No. 86, Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed. Payments made to independent software developers under development agreements are capitalized to software development costs once technological feasibility is established or if the development costs have an alternative future use. Prior to establishing technological feasibility, software development costs are expensed to research and development and to cost of revenues subsequent to technological feasibility. Internal development costs are capitalized to software development costs once technological feasibility is established. Technological feasibility is evaluated on a product-by-product basis. For products where proven game engine technology exists, this may occur early in the development cycle. Commencing upon product release, capitalized software development costs are amortized to "royalties, software costs, license costs and project abandonment." Software development costs are expensed if and when they are deemed unrecoverable. The following criteria are used to evaluate recoverability of software development costs: the commercial acceptance of prior products released on a given hardware platform; orders for a product prior to its release; and actual development costs of a product as compared to forward-looking projections. Amortization of such costs is based on the greater of the proportion of current revenues to total projected revenues, or the straight-line method over the estimated product life (generally three to six months). The Company evaluates the future recoverability of capitalized amounts on a quarterly basis. Research and development costs are expensed as incurred. -------------------------------------------------------------------------------- F- 8 BAM! ENTERTAINMENT, INC. AND SUBSIDIARIES -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Fair Value of Financial Instruments -- The Company's financial instruments include cash equivalents and short-term debt. Cash equivalents are stated at cost, which approximates fair market value, based on quoted market prices. The recorded carrying amount of the Company's short-term debt approximates fair value since such debt instruments bear interest at rates which approximate market rates. Long-Lived Assets -- The Company evaluates long-lived assets, such as property and equipment and certain identifiable intangibles for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by comparison of the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets, as defined in SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long- Lived Assets To Be Disposed Of. Income Taxes -- The Company accounts for income taxes under an asset and liability approach. Deferred income taxes reflect the impact of temporary differences between assets and liabilities recognized for financial reporting purposes and such amounts recognized for income tax reporting purposes, and operating loss and other tax credit carryforwards measured by applying currently enacted tax laws. Valuation allowances are provided when necessary to reduce net deferred tax assets to an amount that is more likely than not to be realized in the future. Stock-Based Compensation -- The Company accounts for stock-based awards to employees using the intrinsic value method in accordance with Accounting Principles Board Opinion (APB) No. 25, Accounting for Stock Issued to Employees, and to nonemployees using the fair value method in accordance with SFAS No. 123, Accounting for Stock-Based Compensation. Redeemable Convertible Preferred Stock Dividend -- Beneficial conversion charges arise in connection with financing arrangements where the Company has issued redeemable convertible preferred stock at a discount to the deemed fair market value of the common stock of the Company at the commitment date, which is generally the date of issuance. Depending on the nature and purpose of the arrangement, the Company values the beneficial conversion feature by subtracting the related effective conversion price from the deemed fair value of the Company's common stock, and then multiplying the difference by the number of shares of common stock that would be issued upon conversion. The value of the beneficial conversion feature is limited to the relative fair value of the converted instrument. The Company records as a deduction of stockholders' equity the value of the beneficial conversion feature and accretes this value over the expected period that the redeemable convertible preferred stock becomes convertible. Revenue Recognition -- The Company recognizes revenue in accordance with Statement of Position 97-2, Software Revenue Recognition, and related interpretations, when persuasive evidence of an arrangement exists, delivery has occurred, the price has been fixed or is determinable and collectibility has been reasonably assured. This occurs when finished goods in the form of software on a cartridge, CD-ROM or similar media are shipped to the customer. Subject to certain limitations, the Company permits customers to obtain exchanges and returns for defective and damaged products within certain specified periods and provides price protection on certain unsold merchandise. On a product by product basis, revenue from product sales is reflected net of the allowance for returns and price protection. The Company estimates the amount of future returns, and price protection based upon current known circumstances and historical results. No right of return exists for sales to distributors. Cost of Revenues -- Cost of revenues includes manufacturing costs of the finished goods, freight, and inventory management costs. Advertising -- Advertising and sales promotion costs are generally expensed as incurred. Advertising costs were $54,000, $2,160,000, $17,000 and $448,000 for the period from October 7, 1999 (inception) through June 30, 2000, the year ended June 30, 2001, and the three month periods ended September 30, 2000 and 2001 respectively. -------------------------------------------------------------------------------- F- 9 BAM! ENTERTAINMENT, INC. AND SUBSIDIARIES -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Net Loss per Share -- Basic earnings per share (EPS) excludes dilution and is computed by dividing net loss attributable to common shareholders by the weighted average number of common shares outstanding for the period excluding the weighted average common shares subject to repurchase. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock (redeemable convertible preferred stock, common stock options and warrants using the treasury stock method) were exercised or converted into common stock. Potential common shares in the diluted EPS computation are excluded in net loss periods as their effect would be antidilutive. Unaudited Pro Forma Net Loss per Share -- Pro forma net loss per share, basic and diluted, is computed to give effect to the conversion of redeemable convertible preferred stock that will automatically convert upon completion of the Company's initial public offering (using the if-converted method). Unaudited Pro Forma Information -- The unaudited pro forma information in the accompanying consolidated balance sheet assumes that the conversion of the outstanding shares of redeemable convertible preferred stock into 7,127,545 shares of common stock resulting from the completion of an initial public offering had actually occurred on September 30, 2001. Common shares issued resulting from such an initial public offering and its related estimated net proceeds are excluded from such pro forma information. Unaudited Interim Financial Information -- The interim financial information for the three month periods ended September 30, 2000 and 2001 are unaudited and has been prepared on the same basis as the audited consolidated financial statements. In the opinion of management, such unaudited financial information includes all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of this interim information. Comprehensive Loss -- In fiscal 2000, the Company adopted SFAS No. 130, Reporting Comprehensive Income, which requires that an enterprise report, by major components and as a single total, the change in its net assets during the period from nonowner sources. Comprehensive loss for the period from October 7, 1999 (inception) through June 30, 2000, for the year ended June 30, 2001 and for the three months ended September 30, 2001 has been disclosed within the statement of stockholders' equity (deficit). Recently Adopted Accounting Pronouncements -- In June 1998, the Financial Accounting Standards Board (FASB) issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. This statement requires companies to record derivatives on the balance sheet as assets or liabilities, measured at fair value. Gains or losses resulting from changes in the values of those derivatives would be accounted for depending on the use of the derivative and whether it qualifies for hedge accounting. SFAS No. 133 was effective for the Company beginning in the first quarter of fiscal year 2001. The Company adopted SFAS No. 133 on July 1, 2001 and the adoption did not have a significant impact on the Company's consolidated financial statements during the year ended June 30, 2001. In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101 (SAB 101), Revenue Recognition in Financial Statements. SAB 101 summarizes certain of the staff's views in applying generally accepted accounting principles in the United States to revenue recognition in financial statements and provides interpretations regarding the application of generally accepted accounting principles to revenue recognition where there is an absence of authoritative literature addressing a specific arrangement or a specific industry. SAB 101 was effective for the Company in the fourth quarter of fiscal 2001. The Company's revenue recognition practices comply with the applicable guidance in SAB 101 and the adoption of SAB 101, therefore did not have a material effect on the financial statements for the year ended June 30, 2001. -------------------------------------------------------------------------------- F- 10 BAM! ENTERTAINMENT, INC. AND SUBSIDIARIES -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) In March 2000, the FASB issued Financial Accounting Standards Board Interpretation No. 44, Accounting for Certain Transactions Involving Stock Compensation ("FIN 44"), an interpretation of APB No. 25. FIN 44 clarifies the application of APB No. 25 for various issues, specifically: + The definition of an employee, + The criteria for determining whether a plan qualifies as a noncompensatory plan, + The accounting consequence of various modifications to the terms of a previously fixed stock option or award, and + The accounting for an exchange of stock compensation awards in a business combination. FIN No. 44 was effective July 1, 2000, but certain conclusions cover specific events that occur after either December 15, 1998 or January 12, 2000. The impact of FIN 44 did not have a material effect on the Company's financial statements. In June 2001, the FASB issued SFAS No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that all business combinations initiated after June 30, 2001 be accounted for under the purchase method and addresses the initial recognition and measurement of goodwill and other intangible assets acquired in a business combination. SFAS No. 142 addresses the initial recognition and measurement of intangible assets acquired outside of a business combination and the accounting for goodwill and other intangible assets subsequent to their acquisition. SFAS No. 142 provides that intangible assets with finite useful lives be amortized and that goodwill and intangible assets with indefinite lives not be amortized, but will instead be tested at least annually for impairment. The Company is required to adopt SFAS No. 142 no later than for its fiscal year beginning July 1, 2002. The Company did not carry any goodwill or other intangibles on its balance sheet as of June 30, 2001 or as of September 30, 2001 and accordingly does not expect the adoption to have material impact on its consolidated financial statements. In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. While SFAS No. 144 supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, it retains many of the fundamental provisions of SFAS No. 121. SFAS No. 144 also supersedes the accounting and reporting provisions of APB No. 30, Reporting the Results of Operations--Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions, for the disposal of a segment of a business. However, it retains the requirement in APB No. 30 to report separately discontinued operations and extends that reporting to a component of an entity that either has been disposed of (by sale, abandonment, or in a distribution to owners) or is classified as held for sale. SFAS No. 144 is effective for fiscal years beginning after December 15, 2001 and interim periods within those fiscal years. The Company does not expect the adoption of SFAS No. 144 to have a material impact on its consolidated financial statements. -------------------------------------------------------------------------------- F- 11 BAM! ENTERTAINMENT, INC. AND SUBSIDIARIES -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 2. PREPAID ROYALTIES, CAPITALIZED SOFTWARE COSTS AND LICENSED ASSETS Prepaid royalties, capitalized software costs and licensed assets consisted of the following:
JUNE 30, ---------------- SEPTEMBER 30, 2000 2001 2001 (Unaudited) (In thousands) ----------------------------------------------------------------------------------------------- Prepaid royalties........................................... $ 150 $ 1,181 $ 1,165 Capitalized software costs.................................. 218 4,681 6,517 Licensed assets............................................. -- 1,607 1,589 ----- ------- -------- 368 7,469 9,271 Less current portion: Prepaid royalties......................................... (150) (1,181) (995) Capitalized software costs................................ (218) (3,926) (5,519) Licensed assets........................................... -- (817) (1,372) ----- ------- -------- (368) (5,924) (7,886) ----- ------- -------- Long term portion........................................... $ -- $ 1,545 $ 1,385 ===== ======= ========
During the period from October 7, 1999 (inception) through June 30, 2000, the year ended June 30, 2001, the three month periods ended September 30, 2000 and 2001 the Company amortized $0, $954,000, $0 and $1,126,000 respectively, of capitalized software costs and recorded $0, $134,000, $0 and $0, respectively, of impaired prepaid royalties and capitalized software costs as part of project abandonment costs. 3. PROPERTY AND EQUIPMENT, NET Property and equipment consisted of the following:
JUNE 30, ------------- SEPTEMBER 30, 2000 2001 2001 (Unaudited) (In thousands) -------------------------------------------------------------------------------------------- Furniture, equipment and leasehold improvements............. $ 27 $ 145 $ 316 Computer equipment.......................................... 23 305 436 Computer software........................................... 41 62 84 ---- ----- -------- 91 512 836 Less accumulated depreciation and amortization.............. (12) (117) (174) ---- ----- -------- Total property and equipment, net.................. $ 79 $ 395 $ 662 ==== ===== ========
4. OTHER ASSETS Other assets include issuance costs in connection with the Company's proposed initial public offering of $0, $1,730,000 and $2,261,000 as of June 30, 2000 and 2001, and September 30, 2001, respectively. 5. SHORT-TERM BORROWINGS FINANCING AGREEMENT In February 2000, the Company entered into a master purchase order assignment agreement (the "Agreement") with a finance company, whereby the Company assigns purchase orders entered into with its customers to the finance company and requests the finance company to finance the purchase of the finished goods to fulfill such customer purchase orders. -------------------------------------------------------------------------------- F- 12 BAM! ENTERTAINMENT, INC. AND SUBSIDIARIES -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The Agreement specifies that the finance company's funding commitment with respect to a customer purchase order shall not exceed 60% of the retail purchase order price. Under the Agreement the finance company's aggregate outstanding funding (i.e., advance of funds or purchase of finished goods to fulfill customer purchase orders) shall not exceed $5,000,000. The Company is responsible for collecting customer receivables, bears the risk of loss on all uncollectible accounts and must remit these receipts directly to the finance company up to the amounts funded by the finance company. The Company retains collections in excess of the amounts funded by the finance company. The Company is required to pay the finance company's expenses under the contract, a deal fee (consisting of a transaction and initiation fee equal to 5.0% of the face amounts of letters of credit issued or other funds advanced by the finance company), a daily maintenance fee of 0.067%, a materials advance fee at prime rate plus 4.0% and a late payment fee where applicable; all of which are included in interest expense. Upon the signing of the agreement, the Company paid the finance company a security deposit of $90,000. An extension payment of $50,000 was made when the contract was amended in December 2000, and a further amendment fee of $120,000 was incurred when the contract was amended in August 2001. The agreement expires on March 31, 2002. The amount outstanding under the agreement as of June 30, 2000 and 2001 and September 30, 2001 was $610,000, $4,164,000 and $6,075,000, respectively. Outstanding borrowings under the above agreement are collateralized by inventories, accounts receivable, fixed assets and intangible assets of the Company. As of June 30, 2001 and September 30, 2001, the Company had outstanding letters of credit issued of $2,019,000 and $3,901,000 respectively. Management does not expect any material losses to result from these off-balance sheet instruments. LINE OF CREDIT In November 2000, the Company entered into a short-term revolving line of credit with a bank under which it could borrow up to $1,000,000. In May 2001 all sums borrowed were repaid and the line of credit was closed. Sums borrowed under the line were secured by restricted cash held in a money market account with the same bank, and interest was payable on sums borrowed at the bank's base rate. 6. REDEEMABLE CONVERTIBLE PREFERRED STOCK AND COMMON STOCK REDEEMABLE CONVERTIBLE PREFERRED STOCK Under the Company's certificate of incorporation, as amended on August 15, 2001, the Company is authorized to issue 10,000,000 shares of redeemable convertible preferred stock. The Company issued 976,220 shares of Series A redeemable convertible preferred stock on June 30, 2000 for cash, services and through the conversion of promissory notes. On December 28, 2000, the Company issued 294,620 shares of Series B redeemable convertible preferred stock and on May 24, 2001, the Company issued 245,659 shares of Series C redeemable convertible preferred stock. As of June 30, 2001, redeemable convertible preferred stock consisted of the following:
CARRYING VALUE, ORIGINAL NET OF PAR ISSUE ISSUANCE SHARES ISSUED AND VALUE LIQUIDATION COMMON PRICE COSTS DESIGNATED OUTSTANDING AMOUNT PREFERENCE STOCK (in thousands) (in thousands) EQUIVALENTS --------------------------------------------------------------------------------------------------------------------------------- Series A...................... $ 2.17 $ 2,103 976,220 976,220 $0.001 $ 2,118 4,588,234 Series B...................... $17.65 $ 4,554 320,000 294,620 $0.001 $ 5,389 1,384,714 Series C...................... $22.55 $10,672 443,400 245,659 $0.001 $ 5,578 1,154,597 ------- --------- --------- ------- --------- $17,329 1,739,620 1,516,499 $13,085 7,127,545 ======= ========= ========= ======= =========
-------------------------------------------------------------------------------- F- 13 BAM! ENTERTAINMENT, INC. AND SUBSIDIARIES -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Significant terms of the redeemable convertible preferred stock are as follows: + Each share of Series A, Series B and Series C redeemable convertible preferred stock is convertible into 4.7 shares of common stock, subject to adjustments for events of dilution, at the option of the holder any time after the date of issuance. In addition, each share of redeemable convertible preferred stock will automatically be converted into common stock upon the completion of a public offering of common stock with aggregate proceeds greater than $15,000,000. + If, as, and when declared by the Board of Directors, the holders of Series A, Series B and Series C redeemable convertible preferred stock are entitled to receive noncumulative dividends at the rate of $0.03, $1.25 and $1.58 per share per annum, respectively, in preference to holders of common shares. + In the event of liquidation, dissolution or winding up of the Company, the holders of Series A redeemable convertible preferred stock shall be entitled to receive, prior and in preference to common stock, an amount equal to the original issuance price of $2.17 per share, plus any declared but unpaid dividends thereon. The holders of Series B redeemable preferred stock shall be entitled to receive, prior and in preference to common stock and Series A redeemable convertible preferred stock, an amount equal to the original issuance price of $17.65 per share plus an amount per each outstanding share of Series B redeemable convertible preferred stock equal to 7.0% per annum accruing on the Series B redeemable convertible stock issuance price of $17.65 per share, calculated from the date of issuance until the date of payment of the liquidation preference, plus any declared, but unpaid dividends thereon. The holders of Series C redeemable convertible preferred stock shall be entitled to receive, prior and in preference to common stock and Series A and Series B redeemable convertible preferred stock, an amount equal to the original issuance price of $22.55 per share plus an amount per each outstanding share of Series C redeemable convertible preferred stock equal to 7.0% per annum accruing on the Series C redeemable convertible stock issuance price of $22.55 per share, calculated from the date of issuance until the date of payment of the liquidation preference, plus any declared, but unpaid dividends thereon. If the amount that would have been payable if the conversion of the redeemable convertible preferred stock took place prior to the liquidation event is greater than the amounts specified above, this amount will be payable. Any remaining assets will be distributed to the holders of common stock. + In the event of a change in control or sale or disposition of substantially all of the Company's assets, a majority of the preferred shareholders may elect to require the Company to redeem the redeemable convertible preferred stock at the above liquidation preference. + Each share has the voting rights equivalent to the number of shares of common stock into which it is convertible. COMMON STOCK In October 1999, the Company issued 580,962 shares of common stock to its founder in exchange for a note receivable from the founder. Also in October 1999, the Company issued 274,950 shares at $0.11 per share to consultants in exchange for services performed valued at $30,000. In June 2000, an additional 614,060 shares were issued at $0.11 per share in exchange for cash of $59,000 and services valued at $7,000. As discussed in Note 13, in April, 2001, the Company issued an additional 68,738 shares of common stock pursuant to a license agreement with a production company. The Company was obligated to issue 68,738 shares of common stock as one of the films for which the Company elected to produce software products was released by the production company. The Company capitalized the cost of this issuance at the fair market value of the common stock, equal to $746,000, and will amortize this amount to royalties, software costs, license costs and project abandonment upon the release of software products. -------------------------------------------------------------------------------- F- 14 BAM! ENTERTAINMENT, INC. AND SUBSIDIARIES -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Note Receivable from Stockholder -- At June 30, 2000, the note receivable from stockholder represented a full-recourse promissory note of $1,000 received in connection with the sale of common stock. The note bore interest at 7.0% and was payable on demand. The note was repaid in April 2001. WARRANTS Warrants to purchase a total of 674,450 and 774,450 shares of common stock have been issued as of June 30, 2001 and September 30, 2001, respectively. Under an agreement (the "Agreement") entered into with a production company during October 2000, the Company obtained the exclusive right of first refusal, for a period of five years, to develop products based on films produced by the production company and to distribute them worldwide. In addition, the production company will provide the Company with free access to any publicity materials it prepares. In exchange for these rights, the Company will have to pay royalties to the production company calculated as a percentage of sales of the developed products. Also, in connection with the Agreement the Company issued the production company warrants to purchase 470,000 shares of common stock at an exercise price of $1.06 per share. The warrants expire in September 2006. Under the warrant agreement, 50% of the warrants became vested and exercisable upon execution of the Agreement, while the remaining warrants became vested in equal portions in December 2000, representing the dates on which the production company delivered, in accordance with the Agreement, written notice that a specific film will be available to be exploited by the Company and when the Company exercised its right of first refusal for another film under the Agreement. The fair value of these warrants at the grant date was estimated to be $708,000, using the Black-Scholes option pricing model with the following assumptions: expected term equal to six years; risk-free interest rate of 5.8%; volatility of 95%; and no dividends during the expected term. Of this amount $354,000 relates to 50% of the warrants that vested upon execution of the Agreement and will be amortized on a straight-line basis over the five-year term of the Agreement. The fair value of the remaining 50% of the warrants has been estimated at the date of vesting using the Black-Scholes option pricing model with the following assumptions: expected term equal to six years; risk-free interest rate of 5.0%; volatility of 95%; and no dividends during the expected term. In December 2000, when the remaining warrants vested, the fair value of the remaining 50% of the warrants of $556,000 was capitalized to prepaid royalties, capitalized software costs and licensed assets and will be amortized over the life of the products (generally between three and six months) to which it relates when these products are released. During the year ended June 30, 2001, and the three month periods ended September 30, 2000 and 2001, $48,000, $0, and $18,000, respectively, was amortized to royalties, software costs, license costs, and project abandonment. In connection with the Series B redeemable convertible preferred stock offering, the Company issued warrants to a service provider to purchase 141,000 shares of its common stock at an exercise price of $3.76 per share. The warrants expire on the earlier of either (i) December 2003, (ii) upon the completion of a public offering of common stock with aggregate proceeds greater than $15,000,000 and at a price per share not less than $15.96 per share or (iii) upon the completion of a subsequent private equity financing or in the event of a change in control, sale or disposition of substantially all of the Company's assets or recapitalization, reclassification or reorganization of the Company's stock resulting in aggregate proceeds greater than $10,000,000 and at a price per share not less than $7.45 per share. The value of these warrants has been estimated using the Black-Scholes option pricing model with the following assumptions: expected term equal to three years; risk-free interest rate of 5.1%; volatility of 95%; and no dividends during the expected term. The fair value of these warrants of $283,000 was recorded as an issuance cost against the proceeds of the Series B redeemable convertible preferred stock offering. In connection with the Series C redeemable convertible preferred stock offering, the Company issued warrants to a service provider to purchase 16,450 shares of its common stock at an exercise price of $4.80 per share. The warrants expire in May 2006. The value of these warrants has been estimated using the Black-Scholes option pricing model with the following assumptions: expected term equal to five years; risk-free interest rate of 5.1%; volatility of 95%; -------------------------------------------------------------------------------- F- 15 BAM! ENTERTAINMENT, INC. AND SUBSIDIARIES -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) and no dividends during the expected term. The fair value of these warrants of $159,000 was recorded as an issuance cost against the proceeds of the Series C redeemable convertible preferred stock offering. The Company calculated the beneficial conversion feature related to the issuance of the 245,659 shares of Series C redeemable convertible preferred stock, in accordance with EITF 00-27 "Application of Issue No. 98-5 to Certain Convertible Instruments" as follows: + The Company calculated the difference between the aggregate deemed fair market value of the common stock into which the Series C redeemable convertible preferred stock is convertible of $13,200,000, and the aggregate purchase price paid for the Series C redeemable convertible preferred stock of $5,540,000, i.e. $7,660,000, and limited the amount of the deemed dividend that will be recorded against the accumulated deficit to the gross amount of proceeds allocated to these shares of Series C redeemable convertible preferred stock to $5,540,000 in accordance with paragraph 6 of EITF 98-5 "Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios" + Since the shares of Series C redeemable convertible preferred stock are immediately convertible, the Company has recorded the amount of the deemed dividend in the financial statements for the year ended June 30, 2001. In May 2001, in exchange for legal services rendered by a service provider in connection with a proposed initial public offering, the Company issued warrants to purchase 47,000 shares of its common stock at an exercise price of $4.80 per share. The warrants expire in May 2006. The value of these warrants has been estimated using the Black-Scholes option pricing model with the following assumptions: expected term equal to five years; risk-free interest rate of 5.1%; volatility of 95%; and no dividends during the expected term. The fair value of these warrants of $456,000 was capitalized to other assets and will be recorded as an issuance cost in connection with a proposed initial public offering. STOCK PLANS Under the Company's 2000 Stock Incentive Plan adopted on July 10, 2000, and amended in May 2001 and on August 15, 2001, the Company may grant options to purchase or directly issue up to 1,527,500 shares of common stock to employees, directors and consultants at prices not less than the fair market value (as determined by the Board of Directors) at the date of grant for incentive stock options and not less than 85% of fair market value at the date of grant for nonstatutory stock options. These options generally vest over a four year period and expire ten years from the date of grant. The Company has a right to repurchase (at the lesser of the fair market value on the date of repurchase and option exercise price, with the right to repurchase the shares at the original exercise price lapsing ratably in accordance with the vesting schedule of the options granted) common stock issued under option exercises for unvested shares. The right to repurchase generally expires 25% after the first 12 months from the date of grant and then ratably over a 36-month period. The Board of Directors, in their determination of fair market value on the date of grant, takes into consideration many factors including, but not limited to, the Company's financial performance, current economic trends, actions by competitors, market maturity, emerging technologies, near-term backlog and, in certain circumstances, valuation analyses performed by independent appraisers. These valuation analyses utilize generally accepted valuation methodologies such as the income and market approaches to valuing the Company's business. At June 30, 2001 and September 30, 2001 there were 713,225 and 548,715 shares, respectively, of common stock available for future grant under the plan. -------------------------------------------------------------------------------- F- 16 BAM! ENTERTAINMENT, INC. AND SUBSIDIARIES -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Stock option activity, including stock option activity outside the plan, is summarized as follows:
OPTIONS OUTSTANDING --------------------- WEIGHTED AVERAGE NUMBER OF EXERCISE SHARES PRICE ---------------------------------------------------------------------------------- Balances, June 30, 2000..................................... -- $ -- Granted (weighted average fair value of $3.74 per share).... 833,075 3.21 Cancelled................................................... (18,800) 0.46 --------- -------- Balances, June 30, 2001..................................... 814,275 3.28 Granted (weighted average fair value of $2.65 per share)*... 200,935 11.05 Cancelled*.................................................. (17,625) 1.96 Exercised*.................................................. (12,729) 0.46 --------- -------- Balances, September 30, 2001*............................... 984,856 $ 4.92 ========= ========
--------------- * Unaudited Additional information regarding options outstanding as of June 30, 2001 is as follows:
OPTIONS OUTSTANDING VESTED OPTIONS --------------------------------------------------------- --------------------------- WEIGHTED AVERAGE RANGE OF EXERCISE REMAINING CONTRACTUAL WEIGHTED AVERAGE NUMBER PRICES NUMBER OF SHARES LIFE (YEARS) EXERCISE PRICE OF SHARES WEIGHTED AVERAGE ---------------------------------------------------------------------------- EXERCISE PRICE $ 0.46........... 166,850 9.0 $ 0.46 23,500 $ 0.46 1.06............ 204,450 9.3 1.06 -- -- 3.76............ 130,425 9.8 3.76 -- -- 4.79............ 265,550 9.9 4.79 47,000 4.79 13.00............ 47,000 9.9 13.00 -- -- ---------------- --------- 814,275 3.28 70,500 3.35 ================ =========
Additional information regarding options outstanding as of September 30, 2001 is as follows (Unaudited):
OPTIONS OUTSTANDING VESTED OPTIONS --------------------------------------------------------- --------------------------- WEIGHTED AVERAGE RANGE OF EXERCISE REMAINING CONTRACTUAL WEIGHTED AVERAGE NUMBER PRICES NUMBER OF SHARES LIFE (YEARS) EXERCISE PRICE OF SHARES WEIGHTED AVERAGE ---------------------------------------------------------------------------- EXERCISE PRICE $ 0.46........... 154,121 8.7 $ 0.46 52,580 $ 0.46 1.06............. 192,700 9.0 1.06 16,450 1.06 3.76............. 124,550 9.5 3.76 -- -- 4.79............. 284,350 9.6 4.79 47,000 4.79 11.70............ 182,135 9.9 11.70 5,875 11.70 13.00............ 47,000 9.6 13.00 -- -- ---------------- --------- 984,856 4.92 121,905 2.75 ================ =========
DEFERRED STOCK COMPENSATION As discussed in Note 1, the Company accounts for its stock-based awards to employees using the intrinsic value method in accordance with APB No. 25. Accordingly, the Company records deferred stock compensation equal to the difference between the grant price and deemed fair value of the Company's common stock on the date of grant. -------------------------------------------------------------------------------- F- 17 BAM! ENTERTAINMENT, INC. AND SUBSIDIARIES -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) No deferred stock compensation was recorded for the period from October 7, 1999 (inception) through June 30, 2000. Deferred stock compensation aggregated $2,714,000, $0, and $89,000 for the year ended June 30, 2001, and the three month periods ended September 30, 2000 and 2001, respectively, and is being amortized to expense over the vesting period of the options, generally four years, using a multiple option award valuation approach, which results in accelerated amortization of the expense resulting in amortization of deferred stock compensation of $618,000, $0, and $352,000 for the year ended June 30, 2001, and for the three month periods ended September 30, 2000 and 2001, respectively. During the three months ended September 30, 2001, the Company granted options to purchase 5,875 shares of common stock to a nonemployee at a weighted average exercise price of $11.70 per share. These options vested on the date of grant and expire ten years from the date of grant. The Company expensed the fair value of these options at grant date which was estimated to be $62,000 using the Black-Scholes option pricing model with the following assumptions: expected term equal to 10 years; risk-free interest rate of 5.0%; volatility of 95%; and no dividends during the expected term. ADDITIONAL STOCK PLAN INFORMATION Since the Company continues to account for its stock-based awards to employees using the intrinsic value method in accordance with APB No. 25, SFAS No. 123 requires the disclosure of pro forma net income (loss) as if the Company had adopted the fair value method. Under SFAS No. 123, the fair value of stock-based awards is calculated through the use of option pricing models, even though such models were developed to estimate the fair value of freely tradable, fully transferable options without vesting restrictions, which significantly differ from the Company's stock option awards. The Company's calculations were made using the minimum value pricing model, which requires subjective assumptions, including expected time to exercise, which greatly affects the calculated values. The following weighted average assumptions were used in the model for the year ended June 30, 2001: expected life, 4 years; risk-free interest rate, 5.9%; and no dividends during the expected term. The Company's calculations are based on a multiple option award valuation and amortization approach, which results in accelerated amortization of the expense. Forfeitures are recognized as they occur. If the computed fair values of the employee awards had been amortized to expense over the vesting period of the awards, the Company's pro forma net loss would have been $803,000, $1,678,000, $435,000 and $582,000 ($0.96, $1.13, $0.30 and $0.38 per share, basic and diluted) for the period from October 7, 1999 (inception) through June 30, 2000 the year ended June 30, 2001, and the three month periods ended September 30, 2000 and 2001, respectively. 7. COST OF REVENUES -- ROYALTIES, SOFTWARE COSTS, LICENSE COSTS, AND PROJECT ABANDONMENT Cost of Revenues -- Royalties, Software Costs, License Costs, and Project Abandonment include amortization of non-cash licensed assets of $0, $48,000, $0, and $18,000 for the period from October 7, 1999 (inception) through June 30, 2000 and for the year ended June 30, 2001, and for the three month periods ended September 30, 2000 and 2001, respectively. See also Note 6. 8. INCOME TAXES Due to the Company's net loss position, there was no income tax provision for the period October 7, 1999 (inception) through June 30, 2000 and for the year ended June 30, 2001. -------------------------------------------------------------------------------- F- 18 BAM! ENTERTAINMENT, INC. AND SUBSIDIARIES -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Significant components of the Company's net deferred tax assets consist of the following as of June 30:
2000 2001 (in thousands) ---------------------------------------------------------------------------- Deferred tax assets: Deferred stock compensation............................... $ -- $ 208 Non-qualified warrants.................................... -- 20 Reserves and accruals..................................... 124 312 Net operating loss carryforwards -- Federal and State..... 203 55 -- Foreign............... -- 253 Other..................................................... (2) 27 ----- ----- Total deferred tax assets................................... 325 875 Valuation allowance......................................... (325) (875) ----- ----- Net deferred tax asset...................................... $ -- $ -- ===== =====
The Company established a 100% valuation allowance at June 30, 2000 and 2001 due to the uncertainty of realizing future tax benefits from its net operating loss carryforwards and other deferred tax assets. At June 30, 2001, the Company has federal and state net operating loss carryforwards of approximately $16,000 and $860,000, respectively, expiring through 2021 and 2011, respectively. Foreign net operating loss carryforwards at June 30, 2001 are approximately $844,000. During the year ended June 30, 2001, the Company utilized federal net operating loss carryforwards of approximately $370,000 to offset taxable income. Current federal and California laws include substantial restrictions on the utilization of net operating losses and credits in the event of an "ownership change" of a corporation. Accordingly, the Company's ability to utilize net operating loss and tax credit carryforwards may be limited as a result of such "ownership change." Such a limitation could result in the expiration of carryforwards before they are utilized. The Company's effective tax rate differs from the federal statutory rate as follows:
PERIOD FROM OCTOBER 7, 1999 YEAR (INCEPTION) THROUGH ENDED JUNE 30, JUNE 30, 2000 2001 --------------------------------------------------------------------------------------------- Income taxes at U.S. statutory rate......................... (35.0)% (35.0)% Meals and entertainment..................................... 0.2 0.3 Stock compensation expense.................................. -- 2.6 Valuation allowances........................................ 34.8 32.8 ----- ------ Effective tax rate.......................................... --% --% ----- ------ ----- ------
-------------------------------------------------------------------------------- F- 19 BAM! ENTERTAINMENT, INC. AND SUBSIDIARIES -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 9. COMPUTATION OF LOSS PER SHARE The following table sets forth the computations of basic and diluted loss per share (in thousands, except per share data):
PERIOD FROM OCTOBER 7, THREE MONTHS 1999 YEAR ENDED (INCEPTION) THROUGH ENDED SEPTEMBER 30, JUNE 30, JUNE 30, -------------------- 2000 2001 2000 2001 (Unaudited) -------------------------------------------------------------------------------------------------------------------------- Numerator: Numerator for basic and diluted net loss per share -- net loss attributable to common shareholders................ $ (803) $(7,142) $ (435) $ (489) ========================= ======= ======= ======= Denominator: Denominator for basic and diluted net loss per share -- weighted average -- common shares outstanding............................................. 834 1,482 1,470 1,544 ========================= ======= ======= ======= Basic and diluted net loss per share........................ $ (0.96) $ (4.82) $ (0.30) $ (0.32) ========================= ======= ======= =======
The following table summarizes common stock equivalents that are not included in the denominator used in the diluted net loss per share calculation because to do so would be antidilutive for the periods indicated (in thousands):
THREE MONTHS PERIOD FROM ENDED OCTOBER 7, SEPTEMBER 30, 1999 YEAR ------------- (INCEPTION) THROUGH ENDED 2000 2001 JUNE 30, JUNE 30, ----- ----- EFFECT OF COMMON STOCK EQUIVALENTS AT: 2000 2001 (UNAUDITED) --------------------------------------------------------------------------------------------------------- Series A redeemable convertible preferred stock............. 17 4,588 4,588 4,588 Series B redeemable convertible preferred stock............. -- 707 -- 1,385 Series C redeemable convertible preferred stock............. -- 121 -- 1,155 Options to purchase common stock............................ -- 292 73 598 Warrants to purchase common stock........................... -- 319 -- 568 ------------------- -------- ----- ----- Total common stock equivalents..................... 17 6,027 4,650 8,294 =================== ======== ===== =====
10. EMPLOYEE BENEFIT PLAN In January 2000, the Company adopted a 401(k) tax deferred savings plan (the 401(k) Plan) to provide for retirement of its employees. Employee contributions are limited to a maximum amount subject to IRS guidelines in any calendar year. The Company may make matching contributions and employer profit sharing contributions at the Board of Directors' discretion. For the period from October 7, 1999 (inception) through June 30, 2000, for the year ended June 30, 2001, and for the three month periods ended September 30, 2000 and 2001, the Company made employer contributions to the 401(k) Plan of $6,500, $41,000, $6,000 and $15,000, respectively. 11. BUSINESS SEGMENT AND GEOGRAPHIC INFORMATION As defined by the requirements of SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information, the Company operates in one reportable segment: the development and publishing of interactive entertainment products. -------------------------------------------------------------------------------- F- 20 BAM! ENTERTAINMENT, INC. AND SUBSIDIARIES -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Financial information by geographical region is summarized below (in thousands):
THREE MONTHS ENDED PERIOD FROM SEPTEMBER 30, OCTOBER 7, 1999 --------------- (INCEPTION) THROUGH YEAR ENDED 2000 2001 JUNE 30, JUNE 30, ----- ------- 2000 2001 (UNAUDITED) --------------------------------------------------------------------------------------------------------------- Revenues from unaffiliated customers: United States............................................. $ 1,377 $ 22,898 $ 495 $10,819 United Kingdom............................................ -- 2,453 -- 8 ------------------- ---------- ----- ------- Consolidated................................................ $ 1,377 $ 25,351 $ 495 $10,827 =================== ========== ===== ======= Operating income (loss): United States............................................. $ (781) $ 469 $(428) $ 1,099 United Kingdom............................................ -- (822) -- (880) ------------------- ---------- ----- ------- Consolidated................................................ $ (781) $ (353) $(428) $ 219 =================== ========== ===== =======
AS OF SEPTEMBER 30, AS OF JUNE 30, AS OF JUNE 30, 2001 2000 2001 (Unaudited) ------------------------------------------------------------------------------ Identifiable assets: United States.......... $ 2,712 $ 19,741 $ 28,141 United Kingdom......... -- 7,789 8,729 Intercompany items and eliminations......... -- (6,538) (8,198) -------------- -------------- ------------------- Consolidated............. $ 2,712 $ 20,992 $ 28,672 ============== ============== =================== Long-lived assets: United States.......... $ 79 $ 3,170 $ 3,488 United Kingdom......... -- 500 858 -------------- -------------- ------------------- Consolidated............. $ 79 $ 3,670 $ 4,346 ============== ============== =================== Revenues from the United States include export sales to Canada, Mexico and South America of $15,000, $624,000, $5,000 and $219,000 for the period from October 7, 1999 (inception) through June 30, 2000, for the year ended June 30, 2001 and for the three month periods ended September 30, 2000 and 2001, respectively. Revenues from the United Kingdom include export sales to France of $0 and $1,966,000, $0, and $0 for the period from October 7, 1999 (inception) through June 30, 2000 for the year ended June 30, 2001 and for the three month periods ended September 30, 2000 and 2001, respectively. -------------------------------------------------------------------------------- F- 21 BAM! ENTERTAINMENT, INC. AND SUBSIDIARIES -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 12. CUSTOMER CONCENTRATIONS The following table summarizes net revenues and accounts receivable for customers which accounted for 10% or more of net revenues or accounts receivable:
NET REVENUES --------------------------------------- PERIOD FROM OCTOBER 7, 1999 THREE MONTHS ACCOUNTS RECEIVABLE ENDED ------------------------------------ SEPTEMBER 30, (INCEPTION) YEAR ------------- SEPTEMBER 30, THROUGH ENDED 2000 2001 JUNE 30, JUNE 30, 2001 JUNE 30, JUNE 30, ----- ----- CUSTOMER 2000 2001 (UNAUDITED) 2000 2001 (UNAUDITED) ------------------------------------------------------------------------------------------------------------------------- A...................................... 52% -- -- 49% -- -- -- B...................................... 17% -- -- 16% 14% -- -- C...................................... 10% -- -- 10% -- 10% -- D...................................... -- 27% -- -- -- -- -- E...................................... -- 13% 20% -- 17% 27% 19% F...................................... -- 12% 12% -- -- 15% 10% G...................................... -- 11% -- -- 12% -- -- H...................................... -- -- 19% -- -- -- 19% I...................................... -- -- 11% -- -- -- 11% J...................................... -- -- -- -- -- 23% --
13. COMMITMENTS AND CONTINGENCIES Under an agreement entered into between the Company and a production company, the Company has a first look right to review screenplays acquired by the production company and to develop products based on films produced from those screenplays. In exchange for these rights, the Company will have to pay royalties to the production company calculated as a percentage of sales of the developed products. For each film (up to a total of ten films) that the Company selects, 68,738 fully vested and non-forfeitable shares of common stock will be issued to the production company following the theatrical release of each film for which the Company has developed a product, up to a maximum of 687,375 shares of common stock. As the shares contingently issuable under this arrangement are dependent upon the theatrical release of the film for which the Company has elected to develop products, the Company will only measure the value of these shares in accordance with EITF 96-18 Accounting for Equity Instruments That Are Issued To Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services if and when this contingency is satisfied. If the software product is released after the release of the film, the Company will amortize the non-cash charge over the life of the product, which is expected to be between three and six months. If the software product is released prior to the release of the film, the Company will at each interim period assess whether it is probable that the value of the shares issued is recoverable through future sales of the product to which it relates. If this is probable, the non-cash charge will be amortized to licensed costs over the life of the product, while the Company will expense the non-cash charge at the time of the issuance of the shares if it is not probable that the value of the shares issued is recoverable through future sales of the product to which these shares relate. The Company cannot estimate the aggregate dollar amount of these future non-cash charges as they are based on the Company's share price at a future point in time. As of June 30, 2001 and September 30, 2001 the Company has elected to produce software products for three films pursuant to this agreement. One of these films had it's theatrical release during the year and accordingly the Company issued 68,738 shares of common stock to the production company. The Company will not be required to issue stock on the remaining two films until such time as the films are released. Under various licensing agreements entered into between the Company and content providers, the Company has contractual marketing commitments to spend $5,250,000 in advertising on the content providers' networks and online mediums. As of June 30, 2001 and September 30, 2001, the Company has made payments totaling -------------------------------------------------------------------------------- F- 22 BAM! ENTERTAINMENT, INC. AND SUBSIDIARIES -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) $1,150,000 and $1,200,000, respectively, under these agreements. Future minimum annual advertising payments under these contractual marketing commitments are as follows (in thousands):
SEPTEMBER 30 YEAR ENDING JUNE 30 (UNAUDITED) ----------------------------------------------------------------------------------- 2002........................................................ $1,200 $1,450 2003........................................................ 1,650 1,650 2004........................................................ 1,250 950 ------- ------------ Total.............................................. $4,100 $4,050 ======= ============
In connection with a number of licensing and developing agreements, the Company is required to pay guaranteed minimum royalties with respect to these agreements. As of June 30, 2001 and September 30, 2001, the Company has capitalized payments totaling $2,025,000 and $2,250,000 respectively under these agreements. These guaranteed amounts will be applied against future royalties that may become payable to the respective licensors under the agreement. Future minimum annual royalty payments under these contractual licensing and developing commitments for the years ending June 30, 2002 and September 30, 2002 are $1,250,000 and $1,000,000 respectively. Under the finance agreement as described in Note 5, a commitment fee of $1,125,000 is payable to the finance company. A portion of the commitment fee is waived based on the Company's usage of the financing agreement and on amounts advanced to the Company. At June 30, 2001 the Company had utilized advances available under the contract, such that $721,000 of the total commitment fee has been waived. At September 30, 2001 the Company had utilized advances available under the finance agreement such the full commitment fee had been waived. The Company leases its principal facilities under a noncancelable operating lease expiring in July 2004. Future minimum annual rental payments under the lease agreements as follows (in thousands):
SEPTEMBER 30 YEAR ENDING JUNE 30 (UNAUDITED) ----------------------------------------------------------------------------------- 2002........................................................ $261 $293 2003........................................................ 238 275 2004........................................................ 244 210 2005........................................................ 20 -- ------- ------------ Total.............................................. $763 $778 ======= ============
Rent expense was $35,000 for the period from October 7, 1999 (inception) through June 30, 2000, $135,000 for the year ended June 30, 2001, $17,000 for the three months ended September 30, 2000 and $67,000 for the three months ended September 30, 2001. 14. RELATED PARTY TRANSACTIONS In October 1999, the Company issued 580,962 shares of common stock to an officer in exchange for a note receivable from the officer. The note was repaid in April 2001. In each of November 1999 and January 2000, the Company issued an officer a convertible promissory note each in the principal amount of $500,000, and in May 2000 issued the officer an additional convertible promissory note in the principal amount of $47,000. Each note bore interest at 7.0% per annum with principal and accrued interest due on demand after one year from the date of issuance. Each note was automatically convertible into shares of Series A Preferred Stock upon the initial closing of the Company's Series A Preferred Stock financing. In May 2000, the notes were converted and the officer was issued 482,625 shares of Series A Preferred Stock at $2.17 per share. -------------------------------------------------------------------------------- F- 23 BAM! ENTERTAINMENT, INC. AND SUBSIDIARIES -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) In November 1999 the Company entered into an agreement to lease its principal facilities under a noncancelable operating lease. As a condition of this agreement, an officer of the Company entered into a separate agreement with the lessor to guarantee the Company's obligations under the agreement. In February 2000, the Company entered into an agreement with a financing company to finance the purchase of materials required to produce products. As a condition of this agreement, an officer of the Company entered into a separate agreement with the financing company to guarantee the Company's obligations under the agreement. In November 2000, the Company entered into a revolving note agreement with a bank. The note was secured by a personal guarantee from an officer of the Company and by a security interest in a money market account maintained at the bank in the name of a director of the Company. The guarantee and security interest lapsed in December 2000. The Company incurred legal services of $9,000, $195,000, $15,000 and $84,000 for the period from October 7, 1999 (inception) through June 30, 2000, the year ended June 30, 2001, the three month periods ended September 30, 2000 and 2001, respectively, to a law firm whose partner is also a director of the Company. As of June 30, 2001 and September 30, 2001, the Company has recorded a payroll accrual of $394,000 related to two employees of the Company. 15. SUBSEQUENT EVENTS ADOPTION OF THE 2001 EMPLOYEE STOCK PURCHASE PLAN The Company adopted an employee stock purchase plan on August 9, 2001. Under the plan, during consecutive six-month offering periods, eligible employees are allowed to have salary withholdings of up to 15% of their compensation to purchase shares of common stock at a price equal to 85% of the lower of the market value of the stock at the beginning of the offering period or at the end of the purchase period. The initial offering period commences upon the effective date of an initial public offering of the Company's common stock. For the first offering period, shares of common stock may be purchased at a price equal to 85% of the lower of the price per share in the initial public offering or the market value on the purchase date. The Company has initially reserved 705,000 shares of common stock under this plan. AMENDMENT OF THE 2000 STOCK INCENTIVE PLAN On August 9, 2001, the Company amended its 2000 Stock Incentive Plan and adopted the 2001 Stock Incentive Plan (UK Part) (the "UK Plan") as Schedule A to the 2000 Stock Incentive Plan. The UK Plan provides for the grant of stock options to UK employees who satisfy certain criteria. The UK Plan contains certain restrictions intended to comply with UK taxation laws, including restrictions on exercise, limitations on the size of options grants, requirements with respect to changes in capitalization and other matters. ISSUANCE OF STOCK OPTIONS In August 2001, the Company granted options to purchase 200,935 shares of common stock, 182,135 at an exercise price of $11.70 per share under the 2000 Stock Incentive Plan and 18,800 at an exercise price of $4.79 per share outside of the 2000 Stock Incentive Plan. As a result of these options to purchase common stock, the Company has recorded deferred stock compensation of $130,000 which will be amortized on a multiple option award valuation approach over the vesting period of the options of four years. Of these options 5,875 were granted to a consultant at an exercise price of $11.70 per share, resulting in a consulting expense of $62,000 at the date of grant. AMENDMENT TO FINANCE AGREEMENT AND ISSUANCE OF WARRANTS On August 16, 2001, the Company amended its agreement with a finance company to increase the aggregate outstanding funding amount to $10,000,000. On August 31, 2001, the agreement was further amended decreasing the transaction and initiation fee to 3.0% until the earlier of the termination of the agreement or December 31, 2001 if the Company's initial public offering of its common stock (the "IPO") has not occurred by that date. In connection -------------------------------------------------------------------------------- F- 24 BAM! ENTERTAINMENT, INC. AND SUBSIDIARIES -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) with this latter amendment and the execution of a $7,000,000 factoring arrangement with an affiliate of the finance company, the Company issued a warrant to the affiliate of the finance company to purchase 100,000 shares of common stock at an exercise price equal to the IPO price. The right to exercise such warrant terminates on August 30, 2004, or on December 31, 2001 if the IPO has not occurred by such date. The fair value of this warrant at the grant date was estimated to be $806,000, and is subject to remeasurement up to the pricing of the IPO. The fair value will be amortized to interest expense on a straight-line basis over the remaining term of the financing agreement. -------------------------------------------------------------------------------- F- 25 We have filed applications to register the trademarks BAM! Entertainment, BAM!, BAM!4 and Bay Area Multimedia, Inc. in the United States. This prospectus also refers to trade names and trademarks of other organizations. All names marked with "(TM)" or "(R)" are the trademarks or registered trademarks, respectively, of their respective owners. Nintendo(R), Nintendo(R) 64, Game Boy(R), Game Boy(R) Color, Game Boy(R) Advance, NINTENDO GAMECUBE(TM), and/or other Nintendo products referenced herein are either trademarks or registered trademarks of Nintendo of America, Inc. Sony PlayStation(R), Sony PlayStation 2(R) and/or other Sony products referenced herein are either trademarks or registered trademarks of Sony Computer Entertainment America Inc. Sega(R) and Dreamcast(R) are registered trademarks of Sega of America, Inc. Microsoft(R), Xbox and/or other Microsoft products referenced herein are either trademarks or registered trademarks of Microsoft Corporation. DEXTER'S LABORATORY, POWERPUFF GIRLS, and all related characters and elements are trademarks of The Cartoon Network, an AOL Time Warner company. YOGI BEAR and all related characters and elements are trademarks of Hanna-Barbera Productions, Inc. Sports Illustrated(R) and Sports Illustrated for Kids(R) are registered trademarks of Time, Inc., an AOL Time Warner company. DRIVEN and all related characters and elements are trademarks of Warner Bros., an AOL Time Warner Company. This prospectus includes trademarks other than those identified in the preceding paragraphs. The use of any such trademark herein is in an editorial form only, and to the benefit of the owner thereof, with no intention of infringement of the trademark. [BAM! Entertainment Logo] -------------------------------------------------------------------------------- Part II INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION The following table sets forth the costs and expenses, other than underwriting discounts and commissions, payable by the Registrant in connection with the sale of common stock being registered. All amounts are estimates except the SEC registration fee, the NASD filing fee and the Nasdaq National Market Listing Fee. SEC registration fee........................................ $ 14,088 NASD filing fee............................................. $ 5,000 Nasdaq National Market listing fee.......................... $ 50,000 Printing and engraving costs................................ $ 290,000 Legal fees and expenses..................................... $ 900,000 Accounting fees and expenses................................ $1,000,000 Underwriters' reimbursable expenses......................... $ 300,000 Blue Sky fees and expenses.................................. $ 5,000 Directors and Officers Insurance............................ $ 600,000 Transfer Agent and Registrar fees........................... $ 20,000 Miscellaneous expenses...................................... $ 115,912 ---------- Total.............................................. $3,300,000 ==========
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS Under Section 145 of the General Corporation Law of the State of Delaware, we can indemnify our directors and officers against liabilities they may incur in such capacities, including liabilities under the Securities Act of 1933, as amended (the "Securities Act"). Our certificate of incorporation provides that, pursuant to Delaware law, our directors shall not be liable for monetary damages for breach of the directors' fiduciary duty of care to us and our stockholders. This provision in the certificate of incorporation does not eliminate the duty of care, and in appropriate circumstances equitable remedies such as injunctive or other forms of nonmonetary relief will remain available under Delaware law. In addition, each director will continue to be subject to liability for breach of the director's duty of loyalty to us or our stockholders, for acts or omissions not in good faith or involving intentional misconduct or knowing violations of the law, for actions leading to improper personal benefit to the director, and for payment of dividends or approval of stock repurchases or redemptions that are unlawful under Delaware law. The provision also does not affect a director's responsibilities under any other law, such as the federal securities laws or state or federal environmental laws. Our bylaws provide for the indemnification of our directors to the fullest extent permitted by the Delaware General Corporation Law. Our bylaws further provide that our Board of Directors has sole discretion to indemnify our officers and other employees. We may limit the extent of such indemnification by individual contracts with our directors and executive officers, but have not done so. We are not, however, required to indemnify any director or executive officer in connection with any proceeding initiated by us and approved by a majority of our Board of Directors, that alleges (a) unlawful misappropriation of corporate assets, (b) disclosure of confidential information or (c) any other willful breach of such director or executive officer's duty to us or our stockholders. We are required to advance, prior to the final disposition of any proceeding, promptly on request, all expenses incurred by any director or executive officer in connection with that proceeding on receipt of an undertaking by or on behalf of that director or executive officer to repay those amounts if it should be determined ultimately that he or she is not entitled to be indemnified under our bylaws or otherwise. We also have directors' and officers' liability insurance. -------------------------------------------------------------------------------- II- 1 -------------------------------------------------------------------------------- ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES The following is a summary of sales of securities of the Registrant during the past three fiscal years involving sales of securities that were not registered under the Securities Act of 1933, as amended: In October 1999, the Registrant sold in private placements, 580,962 shares of common stock to its Chief Executive Officer and President, Raymond C. Musci, at a price of $0.001 per share. The total aggregate offering price for this sale of securities was $633.89. In October 1999, the Registrant sold 50,000 shares of common stock at a price per share of $0.10 to each of the following investors: (1) Robert E. Lloyd; (2) Tracy Ann Sebastian; (3) Philip L. Rosenberg; (4) Robert W. Holmes, Jr.; (5) Gary Nemetz; and (6) D&S Partners, a California general partnership. The total aggregate offering price for this sale of securities was $30,000. In April 2000, the Registrant entered into an agreement that gave it the exclusive first look right to review screenplays acquired by a studio and to develop titles based on films produced from those screenplays. The agreement expires upon the later of three years or the theatrical release of the tenth film on which it bases a product. In connection with the agreement, the Registrant agreed to issue 68,738 shares of its common stock to the studio following the theatrical release of a film for which it has developed a title, up to a maximum of 687,375 shares. In April 2001, the Registrant issued 68,738 shares of common stock to the studio in connection with the release of a film upon which the Registrant had based a product. In May 2000 the Registrant effected a 0.195-for-one split of its common stock. In June 2000, in a private placement, the Registrant sold shares of common stock to private investors at a price per share of $0.109 as follows: (1) Anthony R. Williams, 89,897 shares; (2) Robert W. Holmes, Jr., 22,474; (3) Kevin Bermeister, 3,656 shares; (4) Mark Dyne, 3,656 shares; (5) Elie Samaha, 7,312; and (6) FIMAS, L.P., a partnership, 3,656. The total aggregate offering price for this sale of securities was $67,024. In June 2000, in a private placement, the Registrant sold shares of Series A convertible, redeemable preferred stock at a price per share of $2.17 to the following investors: (1) Raymond C. Musci, 482,625 shares; (2) Anthony R. Williams, 351,000 shares; (3) Robert W. Holmes, Jr., 87,750 shares; (4) Kevin Bermeister, 10,969 shares; (5) Mark Dyne, 10,969 shares; (6) Elie Samaha, 21,938 shares; and (7) FIMAS, L.P., a partnership, 10,969 shares. The total aggregate offering price for this sale of securities was $2,118,397. These shares are convertible into 4,588,234 shares of common stock. In October 2000, the Registrant entered into a strategic arrangement with a studio which gives it the exclusive right of first refusal to develop titles based on films produced by that studio and to distribute them worldwide. In connection with this strategic arrangement, the Registrant granted the studio a warrant to purchase up to 470,000 shares of common stock. The exercise price for shares issued under the warrant is $1.06 and the term of the warrant is five years from the date of issuance. In December 2000, the Registrant entered into an agreement to sell a warrant for 141,000 shares of common stock to PAR Investment Partners, L.P. The exercise price for shares issued under the warrant is $3.76 and the term of the warrant is three years from the date of issuance. In December 2000, in a private placement, the Registrant sold shares of Series B convertible, redeemable preferred stock at a price per share of $17.65 to the following investors: (1) Raymond C. Musci, 28,329 shares; (2) Anthony R. Williams, 28,329 shares; (3) Morgan Keegan Early Stage Fund, L.P., 22,092; (4) Robert W. Holmes, Jr., 11,332 shares; (5) PAR Investment Partners, L.P., 198,301; and (6) Morgan Keegan Employee Investment Fund, L.P., 6,237 shares. The total aggregate offering price for this sale of securities was $5,200,043. These shares are convertible into 1,384,714 shares of common stock. In May 2001, in a private placement, the Registrant sold shares of Series C convertible, redeemable preferred stock at a price per share of $22.553 to the following investors: (1) Raymond C. Musci, 13,302 shares; (2) PAR Investment Partners, L.P., 88,680 shares; (3) Morgan Keegan Early Stage Fund, L.P., 88,680 shares; (4) Anthony R. Williams, 13,302 shares; (5) Robert W. Holmes, Jr., 6,651 shares; (6) Stephen Ambler, 1,109 shares; (7) Joseph Morici, -------------------------------------------------------------------------------- II- 2 -------------------------------------------------------------------------------- 887 shares; (8) Mark Dyne, 4,434 shares; (9) Kevin Bermeister, 4,434 shares; (10) K&L 2000 LLC, 1,109 shares; (11) Pam Colburn, 1,109 shares; (12) Anthony Neumann, 1,109 shares; (13) Terry Phillips, 13,302 shares; (14) Steven Massarsky, 2,217 shares; (15) David Clark, 4,434 shares; and (16) FIMAS L.P., a partnership, 900 shares. The total aggregate offering price for this sale of securities was $5,540,347. These shares are convertible into 1,154,597 shares of common stock. In May 2001, the Registrant sold a warrant for 47,000 shares of common stock to K&L 2000 LLC. The exercise price of the warrant is $4.80 per share and the term of the warrant is five years. In May 2001, the Registrant sold a warrant for 16,450 shares of common stock to Morgan Keegan Early Stage Fund, L.P. The exercise price for these shares is $4.80 and the term of the warrant is five years from the date of issuance. In August 2001, the Registrant effected a 4.7-for-one stock split of its common stock. In August 2001, the Registrant issued a warrant for 100,000 shares of common stock to Transcap Associates, Inc. The exercise price of the warrant is equal to the per share price of the Registrant's initial public offering. The right to exercise such warrant terminates on August 30, 2004 or on December 31, 2001 if the Registrant's initial public offering has not occurred by such date. In August 2001, the Registrant issued 12,729 shares of its common stock upon the exercise of stock options at a per share exercise price of $0.46. Each of the above sales was made pursuant to the exemption provided by (1) Rule 506, promulgated by the Commission under the Securities Act of 1933, as amended (the "Securities Act"), or (2) Section 4(2) of the Securities Act as a sale to accredited investors not involving any general solicitation. No underwriter was used in connection with these sales. All recipients had adequate access, through their relationships with the Registrant or otherwise, to corporate information about the Registrant. ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULE (a) EXHIBITS 1.1 Form of Underwriting Agreement 2.1+ Agreement and Plan of Merger dated September 21, 2000 of Bay Area Multimedia, Inc. (a Delaware corporation) and Bay Area Multimedia, Inc. (a California corporation) 3.1+ Second Amended and Restated Certificate of Incorporation 3.1(a)+ First Amendment to Second Amended and Restated Certificate of Incorporation of the Registrant dated August 15, 2001 3.2+ Bylaws of the Registrant 3.2(a)+ Amendment to Bylaws of the Registrant dated December 28, 2000 3.2(b)+ Amendment to Bylaws of Registrant dated June 1, 2001 3.2(c)+ Amendment to Bylaws of Registrant dated July 31, 2001 4.1+ Specimen Common Stock Certificate 4.2+ Warrant to Purchase Shares of Common Stock between the Registrant and Spyglass Entertainment Group, L.P. 4.3+ Warrant to Purchase Shares of Common Stock dated December 27, 2000 between the Registrant and PAR Capital Management, Inc. 4.4+ Warrant to Purchase Shares of Common Stock dated May 24, 2001 between the Registrant and K&L 2000 LLC. 4.5+ Warrant to Purchase Shares of Common Stock dated May 24, 2001 between the Registrant and Morgan Keegan & Co., Inc. 4.6+ Convertible Promissory Note dated November 24, 1999 between the Registrant and Raymond C. Musci. 4.7+ Convertible Promissory Note dated January 7, 2000 between the Registrant and Raymond C. Musci. 4.8+ Convertible Promissory Note dated May 25, 2000 between the Registrant and Raymond C. Musci. 4.9+ Form of Warrant to Purchase shares of Common Stock dated August 31, 2001 between the Registrant and Transcap Associates, Inc.
-------------------------------------------------------------------------------- II- 3 -------------------------------------------------------------------------------- 5.1+ Opinion of Kirkpatrick & Lockhart LLP 10.1+ Amended and Restated 2000 Stock Incentive Plan 10.2+ Common Stock Purchase Agreement dated October 9, 1999 between the Registrant and Raymond C. Musci. 10.3+ Common Stock Purchase Agreement dated October 25, 1999 between the Registrant and D&S Partners. 10.4+ Common Stock Purchase Agreement dated October 25, 1999 between the Registrant and Robert Holmes. 10.5+ Common Stock Purchase Agreement dated October 25, 1999 between the Registrant and Gary Nemetz. 10.6+ Common Stock Purchase Agreement dated October 25, 1999 between the Registrant and Tracy Ann Sebastian. 10.6(a)+ Amendment to Common Stock Purchase Agreement dated July 16, 2001 between the Registrant and Tracy Ann Sebastian. 10.7+ Common Stock Purchase Agreement dated December 30, 1999 between the Registrant and Philip L. Rosenberg. 10.8+ Series A Preferred Stock and Common Stock Purchase Agreement dated May 17, 2000 among the Registrant and Raymond C. Musci, Anthony R. Williams, Robert Holmes, Mark Dyne, Kevin Bermeister, Franchise Films, and FIMAS L.P. 10.9+ Investor Rights Agreement dated May 17, 2000 among the Registrant and Raymond C. Musci, Anthony R. Williams, Robert Holmes, Mark Dyne, Kevin Bermeister, Franchise Films, and FIMAS L.P. 10.10+ Common Stock Purchase Agreement dated September 21, 2000 between the Registrant and Bay Area Multimedia, Inc., a California corporation. 10.11+ Series B Preferred Stock Purchase Agreement dated December 28, 2000 among the Registrant and PAR Capital Management, Inc., Raymond C. Musci, Anthony R. Williams, Robert Holmes, and Morgan Keegan Early Stage Fund L.P. 10.12+ Co-Sale and Right of First Refusal Agreement dated December 28, 2000 among the Registrant and PAR Capital Management, Inc., Raymond C. Musci, Anthony R. Williams, Robert Holmes, and Morgan Keegan Early Stage Fund L.P. 10.13+ Registration Rights Agreement dated December 28, 2000 among the Registrant and PAR Capital Management, Inc., Raymond C. Musci, Anthony R. Williams, Robert Holmes, and Morgan Keegan Early Stage Fund L.P. 10.14+ Series C Preferred Stock Purchase Agreement dated May 24, 2001 among the Registrant and PAR Capital Management, Inc., Raymond C. Musci, Anthony R. Williams, Robert Holmes, Morgan Keegan Early Stage Fund L.P., Stephen Ambler, Mark Dyne, Joseph Morici, Kevin Bermeister, K&L 2000 LLC, Pam Colburn, Anthony Neumann, Terry Phillips, Steven Massarsky, Daniel Clark, and FIMAS, L.P. 10.15+ Registration Rights Agreement dated May 24, 2001 among the Registrant and PAR Capital Management, Inc., Raymond C. Musci, Anthony R. Williams, Robert Holmes, Morgan Keegan Early Stage Fund L.P., Stephen Ambler, Mark Dyne, Joseph Morici, Kevin Bermeister, K&L 2000 LLC, Pam Colburn, Anthony Neumann, Terry Phillips, Steven Massarsky, Daniel Clark, and FIMAS, L.P. 10.16+ Co-Sale and Right of First Refusal Agreement dated May 24, 2001 among the Registrant and PAR Capital Management, Inc., Raymond C. Musci, Anthony R. Williams, Robert Holmes, Morgan Keegan Early Stage Fund L.P., Stephen Ambler, Mark Dyne, Joseph Morici, Kevin Bermeister, K&L 2000 LLC, Pam Colburn, Anthony Neumann, Terry Phillips, Steven Massarsky, Daniel Clark, and FIMAS, L.P. 10.17+ Master Purchase Order Assignment Agreement dated February 23, 2000 between the Registrant and Transcap Trade Finance. 10.17(a)+ First Amendment to Master Purchase Order Assignment Agreement dated September 13, 2000 between the Registrant and Transcap Trade Finance. 10.17(b)+ Second Amendment to Master Purchase Order Assignment Agreement dated December 12, 2000 between the Registrant and Transcap Trade Finance. 10.17(c)+ Third Amendment to Master Purchase Order Assignment Agreement dated March 22, 2001 between the Registrant and Transcap Trade Finance. 10.17(d)+ Fourth Amendment to Master Purchase Order Assignment Agreement dated July 2, 2001 between the Registrant and Transcap Trade Finance. 10.17(e)+ Fifth Amendment to Master Purchase Order Assignment Agreement dated August 16, 2001 between the Registrant and Transcap Trade Finance. 10.17(f)+ Form of Sixth Amendment to Master Purchase Order Assignment Agreement between the Registrant and Transcap Trade Finance. 10.18+ Security Agreement and Financing Statement dated February 23, 2000 between the Registrant and Transcap Trade Finance.
-------------------------------------------------------------------------------- II- 4 -------------------------------------------------------------------------------- 10.19+ Subordination Agreement dated February 23, 2000 between the Registrant, Raymond C. Musci, and Transcap Trade Finance. 10.20+ Guaranty and Pledge Agreement dated February 23, 2000 between the Registrant , Raymond C. Musci, and Transcap Trade Finance. 10.21+ Master Revolving Note dated November 13, 2000 between the Registrant and Comerica Bank-California. 10.22+ Security Agreement dated November 13, 2000 between the Registrant and Comerica Bank-California. 10.23+ Letter Agreement dated November 13, 2000 between the Registrant and Comerica Bank-California. 10.24+ Guaranty Agreement dated November 13, 2000 between Comerica Bank-California and Raymond C. Musci. 10.25+ Letter Agreement dated December 26, 2000 between the Registrant and Comerica Bank-California. 10.26+** Sony PlayStation Licensed Publisher Agreement dated February 2, 2000 between the Registrant and Sony Computer Entertainment America, Inc. 10.27+** Amendment to the Licensed Publisher Agreement dated April 1, 2000 between the Registrant and Sony Computer Entertainment America, Inc. 10.28+** PlayStation 2 Licensed Publisher Agreement dated April 1, 2000 between the Registrant and Sony Computer Entertainment America, Inc. 10.29+** PlayStation 2 Development System Agreement dated August 2, 2000 between the Registrant and Sony Computer Entertainment America, Inc. 10.30+** Licensed Publisher Agreement for Game Boy, Game Boy Color and Game Boy Pocket dated February 18, 2000 between the Registrant and Nintendo of America, Inc. 10.31+** Licensed Publisher Agreement for Nintendo 64 dated February 18, 2000 between the Registrant and Nintendo of America, Inc. 10.32+ Confidential License Agreement for Game Boy Advance dated May 21, 2001 between the Registrant and Nintendo of America, Inc. 10.33+** Xbox Publisher License Agreement dated November 28, 2000 between the Registrant and Microsoft Corporation. 10.34+** Retail License Agreement #12177-PPG dated March 8, 2000 between the Registrant and Warner Bros. Consumer Products. 10.35+** Amendment #1 to Retail License Agreement #12177-PPG dated November 27, 2000 between the Registrant and Warner Bros. Consumer Products. 10.36+** License Agreement #12697-DEX dated October 4, 2000 between the Registrant and Warner Bros. Consumer Products. 10.37+** License Agreement #12698-YOGI dated October 4, 2000 between the Registrant and Warner Bros. Consumer Products. 10.38+** License Agreement dated March 31, 2000 between the Registrant and Takara Co., Ltd. 10.39+** Exclusive Output Agreement dated April 7, 2000 between the Registrant and Franchise Films, Inc. 10.40 First Amendment to Exclusive Output Agreement dated April 2001 between the Registrant and Franchise Films, Inc. 10.41+** License Agreement dated July 12, 2000 between the Registrant and Time, Inc. for its Sports Illustrated for Kids division. 10.42+** Exclusive Output Agreement dated October 25, 2000 between the Registrant and Spyglass Entertainment Group, L.P. 10.43+ Office Lease dated November 15, 1999 between the Registrant and Macanan Investments, L.P. 10.43(a)+ First Amendment to Office Lease dated July 31, 2001 between the Registrant and Macanan Investments L.P. 10.44+ Employment Agreement dated October 1, 1999 between the Registrant and Raymond C. Musci. 10.45 [Reserved]. 10.46+ Employment Agreement dated July 1, 2000 between the Registrant and Anthony R. Williams. 10.47 [Reserved]. 10.48+ Agreement for Chairman of Board of Directors dated June 7, 2001 between the Registrant and Robert W. Holmes, Jr. 10.49 2001 Employee Stock Purchase Plan 10.50**+ Software Distribution Agreement dated February 21, 2001 between BAM Entertainment Ltd., a subsidiary of the Registrant, and Ubi Soft Entertainment, S.A. 10.51**+ Amendment to Software Distribution Agreement dated April 23, 2001 between BAM Entertainment Ltd., a subsidiary of the Registrant, and Ubi Soft Entertainment, S.A.
-------------------------------------------------------------------------------- II- 5 -------------------------------------------------------------------------------- 10.52**+ Distribution Agreement dated July 31, 2001 between BAM Entertainment Ltd., a subsidiary of the Registrant, and Ubi Soft Entertainment, S.A. 10.53+ Form of Purchase of Accounts and Security Agreement between the Registrant and Transcap Manufacturing Services, Inc. 21.1+ List of Registrant's Subsidiaries 23.1 Consent of Deloitte & Touche LLP 23.2+ Consent of Kirkpatrick & Lockhart LLP (contained in exhibit 5.1) 24.1+ Power of attorney
------------------------- ** The Registrant has applied with the Secretary of the Securities and Exchange Commission for confidential treatment of certain information pursuant to Rule 406 under the Securities Act of 1933. The Registrant has filed separately with its application a copy of the exhibit including all confidential portions, which may be made available for public inspection pending the Securities and Exchange Commission's review of the application in accordance with Rule 406. + Previously filed. (b) FINANCIAL STATEMENT SCHEDULES The following consolidated financial statement schedule is filed as part of this registration statement and should be read with the consolidated financial statements:
SCHEDULE PAGE ------------------------------------------------------------------ Schedule II -- Valuation and Qualifying Accounts............ S-2
Schedules other than those referred to above have been omitted because they are not applicable or not required or because they are not applicable or not required or because the information is included elsewhere in the consolidated financial statements or the related notes. ITEM 17. UNDERTAKINGS The undersigned hereby undertakes to provide to the underwriters at the closing specified in the underwriting agreement certificates in denominations as required by the underwriters and registered in names as required by the underwriters to permit prompt delivery to each purchaser. Insofar as indemnification for liabilities arising under the Securities Act may be permitted to our directors, officers and controlling persons pursuant to the foregoing provisions, or otherwise, we have been advised that in the opinion of the Securities and Exchange Commission indemnification is against public policy as expressed in the Securities Act, and is, therefore, unenforceable. In the event that a claim for indemnification against liabilities, other than the payment by us of expenses incurred or paid by a director, officer, or controlling person of the registrant in the successful defense of any action, suit or proceeding, is asserted by a director, officer or controlling person in connection with the securities being registered, we will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether indemnification by it is against public policy as expressed in the Securities Act and will be governed by the final adjudication of this issue. The undersigned hereby undertakes that: (1) For purposes of determining any liability under the Securities Act, the information omitted from the form of prospectus filed as part of this registration statement in reliance upon Rule 430A and contained in a form of prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be part of this registration statement as of the time it was declared effective. (2) For the purpose of determining any liability under the Securities Act, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and this offering of these securities at that time shall be deemed to be the initial bona fide offering thereof. -------------------------------------------------------------------------------- II- 6 -------------------------------------------------------------------------------- SIGNATURES Pursuant to the requirements of the Securities Act of 1933, the registrant has duly caused this amendment no. 3 to registration statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of San Jose, State of California, on October 26, 2001. BAM! ENTERTAINMENT, INC. By: /s/ RAYMOND C. MUSCI ---------------------------------------- Raymond C. Musci Chief Executive Officer and President Pursuant to the requirements of the Securities Act of 1933, as amended, this amendment no. 3 to registration statement has been signed below by the following persons in the capacities and on the dates indicated:
SIGNATURE TITLE DATE --------- ----- ---- /s/ RAYMOND C. MUSCI Chief Executive Officer, President October 26, 2001 -------------------------------------------------------- and Director (Principal Executive Raymond C. Musci Officer) /s/ ANTHONY R. WILLIAMS Vice Chairman of the Board October 26, 2001 -------------------------------------------------------- Anthony R. Williams * Chief Financial Officer and Vice October 26, 2001 -------------------------------------------------------- President of Finance (Principal Stephen M. Ambler Financial and Accounting Officer) /s/ ROBERT W. HOLMES, JR. Chairman of the Board October 26, 2001 -------------------------------------------------------- Robert W. Holmes, Jr. * Secretary and Director October 26, 2001 -------------------------------------------------------- George M. Sundheim, III * Director October 26, 2001 -------------------------------------------------------- Mark Dyne * Director October 26, 2001 -------------------------------------------------------- David E. Tobin * Director October 26, 2001 -------------------------------------------------------- Anthony G. Williams * Director October 26, 2001 -------------------------------------------------------- Steven J. Massarsky * Director October 26, 2001 -------------------------------------------------------- Robert T. Slezak *By: /s/ RAYMOND C. MUSCI -------------------------------------------------------- Raymond C. Musci, Attorney-in-fact
-------------------------------------------------------------------------------- INDEPENDENT AUDITORS' REPORT ON SCHEDULE To the Board of Directors and Stockholders of BAM! Entertainment, Inc. We have audited the consolidated balance sheets of BAM! Entertainment, Inc. and its subsidiaries (the "Company") as of June 30, 2000 and 2001, and the related consolidated statements of operations, stockholders' equity (deficit) and comprehensive loss, and cash flows for the period from October 7, 1999 (inception) through June 30, 2000 and the year ended June 30, 2001 and have issued our report thereon dated August 15, 2001 (August 31, 2001 as to the last two paragraphs of Note 15). Our audits also included the consolidated financial statement schedule listed in Item 16(b) of this registration statement. The consolidated financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such consolidated financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein. DELOITTE & TOUCHE LLP San Jose, California August 15, 2001 -------------------------------------------------------------------------------- S- 1 -------------------------------------------------------------------------------- SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS (IN THOUSANDS)
BALANCE -- BALANCE -- BEGINNING END OF DESCRIPTION OF PERIOD ADDITIONS DEDUCTIONS PERIOD -------------------------------------------------------------------------------------------------------------- Period from October 7, 1999 (inception) through June 30, 2000 Allowance for doubtful accounts............................. $ -- $ 77 $ -- $ 77 Allowance for sales return and price protection............. $ -- $ -- $ -- $ -- Allowance for cooperative advertising....................... $ -- $ -- $ -- $ -- ------ ------ ---- ------ $ -- $ 77 $ -- $ 77 ====== ====== ==== ====== Year ended June 30, 2001 Allowance for doubtful accounts............................. $ 77 $ 143 $150 $ 70 Allowance for sales return and price protection............. $ -- $ 893 $243 $ 650 Allowance for cooperative advertising....................... $ -- $ 953 $510 $ 443 ------ ------ ---- ------ $ 77 $1,989 $903 $1,163 ====== ====== ==== ======
-------------------------------------------------------------------------------- S- 2 -------------------------------------------------------------------------------- Exhibit index 1.1 Form of Underwriting Agreement 2.1+ Agreement and Plan of Merger dated September 21, 2000 of Bay Area Multimedia, Inc. (a Delaware corporation) and Bay Area Multimedia, Inc. (a California corporation) 3.1+ Second Amended and Restated Certificate of Incorporation 3.1(a)+ First Amendment to Second Amended and Restated Certificate of Incorporation of the Registrant dated August 15, 2001 3.2+ Bylaws of the Registrant 3.2(a)+ Amendment to Bylaws of the Registrant dated December 28, 2000 3.2(b)+ Amendment to Bylaws of Registrant dated June 1, 2001 3.2(c)+ Amendment to Bylaws of Registrant dated July 31, 2001 4.1+ Specimen Common Stock Certificate 4.2+ Warrant to Purchase Shares of Common Stock between the Registrant and Spyglass Entertainment Group, L.P. 4.3+ Warrant to Purchase Shares of Common Stock dated December 27, 2000 between the Registrant and PAR Capital Management, Inc. 4.4+ Warrant to Purchase Shares of Common Stock dated May 24, 2001 between the Registrant and K&L 2000 LLC. 4.5+ Warrant to Purchase Shares of Common Stock dated May 24, 2001 between the Registrant and Morgan Keegan & Co., Inc. 4.6+ Convertible Promissory Note dated November 24, 1999 between the Registrant and Raymond C. Musci. 4.7+ Convertible Promissory Note dated January 7, 2000 between the Registrant and Raymond C. Musci. 4.8+ Convertible Promissory Note dated May 25, 2000 between the Registrant and Raymond C. Musci. 4.9+ Form of Warrant to Purchase shares of Common Stock dated August 31, 2001 between the Registrant and Transcap Associates, Inc. 5.1+ Opinion of Kirkpatrick & Lockhart LLP 10.1+ Amended and Restated 2000 Stock Incentive Plan 10.2+ Common Stock Purchase Agreement dated October 9, 1999 between the Registrant and Raymond C. Musci. 10.3+ Common Stock Purchase Agreement dated October 25, 1999 between the Registrant and D&S Partners. 10.4+ Common Stock Purchase Agreement dated October 25, 1999 between the Registrant and Robert Holmes. 10.5+ Common Stock Purchase Agreement dated October 25, 1999 between the Registrant and Gary Nemetz. 10.6+ Common Stock Purchase Agreement dated October 25, 1999 between the Registrant and Tracy Ann Sebastian. 10.6(a)+ Amendment to Common Stock Purchase Agreement dated July 16, 2001 between the Registrant and Tracy Ann Sebastian. 10.7+ Common Stock Purchase Agreement dated December 30, 1999 between the Registrant and Philip L. Rosenberg. 10.8+ Series A Preferred Stock and Common Stock Purchase Agreement dated May 17, 2000 among the Registrant and Raymond C. Musci, Anthony R. Williams, Robert Holmes, Mark Dyne, Kevin Bermeister, Franchise Films, and FIMAS L.P. 10.9+ Investor Rights Agreement dated May 17, 2000 among the Registrant and Raymond C. Musci, Anthony R. Williams, Robert Holmes, Mark Dyne, Kevin Bermeister, Franchise Films, and FIMAS L.P. 10.10+ Common Stock Purchase Agreement dated September 21, 2000 between the Registrant and Bay Area Multimedia, Inc., a California corporation.
-------------------------------------------------------------------------------- 10.11+ Series B Preferred Stock Purchase Agreement dated December 28, 2000 among the Registrant and PAR Capital Management, Inc., Raymond C. Musci, Anthony R. Williams, Robert Holmes, and Morgan Keegan Early Stage Fund L.P. 10.12+ Co-Sale and Right of First Refusal Agreement dated December 28, 2000 among the Registrant and PAR Capital Management, Inc., Raymond C. Musci, Anthony R. Williams, Robert Holmes, and Morgan Keegan Early Stage Fund L.P. 10.13+ Registration Rights Agreement dated December 28, 2000 among the Registrant and PAR Capital Management, Inc., Raymond C. Musci, Anthony R. Williams, Robert Holmes, and Morgan Keegan Early Stage Fund L.P. 10.14+ Series C Preferred Stock Purchase Agreement dated May 24, 2001 among the Registrant and PAR Capital Management, Inc., Raymond C. Musci, Anthony R. Williams, Robert Holmes, Morgan Keegan Early Stage Fund L.P., Stephen Ambler, Mark Dyne, Joseph Morici, Kevin Bermeister, K&L 2000 LLC, Pam Colburn, Anthony Neumann, Terry Phillips, Steven Massarsky, Daniel Clark, and FIMAS, L.P. 10.15+ Registration Rights Agreement dated May 24, 2001 among the Registrant and PAR Capital Management, Inc., Raymond C. Musci, Anthony R. Williams, Robert Holmes, Morgan Keegan Early Stage Fund L.P., Stephen Ambler, Mark Dyne, Joseph Morici, Kevin Bermeister, K&L 2000 LLC, Pam Colburn, Anthony Neumann, Terry Phillips, Steven Massarsky, Daniel Clark, and FIMAS, L.P. 10.16+ Co-Sale and Right of First Refusal Agreement dated May 24, 2001 among the Registrant and PAR Capital Management, Inc., Raymond C. Musci, Anthony R. Williams, Robert Holmes, Morgan Keegan Early Stage Fund L.P., Stephen Ambler, Mark Dyne, Joseph Morici, Kevin Bermeister, K&L 2000 LLC, Pam Colburn, Anthony Neumann, Terry Phillips, Steven Massarsky, Daniel Clark, and FIMAS, L.P. 10.17+ Master Purchase Order Assignment Agreement dated February 23, 2000 between the Registrant and Transcap Trade Finance. 10.17(a)+ First Amendment to Master Purchase Order Assignment Agreement dated September 13, 2000 between the Registrant and Transcap Trade Finance. 10.17(b)+ Second Amendment to Master Purchase Order Assignment Agreement dated December 12, 2000 between the Registrant and Transcap Trade Finance. 10.17(c)+ Third Amendment to Master Purchase Order Assignment Agreement dated March 22, 2001 between the Registrant and Transcap Trade Finance. 10.17(d)+ Fourth Amendment to Master Purchase Order Assignment Agreement dated July 2, 2001 between the Registrant and Transcap Trade Finance. 10.17(e)+ Fifth Amendment to Master Purchase Order Assignment Agreement dated August 16, 2001 between the Registrant and Transcap Trade Finance. 10.17(f)+ Form of Sixth Amendment to Master Purchase Order Assignment Agreement between the Registrant and Transcap Trade Finance. 10.18+ Security Agreement and Financing Statement dated February 23, 2000 between the Registrant and Transcap Trade Finance. 10.19+ Subordination Agreement dated February 23, 2000 between the Registrant, Raymond C. Musci, and Transcap Trade Finance. 10.20+ Guaranty and Pledge Agreement dated February 23, 2000 between the Registrant , Raymond C. Musci, and Transcap Trade Finance. 10.21+ Master Revolving Note dated November 13, 2000 between the Registrant and Comerica Bank-California. 10.22+ Security Agreement dated November 13, 2000 between the Registrant and Comerica Bank-California. 10.23+ Letter Agreement dated November 13, 2000 between the Registrant and Comerica Bank-California. 10.24+ Guaranty Agreement dated November 13, 2000 between Comerica Bank-California and Raymond C. Musci. 10.25+ Letter Agreement dated December 26, 2000 between the Registrant and Comerica Bank-California. 10.26+** Sony PlayStation Licensed Publisher Agreement dated February 2, 2000 between the Registrant and Sony Computer Entertainment America, Inc. 10.27+** Amendment to the Licensed Publisher Agreement dated April 1, 2000 between the Registrant and Sony Computer Entertainment America, Inc. 10.28+** PlayStation 2 Licensed Publisher Agreement dated April 1, 2000 between the Registrant and Sony Computer Entertainment America, Inc. 10.29+** PlayStation 2 Development System Agreement dated August 2, 2000 between the Registrant and Sony Computer Entertainment America, Inc.
-------------------------------------------------------------------------------- 10.30+** Licensed Publisher Agreement for Game Boy, Game Boy Color and Game Boy Pocket dated February 18, 2000 between the Registrant and Nintendo of America, Inc. 10.31+** Licensed Publisher Agreement for Nintendo 64 dated February 18, 2000 between the Registrant and Nintendo of America, Inc. 10.32+ Confidential License Agreement for Game Boy Advance dated May 21, 2001 between the Registrant and Nintendo of America, Inc. 10.33+** Xbox Publisher License Agreement dated November 28, 2000 between the Registrant and Microsoft Corporation. 10.34+** Retail License Agreement #12177-PPG dated March 8, 2000 between the Registrant and Warner Bros. Consumer Products. 10.35+** Amendment #1 to Retail License Agreement #12177-PPG dated November 27, 2000 between the Registrant and Warner Bros. Consumer Products. 10.36+** License Agreement #12697-DEX dated October 4, 2000 between the Registrant and Warner Bros. Consumer Products. 10.37+** License Agreement #12698-YOGI dated October 4, 2000 between the Registrant and Warner Bros. Consumer Products. 10.38+** License Agreement dated March 31, 2000 between the Registrant and Takara Co., Ltd. 10.39+** Exclusive Output Agreement dated April 7, 2000 between the Registrant and Franchise Films, Inc. 10.40 First Amendment to Exclusive Output Agreement dated April 2001 between the Registrant and Franchise Films, Inc. 10.41+** License Agreement dated July 12, 2000 between the Registrant and Time, Inc. for its Sports Illustrated for Kids division. 10.42+** Exclusive Output Agreement dated October 25, 2000 between the Registrant and Spyglass Entertainment Group, L.P. 10.43+ Office Lease dated November 15, 1999 between the Registrant and Macanan Investments, L.P. 10.43(a)+ First Amendment to Office Lease dated July 31, 2001 between the Registrant and Macanan Investments L.P. 10.44+ Employment Agreement dated October 1, 1999 between the Registrant and Raymond C. Musci. 10.45 [Reserved]. 10.46+ Employment Agreement dated July 1, 2000 between the Registrant and Anthony R. Williams. 10.47 [Reserved]. 10.48+ Agreement for Chairman of Board of Directors dated June 7, 2001 between the Registrant and Robert W. Holmes, Jr. 10.49 2001 Employee Stock Purchase Plan 10.50**+ Software Distribution Agreement dated February 21, 2001 between BAM Entertainment Ltd., a subsidiary of the Registrant, and Ubi Soft Entertainment, S.A. 10.51**+ Amendment to Software Distribution Agreement dated April 23, 2001 between BAM Entertainment Ltd., a subsidiary of the Registrant, and Ubi Soft Entertainment, S.A. 10.52**+ Distribution Agreement dated July 31, 2001 between BAM Entertainment Ltd., a subsidiary of the Registrant, and Ubi Soft Entertainment, S.A. 10.53+ Form of Purchase of Accounts and Security Agreement between the Registrant and Transcap Manufacturing Services, Inc. 21.1+ List of Registrant's Subsidiaries 23.1 Consent of Deloitte & Touche LLP 23.2+ Consent of Kirkpatrick & Lockhart LLP (contained in exhibit 5.1) 24.1+ Power of attorney
------------------------- ** The Registrant has applied with the Secretary of the Securities and Exchange Commission for confidential treatment of certain information pursuant to Rule 406 under the Securities Act of 1933. The Registrant has filed separately with its application a copy of the exhibit including all confidential portions, which may be made available for public inspection pending the Securities and Exchange Commission's review of the application in accordance with Rule 406. + Previously filed. -------------------------------------------------------------------------------- EX-1.1 3 v72115a3ex1-1.txt EXHIBIT 1.1 EXHIBIT 1.1 4,000,000 Shares Common Stock ($0.001 Par Value) UNDERWRITING AGREEMENT __________, 2001 UNDERWRITING AGREEMENT _________, 2001 Jefferies & Company, Inc. Morgan Keegan & Co., Inc., As representatives of the several underwriters named in Schedule A hereto c/o Jefferies & Company, Inc. 1100 Santa Monica Blvd., 11th Floor Los Angeles, CA 90025 Ladies and Gentlemen: BAM! Entertainment, Inc., a Delaware corporation (the "Company"), proposes to issue and sell to the underwriters named in Schedule A annexed hereto (the "Underwriters") an aggregate of 4,000,000 shares (the "Firm Shares") of Common Stock, $0.001 par value (the "Common Stock"), of the Company. In addition, solely for the purpose of covering over-allotments, the Company proposes to grant to the Underwriters the option to purchase from the Company up to an additional 600,000 shares of Common Stock (the "Additional Shares"). The Firm Shares and the Additional Shares are hereinafter collectively sometimes referred to as the "Shares." The Shares are described in the Prospectus which is referred to below. The Company has filed, in accordance with the provisions of the Securities Act of 1933, as amended, and the rules and regulations thereunder (collectively called the "Act"), with the Securities and Exchange Commission (the "Commission") a registration statement on Form S-1, (File No. 333-62436) including a prospectus, relating to the Shares. The Company has furnished to you, for use by the Underwriters and by dealers, copies of one or more preliminary prospectuses (each thereof being herein called a "Preliminary Prospectus") relating to the Shares. Except where the context otherwise requires, the registration statement, as amended when it becomes effective, including all documents filed as a part thereof, and including any information contained in a prospectus subsequently filed with the Commission pursuant to Rule 424(b) under the Act and deemed to be part of the registration statement at the time of effectiveness pursuant to Rule 430(A) under the Act and also including any registration statement filed pursuant to Rule 462(b) under the Act, is herein called the Registration Statement, and the prospectus, in the form filed by the Company with the Commission pursuant to Rule 424(b) under the Act on or before the second business day after the date hereof (or such earlier time as may be required under the Act) or, if no such filing is required, the form of final prospectus included in the Registration Statement at the time it became effective, is herein called the Prospectus. The Company and the Underwriters agree as follows: 1. Sale and Purchase. Upon the basis of the warranties and representations and subject to the terms and conditions herein set forth, the Company agrees to sell to the respective Underwriters and each of the Underwriters, severally and not jointly, agrees to purchase from the Company the aggregate number of Firm Shares set forth opposite the name of such Underwriter in Schedule A annexed hereto, in each case at a purchase price of $[______] per Share. The time of the purchase is hereafter referred to as the "Time of Purchase." The Company is advised by you that the Underwriters intend (i) to make a public offering of their respective portions of the Firm Shares as soon after the effective date of the Registration Statement as in your judgment is advisable and (ii) initially to offer the Firm Shares upon the terms set forth in the Prospectus. You may from time to time increase or decrease the public offering price after the initial public offering to such extent as you may determine. In addition, the Company hereby grants to the several Underwriters the option to purchase, and upon the basis of the warranties and representations and subject to the terms and conditions herein set forth, the Underwriters shall have the right to purchase, severally and not jointly, from the Company, ratably in accordance with the number of Firm Shares to be purchased by each of them (subject to such adjustment as you shall determine to avoid fractional shares), all or a portion of the Additional Shares as may be necessary to cover over-allotments made in connection with the offering of the Firm Shares, at the same purchase price per share to be paid by the Underwriters to the Company for the Firm Shares. This option may be exercised, in whole or in part, by you on behalf of the several Underwriters at any time and from time to time on or before the thirtieth day following the date hereof, by written notice to the Company. Such notice shall set forth the aggregate number of Additional Shares as to which the option is being exercised, and the date and time when the Additional Shares are to be delivered (such date and time being herein referred to as the "Additional Time of Purchase"); provided, however, that the Additional Time of Purchase shall not be earlier than the Time of Purchase (as defined below) nor earlier than the second business day(1) after the date on which the option shall have been exercised nor later than the tenth business day after the date on which the option shall have been exercised. The number of Additional Shares to be sold to each Underwriter shall be the number which bears the same proportion to the aggregate number of Additional Shares being purchased as the number of Firm Shares set forth opposite the name of such Underwriter on Schedule A hereto bears to the total number of Firm Shares (subject, in each case, to such adjustment as you may determine to eliminate fractional shares). ---------- (1) As used herein "business day" shall mean a day on which the New York Stock Exchange is open for trading. 2 2. Payment and Delivery. Payment of the purchase price for the Firm Shares shall be made to the Company by Federal Funds wire transfer, against delivery of the certificates for the Firm Shares to you through the facilities of the Depository Trust Company ("DTC") for the respective accounts of the Underwriters. Such payment and delivery shall be made at 10:00 A.M., New York City time, on [______________], 2001 (unless another time shall be agreed to by you and the Company or unless postponed in accordance with the provisions of Section 8 hereof). The time at which such payment and delivery are actually made is hereinafter sometimes called the "Time of Purchase." Certificates for the Firm Shares shall be delivered to you in definitive form in such names and in such denominations as you shall specify no later than the second business day preceding the Time of Purchase. For the purpose of expediting the checking of the certificates for the Firm Shares by you, the Company agrees to make such certificates available to you for such purpose at least two full business days preceding the Time of Purchase. Payment of the purchase price for the Additional Shares shall be made at the Additional Time of Purchase in the same manner and at the same office as the payment for the Firm Shares. Certificates for the Additional Shares shall be delivered to you in definitive form in such names and in such denominations as you shall specify no later than the second business day preceding the Additional Time of Purchase. For the purpose of expediting the checking of the certificates for the Additional Shares by you, the Company agrees to make such certificates available to you for such purpose at least one full business day preceding the Additional Time of Purchase. 3. Representations and Warranties of the Company. The Company represents and warrants to each of the Underwriters that: (a) the Company has not received, and has no notice of, any order of the Commission preventing or suspending the use of any Preliminary Prospectus, or instituting or threatening proceedings for that purpose, and each Preliminary Prospectus, at the time of filing thereof, conformed in all material respects to the requirements of the Act and did not contain an untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading; and when the Registration Statement became effective, the Registration Statement, all amendments thereto or modifications thereof, and the Prospectus fully complied in all material respects with the provisions of the Act, and the Registration Statement and all amendments thereto or modifications thereof do not and will not contain an untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein not misleading, and the Prospectus and all amendments or supplements thereto, or modifications thereof, if any, will not contain an untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading; any statutes, regulations, contracts or other documents that are required to be described in the Registration Statement or the Prospectus or to be filed as exhibits to the Registration Statement have been so 3 described or filed; provided, however, that the Company makes no warranty or representation with respect to any statement contained in the Registration Statement, the Preliminary Prospectus or the Prospectus in reliance upon and in conformity with information concerning the Underwriters and furnished in writing by or on behalf of any Underwriter through you to the Company expressly for use in the Registration Statement, the Preliminary Prospectus or the Prospectus; and the Company has not distributed any offering material in connection with the offering or sale of the Shares other than the Registration Statement, the Preliminary Prospectus or the Prospectus; (b) as of the date of this Agreement, the Company has the authorized and outstanding capitalization as set forth in the section of the Registration Statement, the Preliminary Prospectus and the Prospectus entitled "Capitalization" and, as of the Time of Purchase and the Additional Time of Purchase, as the case may be, the Company shall have the authorized capitalization as set forth under the heading entitled "Pro Forma As Adjusted" in the section of the Registration Statement and the Prospectus entitled "Capitalization"; other than as described in the Prospectus, no options, warrants or other rights to purchase, agreements or other obligations to issue or other rights to convert any obligation into shares of capital stock or ownership interests in the Company are outstanding; all of the issued and outstanding shares of capital stock including Common Stock and Preferred Stock of the Company have been duly and validly authorized and issued and are fully paid and non-assessable, have been issued in compliance with all federal and state securities laws and were not issued in violation of any preemptive right, resale right, co-sale right, right of first refusal or similar right; (c) the Company has been duly incorporated and is validly existing as a corporation in good standing under the laws of the State of Delaware, with full corporate power and authority to own, lease and operate its properties and conduct its business as described in the Registration Statement; (d) the Company is duly qualified to do business as a foreign corporation in good standing in each jurisdiction where the ownership or leasing of its properties or the conduct of its business requires such qualification, except where the failure to so qualify would not have a material adverse effect on the business, properties, financial condition or results of operation of the Company and its Subsidiaries (as hereinafter defined) taken as a whole (a "Material Adverse Effect"). The Company has no subsidiaries (as defined in the Act) other than (1) BAM Entertainment Limited and (2) Bam Studios (Europe) Limited (collectively, the "Subsidiaries"); the Company owns 100% of the outstanding capital stock of each of the Subsidiaries; other than the Subsidiaries, the Company does not own, directly or indirectly, any shares of stock or any other equity or long-term debt securities of any corporation or have any equity interest in any firm, partnership, joint venture, association or other entity; complete and correct copies of the charter documents, certificates or articles of incorporation and of the bylaws of the Company and the Subsidiaries and all amendments thereto have been delivered to you, and except as set forth 4 in the exhibits to the Registration Statement no changes therein will be made subsequent to the date hereof and prior to the Time of Purchase or, if later, the Additional Time of Purchase; each Subsidiary has been duly incorporated and is validly existing as a corporation in good standing under the laws of the jurisdiction of its incorporation, with full corporate power and authority to own, lease and operate its properties and to conduct its business as described in the Registration Statement; each Subsidiary is duly qualified to do business as a foreign corporation in good standing in each jurisdiction where the ownership or leasing of the properties or the conduct of its business requires such qualification, except where the failure to so qualify would not have a Material Adverse Effect; all of the outstanding shares of capital stock of each of the Subsidiaries have been duly authorized and validly issued, are fully paid and non-assessable and (except as otherwise described in this Section 3(d)) are owned by the Company subject to no security interest, other encumbrance or adverse claims; no options, warrants or other rights to purchase, agreements or other obligations to issue or other rights to convert any obligation into shares of capital stock or ownership interests in the Subsidiaries are outstanding; (e) the Company and each of its Subsidiaries are in compliance in all material respects with the laws, orders, rules, licenses, authorizations, approvals, regulations and directives issued or administered by each jurisdiction applicable to it, except where non-compliance will not singly or in the aggregate result in a Material Adverse Effect; (f) each of the agreements (the "Reincorporation Agreements") entered into by the Company in connection with the changing of its state of incorporation from California to Delaware (the "Reincorporation") has been duly and validly authorized, executed and delivered by the Company, are in full force and effect, and constitutes a valid and binding obligation of the Company, enforceable against the Company in accordance with its terms and, to the knowledge of the Company, is a valid and binding obligation of each other party thereto, enforceable against each party in accordance with its terms. The Reincorporation has been validly effected in accordance with the laws of the states of California and Delaware; (g) neither the Company nor any of its Subsidiaries is in breach of, or in default under (nor has any event occurred which with notice, lapse of time, or both would result in any breach of, or constitute a default under), its respective charter or bylaws or, other than that would not have a material adverse effect on the Company or its Subsidiaries, in the performance or observance of any obligation, agreement, covenant or condition contained in any indenture, mortgage, deed of trust, bank loan or credit agreement or other evidence of indebtedness, or any lease, contract or other agreement or instrument to which the Company or any of its Subsidiaries is a party or by which any of them or any of their properties is bound, and the execution, delivery and performance of this Agreement, the issuance and sale of the Shares and the consummation of the transactions contemplated hereby will not conflict with, or result in any breach of or constitute a default under (nor constitute any event which with notice, lapse of time, or both would result in any breach of, or constitute a default under), any provisions of the charter or 5 bylaws of the Company or any of its Subsidiaries or under any provision of any license, indenture, mortgage, deed of trust, bank loan or credit agreement or other evidence of indebtedness, or any lease, contract or other agreement or instrument to which the Company or any of its Subsidiaries is a party or by which any of them or their respective properties may be bound or affected, or under any federal, state, local or foreign law, regulation or rule or any decree, judgment or order applicable to the Company or any of its Subsidiaries; (h) this Agreement has been duly authorized, executed and delivered by the Company and is a legal, valid and binding agreement of the Company enforceable in accordance with its terms, except as rights to indemnity and contribution hereunder may be limited by applicable law and except as enforceability may be limited by bankruptcy, insolvency or other laws affecting the rights of creditors generally or by general equitable principles; (i) the capital stock of the Company, including the Shares, conforms in all material respects to the description thereof contained in the Registration Statement, the Preliminary Prospectus and Prospectus and the certificates for the Shares are in due and proper form and the holders of the Shares will not be subject to personal liability by reason of being such holders; (j) the Shares have been duly and validly authorized and, when issued and delivered against payment therefor as provided herein, will be duly and validly issued and fully paid and non-assessable; (k) no approval, authorization, consent or order of or filing with any national, state or local governmental or regulatory commission, board, body, court, authority or agency is required in connection with the issuance and sale of the Shares or the consummation by the Company of the transaction as contemplated hereby other than registration of the Shares under the Act and any necessary qualification under the securities or blue sky laws of the various jurisdictions in which the Shares are being offered by the Underwriters or under the rules and regulations of the National Association of Securities Dealers, Inc. ("NASD"); (l) no person has the right, contractual or otherwise, to cause the Company to issue to it, or register pursuant to the Act, any shares of capital stock of the Company upon the issue and sale of the Shares to the Underwriters hereunder, nor does any person have preemptive rights, co-sale rights, rights of first refusal or other rights to purchase any of the Shares other than those that have been expressly waived prior to the dates hereof; (m) Deloitte & Touche LLP, whose report on the consolidated financial statements of the Company and its Subsidiaries is filed with the Commission as part of the Registration 6 Statement, the Preliminary Prospectus and Prospectus, are independent public accountants as required by the Act; (n) each of the Company and its Subsidiaries has all necessary licenses, authorizations, consents and approvals and has made all necessary filings required under any federal, state, local or foreign law, regulation or rule, and has obtained all necessary authorizations, consents and approvals from other persons, in order to conduct its respective business; (o) all legal or governmental proceedings, contracts, leases or documents of a character required to be described in the Registration Statement or the Prospectus or to be filed as an exhibit to the Registration Statement have been so described or filed as required; (p) there are no actions, suits, claims, investigations or proceedings pending or threatened to which the Company or any of its Subsidiaries or any of their respective officers is a party or of which any of their respective properties is subject at law or in equity, or before or by any federal, state, local or foreign governmental or regulatory commission, board, body, authority or agency which could result in a judgment, decree or order having a Material Adverse Effect or prevent consummation of the transactions contemplated hereby, and the Company knows of no facts which would form a reasonable basis for such an action; (q) the audited financial statements and summary consolidated financial data included in the Registration Statement, the Preliminary Prospectus and the Prospectus present fairly the consolidated financial position of the Company and its Subsidiaries as of the dates indicated and the consolidated results of operations and cash flows of the Company and its Subsidiaries for the periods specified; the financial statements have been prepared in conformity with generally accepted accounting principles applied on a consistent basis during the periods involved; (r) subsequent to the respective dates as of which information is given in the Registration Statement and the Prospectus, there has not been (i) any material adverse change, or any development which, in the Company's reasonable judgment, is likely to cause a material adverse change, in the business, properties or assets described or referred to in the Registration Statement, or the results of operations, condition (financial or otherwise), business, prospects or operations of the Company and its Subsidiaries taken as a whole, (ii) any transaction which is material to the Company or its Subsidiaries taken as a whole, except transactions in the ordinary course of business, (iii) any obligation, direct or contingent, which is material to the Company and its Subsidiaries taken as a whole, incurred by the Company or its Subsidiaries, except obligations incurred in the ordinary course of business, (iv) except as contemplated in the Prospectus, any change in the capital stock or outstanding indebtedness of the Company or its Subsidiaries or (v) any dividend or distribution of any kind declared, paid or made on the capital 7 stock of the Company. Neither the Company nor its Subsidiaries has any material contingent obligation which is not disclosed in the Registration Statement; (s) during the six months prior to the date hereof, neither the Company nor any person acting on behalf of the Company has offered or sold to any person any capital stock, or any securities of the same or a similar class as the Shares, other than the Shares and other than under restrictions and other circumstances so as to ensure that such offers or sales do not become integrated into the offer and sale of the Shares; (t) the Company has obtained the agreement (in the form approved by you) of each of its directors, officers, stockholders, optionholders and other securityholders not to sell, offer to sell, contract to sell, hypothecate, grant any option to sell or otherwise dispose of, directly or indirectly, any shares of Common Stock or securities convertible into or exchangeable for Common Stock or warrants or other rights to purchase Common Stock for a period of 180 days after the date of the Prospectus without the prior written consent of Jefferies & Company, Inc.; (u) the Company is not and, after giving effect to the offering and sale of the Shares, will not be an "investment company" or an entity "controlled" by an "investment company," as such terms are defined in the Investment Company Act of 1940, as amended (the "Investment Company Act"); (v) the Company and its Subsidiaries have good and marketable title to all property (real and personal) described in the Prospectus as being owned by them, free and clear of all liens, claims, security interests or other encumbrances or defects except such as are described in the Registration Statement and the Prospectus and except as would not individually or in the aggregate have a Material Adverse Effect. All the property being held under lease by the Company and its Subsidiaries is held thereby under valid and enforceable leases; (w) each of the Company and its Subsidiaries is insured by insurers of recognized financial responsibility against such losses and risks and in such amount as are customary in the business in which it is engaged. All policies of insurance insuring the Company, the Subsidiaries or any of their businesses, material assets, employees, officers and directors are in full force and effect, and each of the Company and each of its Subsidiaries is in compliance with the terms of such policies in all material respects. There are no claims by the Company or any of its Subsidiaries under any such policy or instrument as to which any insurance company is denying liability or defending under a reservation of rights clause; (x) the Company has received the written consent to the use of all statistical and market-related data included in the Prospectus from appropriate sources to the extent required; 8 (y) neither the Company nor any of its affiliates has taken, directly or indirectly, any action designed to or which has constituted or which might reasonably be expected to cause or result, under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and the rules and regulations thereunder, or otherwise, in stabilization or manipulation of the price of any security of the Company to facilitate the sale or resale of the Shares; (z) the Company owns or has obtained licenses (which licenses are enforceable against the Company and, to the Company's best knowledge, the other parties thereto) for the patents, patent applications, inventions, technology, know-how (including trade secrets and other unpatented and/or unpatentable proprietary or confidential information systems or procedures), trademarks, trademark registrations, service marks, service mark registrations, mask work rights, trade names, copyrights, and other rights described in the Prospectus as being owned or used by or licensed to the Company or its Subsidiaries or necessary for the conduct of their respective businesses as currently conducted (collectively, the "Intellectual Property"). Each employee of and consultant to the Company has entered into a confidentiality and invention assignment agreement in favor of the Company as a condition of his or her employment or retention in service. Except as set forth in the Prospectus: (i) to the Company's knowledge, there are no rights of third parties to any such Intellectual Property inconsistent with the rights of the Company related to such Intellectual Property; (ii) to the Company's knowledge, there is no infringement by third parties of any such Intellectual Property owned or exclusively licensed by the Company; (iii) there is no pending or threatened action, suit, proceeding or claim by others challenging the Company's rights in or to any Intellectual Property which would cause a Material Adverse Effect on the Company; (iv) there is no pending or threatened action, suit, proceeding or claim by others challenging the validity or scope of any Intellectual Property which would cause a material adverse effect on the Company; (v) there is no pending or threatened action, suit, proceeding or claim by others that the Company or any of its Subsidiaries infringes or otherwise violates, or would infringe or otherwise violate upon commercialization of its products and product candidates described in the Prospectus, any patent, trademark, copyright, trade secret or other proprietary rights of others which would cause a material adverse effect on the Company; and (vi) to the Company's actual knowledge there is no patent or patent application which contains claims that conflict or interfere with or may conflict or interfere with any Intellectual Property described in the Prospectus as being owned by or licensed to the Company or any of its Subsidiaries or that is necessary for the conduct of their respective businesses as currently or contemplated to be conducted; (aa) neither the Company nor any of its Subsidiaries has violated any foreign, federal, state or local law or regulation relating to the protection of human health and safety, the environment or hazardous or toxic substances or wastes, pollutants or contaminants, nor any federal or state law relating to discrimination in the hiring, promotion or pay of employees nor any applicable federal or state wages and hours laws, nor any provisions of the Employee Retirement Income Security Act or the rules and regulations promulgated thereunder, which 9 violation individually or in the aggregate could reasonably be expected to result in a Material Adverse Effect; (bb) the Company and the Subsidiaries maintain a system of internal accounting controls sufficient to provide reasonable assurances that (i) transactions are executed in accordance with management's general or specific authorization; (ii) records (including sales contracts) are kept in accordance with management's general or specific authorization and true and accurate copies are provided to the Company's independent auditors; (iii) transactions are recorded as necessary to permit preparation of financial statements in conformity with generally accepted accounting principles and to maintain accountability for assets; (iv) access to assets is permitted only in accordance with management's general or specific authorization; and (v) the recorded accountability for assets is compared with existing assets at reasonable intervals and appropriate action is taken with respect to any differences; (cc) each of the Company and its Subsidiaries has filed all federal, state, local and foreign tax returns and tax forms required to be filed. Such returns and forms are complete and correct in all material respects, and all taxes shown by such returns or otherwise assessed that are due or payable have been paid, except such taxes as are being contested in good faith and as to which adequate reserves have been provided. All payroll withholdings required to be made by the Company and each of its Subsidiaries with respect to employees have been made. The charges, accruals and reserves on the books of the Company and each of its Subsidiaries in respect of any tax liability for any year not finally determined are, in management's determination, adequate to meet any assessments or reassessments for additional taxes. There have been no tax deficiencies asserted and, to the knowledge of the Company, no tax deficiency might be reasonably asserted or threatened against the Company or any of its Subsidiaries which individually or in the aggregate could have a Material Adverse Effect; and In addition, any certificate signed by any executive officer of the Company delivered to the Representatives or counsel for the Underwriters in connection with the offering of the Shares shall be deemed to be a representation and warranty by the Company, as to matters covered thereby, to each Underwriter. 4. Certain Covenants of the Company. The Company hereby agrees: (a) to furnish such information as may be required and otherwise to cooperate in qualifying the Shares for offering and sale under the securities or blue sky laws of such states as you may designate and to maintain such qualifications in effect so long as required for the distribution of the Shares; provided that the Company shall not be required to qualify as a foreign corporation (unless it is already so qualified) or to consent to the service of process under the laws of any such state (except service of process with respect to the offering and sale of the 10 Shares); and to promptly advise you of the receipt by the Company of any notification with respect to the suspension of the qualification of the Shares for sale in any jurisdiction or the initiation or threatening of any proceeding for such purpose; (b) to make available to the Underwriters in New York City, as soon as practicable after the Registration Statement becomes effective, and thereafter from time to time to furnish to the Underwriters, as many copies of the Prospectus (or of the Prospectus as amended or supplemented if the Company shall have made any amendments or supplements thereto after the effective date of the Registration Statement) as the Underwriters may request for the purposes contemplated by the Act; in case any Underwriter is required to deliver a prospectus within the nine-month period referred to in Section 10(a)(3) of the Act in connection with the sale of the Shares, the Company will prepare promptly upon request, but at the expense of such Underwriter, such amendment or amendments to the Registration Statement and such prospectuses as may be necessary to permit compliance with the requirements of Section 10(a)(3) of the Act; (c) to advise you promptly and (if requested by you) to confirm such advice in writing, (i) when the Registration Statement has become effective and when any post-effective amendment thereto becomes effective and (ii) if Rule 430A under the Act is used, when the Prospectus is filed with the Commission pursuant to Rule 424(b) under the Act (which the Company agrees to file in a timely manner under such Rules); (d) to advise you promptly, confirming such advice in writing, of any request by the Commission for amendments or supplements to the Registration Statement, the Preliminary Prospectus or the Prospectus or for additional information with respect thereto, or of notice of institution of proceedings for, or the entry of a stop order suspending the effectiveness of the Registration Statement and, if the Commission should enter a stop order suspending the effectiveness of the Registration Statement, to make every reasonable effort to obtain the lifting or removal of such order as soon as possible; to advise you promptly of any proposal to amend or supplement the Registration Statement or Prospectus and to file no such amendment or supplement to which you shall object in writing; (e) to file promptly all reports and any definitive proxy or information statement required to be filed by the Company with the Commission and otherwise take all actions in order to comply with the Exchange Act subsequent to the date of the Prospectus and for so long as the delivery of a prospectus is required in connection with the offering or sale of the shares, and to promptly notify you of such filing; (f) if necessary or appropriate, to file a registration statement pursuant to Rule 462(b) under the Act; (g) to furnish to you and, upon request, to each of the other Underwriters for a period of five years from the date of this Agreement (i) copies of any reports or other communications which the Company shall send to its stockholders or shall from time to time publish or publicly disseminate, (ii) copies of all annual, quarterly and current reports filed with the Commission on 11 Forms 10-K, 10-Q and 8-K, or such other similar form as may be designated by the Commission, (iii) copies of documents or reports filed with any national securities exchange or authorized quotation system on which any class of securities of the Company is listed, and (iv) such other information as you may reasonably request regarding the Company or its Subsidiaries, in each case as soon as such communications, documents or information becomes available; (h) to advise the Underwriters promptly of the happening of any event known to the Company within the time during which a Prospectus relating to the Shares is required to be delivered under the Act which, in the judgment of the Company, would require the making of any change in the Prospectus then being used so that the Prospectus would not include an untrue statement of material fact or omit to state a material fact necessary to make the statements therein, in the light of the circumstances under which they are made, not misleading and, during such time, to prepare and furnish, at the Company's expense, to the Underwriters promptly such amendments or supplements to such Prospectus as may be necessary to reflect any such change and to furnish you a copy of such proposed amendment or supplement before filing any such amendment or supplement with the Commission; (i) to make generally available to its security holders, and to deliver to you, an earnings statement of the Company (which will satisfy the provisions of Section 11(a) of the Act) covering a period of twelve months beginning after the effective date of the Registration Statement (as defined in Rule 158(c) of the Act) as soon as is reasonably practicable after the termination of such twelve-month period but not later than eighteen months after such effective date; (j) to furnish to its stockholders as soon as practicable after the end of each fiscal year an annual report (including a balance sheet and statements of income, shareholders' equity and of cash flow of the Company for such fiscal year), accompanied by a copy of the certificate or report thereon of nationally recognized independent certified public accountants; (k) to furnish to you five (5) signed copies of the Registration Statement, as initially filed with the Commission, and of all amendments thereto (including all exhibits thereto) and sufficient conformed copies of the foregoing (other than exhibits) for distribution of a copy to each of the other Underwriters; (l) to furnish to you as early as practicable prior to the Time of Purchase and the Additional Time of Purchase, as the case may be, but not later than two business days prior thereto, a copy of the latest available unaudited interim consolidated financial statements, if any, of the Company and its Subsidiaries which have been reviewed by the Company's independent certified public accountants, as stated in their letter to be furnished pursuant to Section 6(b) hereof; (m) to apply the net proceeds from the sale of the Shares in the manner set forth under the caption "Use of Proceeds" in the Prospectus; 12 (n) to furnish to you, before filing with the Commission subsequent to the effective date of the Registration Statement and during the period referred to in paragraph (e) above, a copy of any document proposed to be filed pursuant to Section 13, 14 or 15(d) of the Exchange Act; (o) not to issue, sell, offer or agree to sell, contract to sell, grant any option to sell or otherwise dispose of, directly or indirectly, any shares of capital stock or securities convertible into or exchangeable or exercisable for capital stock or warrants or other rights to purchase capital stock or any other securities of the Company that are substantially similar to capital stock or permit the registration under the Act of any shares of capital stock, except for the registration of the Shares and the sales to the Underwriters pursuant to this Agreement and except for issuances of options to purchase 713,225 shares of Common Stock under employee stock option plans existing on the date of this Agreement, an issuance to Transcap Associates, Inc. of a warrant to purchase an additional 100,000 shares of Common Stock with an exercise price equal to the initial public offering price, issuances of up to 500,000 shares of or securities convertible into or exercisable for Common Stock in strategic partnering transactions or other transactions, the primary purpose thereof is not to raise capital, issuances of Common Stock upon the exercise of outstanding options, warrants and debentures described in the Registration Statement or Prospectus, for a period of 180 days after the date hereof, without the prior written consent of Jefferies & Company, Inc.; (p) to use its best efforts to cause the Common Stock to be included, and thereafter have such inclusion maintained, for quotation on the Nasdaq National Market; (q) to pay all costs, expenses, fees and taxes (other than any transfer taxes), including the fees and expenses of counsel to the Underwriters and certain travel costs, in the maximum aggregate amount of $300,000, in connection with (i) the preparation and filing of the Registration Statement, each Preliminary Prospectus, the Prospectus, and any amendments or supplements thereto, and the printing and furnishing of copies of each thereof to the Underwriters and to dealers (including costs of mailing and shipment), (ii) the registration, issuance, sale and delivery of the Shares, (iii) the word processing and/or printing of this Agreement, any Agreement Among Underwriters, any dealer agreements, any Statements of Information, any Powers of Attorney and any closing documents (including compilations thereof) and the reproduction and/or printing and furnishing of copies of each thereof to the Underwriters and to dealers (including costs of mailing and shipment), (iv) the qualification of the Shares for offering and sale under state laws and the determination of their eligibility for investment under state law as aforesaid (including the legal fees and filing fees and other disbursements of counsel to the Underwriters) and the printing and furnishing of copies of any blue sky surveys or legal investment surveys to the Underwriters and to dealers, (v) any listing of the Shares on any securities exchange or qualification of the Shares for quotation on the Nasdaq Stock Market and any registration thereof under the Exchange Act, (vi) the filing for review of the public offering of the Shares by the NASD, including attorneys' fees related thereto, and (vii) the performance of the Company's other obligations hereunder; and 13 (r) to use its best efforts to do and perform all things required or necessary to be done and performed under this Agreement by the Company prior to the Time of Purchase or the Additional Time of Purchase, as the case may be, and to satisfy all conditions precedent to the delivery of the Shares. 5. Reimbursement of Underwriters' Expenses. If the Shares are not delivered for any reason other than the default by one or more of the Underwriters in its or their respective obligations hereunder, the Company shall, in addition to paying the amounts described in Section 4(q) hereof, reimburse the Underwriters for all of their out-of-pocket expenses, including the fees and disbursements of their counsel. 6. Conditions of Underwriters' Obligations. The several obligations of the Underwriters hereunder are subject to the accuracy of the representations and warranties on the part of the Company on the date hereof and at the Time of Purchase (and the several obligations of the Underwriters at the Additional Time of Purchase are subject to the accuracy of the representations and warranties on the part of the Company on the date hereof and at the Time of Purchase (unless previously waived) and at the Additional Time of Purchase, as the case may be), the performance by the Company of its obligations hereunder and to the following additional conditions precedent: (a) The Company shall furnish to you at the Time of Purchase and at the Additional Time of Purchase, as the case may be, a written opinion of Kirkpatrick & Lockhart LLP, counsel for the Company, or, with respect to the opinions in subsections (i), (ii), (iii), (v), (vi), (viii), (ix), (x), (xii), (xvii), (xviii), (xix), (xxiv) and (xxv), of Doty, Sundheim & Gilmore; provided that the opinion with respect to subsection (v) shall also be given by Kirkpatrick & Lockhart LLP, which opinion shall be made to their knowledge, addressed to the Underwriters, and dated the Time of Purchase or the Additional Time of Purchase, as the case may be, with reproduced copies for each of the other Underwriters and in form satisfactory to Brobeck, Phleger & Harrison LLP, counsel for the Underwriters, stating that: (i) the Company is duly organized and is validly existing as a corporation in good standing under the laws of the State of Delaware, with full corporate power and authority to own, lease and operate its properties and conduct its business as described in the Registration Statement and the Prospectus (and any amendment or supplement thereto), to execute and deliver the Underwriting Agreement and to issue, sell and deliver the Shares as therein contemplated; (ii) each of the Subsidiaries has been duly organized and is validly existing as a corporation in good standing under the laws of its respective jurisdiction of incorporation with full corporate power and authority to own, lease and operate its respective properties and to conduct its respective business; 14 (iii) the Company and its Subsidiaries are duly qualified in or licensed by each jurisdiction in which they conduct their respective businesses and in which the failure, individually or in the aggregate, to be so licensed or qualified could have a Material Adverse Effect and the Company and its Subsidiaries are duly qualified, and are in good standing, in each jurisdiction in which they own or lease real property or maintain an office and in which such qualification is necessary; (iv) the Underwriting Agreement has been duly authorized, executed and delivered by the Company and is a legal, valid and binding agreement of the Company enforceable by you in accordance with its terms; (v) the authorized, issued and outstanding capital stock as of _________, 2001 is as set forth under the heading "Capitalization" in the Prospectus, and all of the issued shares of capital stock of the Company have been duly and validly authorized and issued and to our knowledge are fully paid and non-assessable; (vi) the outstanding shares of capital stock of the Company are free of statutory and contractual preemptive rights and have been issued in compliance with all state, federal and foreign securities laws; to the best of such counsel's knowledge, except as described in the Prospectus, there are no outstanding securities of the Company convertible or exchangeable into, or evidencing the right to purchase or subscribe for, any shares of capital stock of the Company and there are no outstanding or authorized options, warrants or rights of a similar character obligating the Company to issue any shares of its capital stock or any securities convertible or exchangeable into, or evidencing the right to purchase or subscribe for, any shares of such stock; (vii) the Shares to be sold by the Company have been duly authorized, and, when issued and delivered in accordance with the terms of this Agreement, will be validly issued, fully paid and non-assessable; (viii) the Shares, when issued, will be free of statutory and, to the knowledge of such counsel, contractual preemptive rights, resale rights, rights of first refusal and similar rights; the certificates for the Shares are in due and proper form and the holders of the Shares will not be subject to personal liability by reason of being such holders; (ix) other than as set forth in the Prospectus and to our knowledge, there are no legal or governmental proceedings pending to which the Company or any of the Subsidiaries is a party or of which any property of the Company or the Subsidiaries is the subject which are required to be described in the Registration Statement that are not so described; and no such proceedings are threatened or contemplated by governmental authorities or threatened by others; 15 (x) other than the Subsidiaries, the Company does not own or control, directly or indirectly, any corporation, association or other entity; all of the outstanding shares of capital stock of each of the Subsidiaries have been duly authorized and validly issued, are fully paid and non-assessable and, except as otherwise stated in the Registration Statement, are owned by the Company, in each case subject to no security interest, other encumbrance or adverse claim; to the best of such counsel's knowledge, no options, warrants or other rights to purchase, agreements or other obligations to issue or other rights to convert any obligation into shares of capital stock or ownership interests in the Subsidiaries are outstanding; (xi) the statements set forth under the caption "Description of Capital Stock" in the Prospectus, insofar as such statements purport to summarize certain provisions of the capital stock of the Company, provide a fair summary of such provisions in all material respects; the statements set forth under the captions "Risk Factors--Risks Relating to this Offering -- Anti-takeover provisions in our charter documents and in Delaware law could prevent or delay a change in control and, as a result, negatively impact our stockholders;" "Legal Proceedings;" "Business -- Strategic Relationships;" "Management--2000 Stock Incentive Plan," ["--Employee Stock Purchase Plan,"] "--401(k) Retirement Plan" and "--Indemnification of Directors and Officers"; "Certain Transactions" and "Underwriters" (to the extent it is a description of this Agreement) in the Prospectus and in the Registration Statement in Item 15 and in the Registration Statement on Form 8-A relating to the Common Stock filed under the Exchange Act, in each case insofar as such statements constitute summaries of the legal matters, documents or proceedings referred to therein, have been reviewed by us, are correct in all material respects and fairly summarize the matters referred to therein to the extent required by the Act or the Exchange Act; (xii) other than as set forth in the Prospectus, such counsel has no knowledge of any persons with registration rights or other similar rights to have any securities registered pursuant to the Registration Statement who have not waived such rights; (xiii) the Registration Statement and the Prospectus (except as to the financial statements and schedules and other financial data contained or incorporated by reference therein, as to which such counsel need express no opinion) comply as to form in all material respects with the requirements of the Act and no amendment to the Registration Statement is required to be filed which has not been filed; (xiv) the Registration Statement and all post-effective amendments, if any, have become effective under the Act and, to such counsel's knowledge, no stop order proceedings with respect thereto are pending or threatened under the Act and any required filing of the Prospectus and any supplement thereto pursuant to Rule 424 under the Act has been made in the manner and within the time period required by such Rule 424; 16 (xv) no approval, authorization, consent or order of or filing with any national, state or local governmental or regulatory commission, board, body, court, authority or agency is required in connection with the issuance and sale of the Shares and consummation by the Company of the transactions contemplated hereby other than registration of the Shares under the Act (except such counsel need express no opinion as to any necessary qualification under the state securities or blue sky laws of the various jurisdictions in which the Shares are being offered by the Underwriters); (xvi) the execution, delivery and performance of the Underwriting Agreement by the Company and the consummation by the Company of the transactions contemplated thereby do not and will not conflict with, or result in any breach of, or constitute a default under (nor constitute any event which with notice, lapse of time, or both, would result in any breach of or constitute a default under), any provisions of the charter or bylaws of the Company or any of its Subsidiaries or under any provision of any license, indenture, mortgage, deed of trust, bank loan, credit agreement or other evidence of indebtedness, or any lease, contract or other agreement or instrument to which the Company or any of its Subsidiaries is a party or by which any of them or their respective properties may be bound or affected and which would have a material adverse effect on the Company or any of its Subsidiaries, or under any federal, state, local or foreign law, regulation or rule or any decree, judgment or order applicable to the Company or any of its Subsidiaries; (xvii) to such counsel's knowledge, neither the Company nor any of its Subsidiaries is in violation of its charter or bylaws or is in breach of, or in default under (nor has any event occurred which with notice, lapse of time, or both would result in any breach of, or constitute a default under), any license, indenture, mortgage, deed of trust, bank loan or any other agreement or instrument to which the Company or any of its Subsidiaries is a party or by which any of them or their respective properties may be bound or affected or under any federal, state, local or foreign law, regulation or rule or any decree, judgment or order applicable to the Company or any of its Subsidiaries; (xviii) to such counsel's knowledge, there are no contracts, licenses, agreements, leases or documents of a character which are required to be filed as exhibits to the Registration Statement or to be summarized or described in the Prospectus which have not been so filed, summarized or described; (xix) to the best of such counsel's knowledge, there are no actions, suits, claims, investigations or proceedings pending, threatened or contemplated to which the Company or any of its Subsidiaries is subject or of which any of their respective properties, is subject at law or in equity or before or by any federal, state, local or foreign governmental or regulatory commission, board, body, authority or agency which are required to be described in the Prospectus but are not so described; 17 (xx) the Company is not and, after giving effect to the offering and sale of the Shares, will not be an "investment company" or an entity "controlled" by an "investment company," as such terms are defined in the Investment Company Act; (xxi) the Shares have been approved for quotation on the Nasdaq National Market upon issuance as contemplated by the Underwriting Agreement; (xxii) nothing has come to the attention of such counsel that causes them to believe that the Registration Statement or any amendment thereto at the time such Registration Statement or amendment became effective contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading, or that the Prospectus or any supplement thereto at the date of such Prospectus or such supplement, and at all times up to and including the Time of Purchase or Additional Time of Purchase, as the case may be, contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading (it being understood that such counsel need express no opinion with respect to the financial statements and schedules and other financial data included in the Registration Statement or Prospectus); (xxiii) the execution and delivery of the Agreement and Plan of Merger (the "Merger Agreement"), dated ______________, 2001 between the Company and Bay Area Multimedia, Inc., a California corporation (the "California Corporation"), effecting the reincorporation of the California Corporation under the laws of the State of Delaware, was duly authorized by all necessary corporate action on the part of each of the California Corporation and the Company; (xxiv) each of the California Corporation and the Company had all corporate power and authority necessary to execute and file the [Certificate of Ownership and Merger] with the Secretary of State of the State of California and the Secretary of State of the State of Delaware and to consummate the reincorporation contemplated by the Merger Agreement, and the Merger Agreement at the time of execution and immediately prior to the effectiveness of the Merger constituted a valid and binding obligation of each of the California Corporation and the Company, subject to the effect of (x) bankruptcy, insolvency, reorganization, arrangement, moratorium, fraudulent transfer or other similar federal or state laws affecting the rights of creditors and (y) general principles of equity; and (xxv) the [Certificate of Ownership and Merger] has been filed with the Secretary of State of the State of California and the State of Delaware, and is in effect without amendment thereto on the date hereof and all other actions necessary to effect the reincorporation have been taken such that the California Corporation is reincorporated in Delaware as of the date hereof. 18 (b) You shall have received from Deloitte & Touche LLP, letters dated, respectively, the date of this Agreement and the Time of Purchase and Additional Time of Purchase, as the case may be, and addressed to the Underwriters (with reproduced copies for each of the Underwriters) in the forms heretofore approved by Jefferies & Company, Inc. (c) The Company shall have complied with the provisions of Section 4(b) hereof with respect to the furnishing of copies of the Prospectus as soon as practicable after the Registration Statement becomes effective. (d) You shall have received at the Time of Purchase and at the Additional Time of Purchase, as the case may be, the favorable opinion of Brobeck, Phleger & Harrison LLP, counsel for the Underwriters, dated the Time of Purchase or the Additional Time of Purchase, as the case may be, as to the matters referred to in subparagraphs (iv), (vii), and (xiv) of paragraph (a) of this Section 6. In addition, such counsel shall state that such counsel have participated in conferences with officers and other representatives of the Company, counsel for the Company, representatives of the independent public accountants of the Company and representatives of the Underwriters at which the contents of the Registration Statement and Prospectus and related matters were discussed and, although such counsel is not passing upon and does not assume any responsibility for the accuracy, completeness or fairness of the statements contained in the Registration Statement and Prospectus, on the basis of the foregoing (relying as to materiality to a large extent upon the opinions of officers and other representatives of the Company), no facts have come to the attention of such counsel which lead them to believe that the Registration Statement or any amendment thereto at the time such Registration Statement or amendment became effective contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading or that the Prospectus as of its date or any supplement thereto as of its date contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading (it being understood that such counsel need express no comment with respect to the financial statements and schedules and other financial and statistical data derived therefrom included in the Registration Statement or Prospectus). (e) No amendment or supplement to the Registration Statement or Prospectus shall be filed prior to the time the Registration Statement becomes effective to which you object in writing. (f) The Registration Statement shall become effective, or if Rule 430A under the Act is used, the Prospectus shall have been filed with the Commission pursuant to Rule 424(b) under the Act, at or before 5:00 P.M., New York City time, on the date of this Agreement, unless a later time (but not later than 5:00 P.M., New York City time, on the second full business day after the date of this Agreement) shall be agreed to by the Company and you in writing or by telephone, confirmed in writing; provided, however, that the Company and you and any group of 19 Underwriters, including you, who have agreed hereunder to purchase in the aggregate at least 50% of the Firm Shares may from time to time agree on a later date. (g) Prior to the Time of Purchase or the Additional Time of Purchase, as the case may be, no stop order with respect to the effectiveness of the Registration Statement shall have been issued under the Act or proceedings initiated under Section 8(d) or 8(e) of the Act. (h) Between the time of execution of this Agreement and the Time of Purchase or the Additional Time of Purchase, as the case may be, no material and unfavorable change, financial or otherwise (other than as referred to in the Registration Statement and Prospectus), in the business, condition or prospects of the Company and its Subsidiaries taken as a whole shall occur or become known. (i) The Company will, at the Time of Purchase or Additional Time of Purchase, as the case may be, deliver to you a certificate of two of its executive officers to the effect that the representations and warranties of the Company as set forth in this Agreement are true and correct as of each such date, that the Company shall perform such of its obligations under this Agreement as are to be performed at or before the Time of Purchase and at or before the Additional Time of Purchase, as the case may be, and the conditions set forth in paragraphs (f) and (g) of this Section 6 have been met. (j) The Company shall have furnished to you such other documents and certificates as to the accuracy and completeness of any statement in the Registration Statement and the Prospectus as of the Time of Purchase and the Additional Time of Purchase, as the case may be, as you may reasonably request. (k) The Shares shall have been approved for listing for quotation on the Nasdaq National Market, subject only to notice of issuance at or prior to the Time of Purchase or the Additional Time of Purchase, as the case may be. 7. Effective Date of Agreement; Termination. This Agreement shall become effective (i) if Rule 430A under the Act is not used, when you shall have received notification of the effectiveness of the Registration Statement, or (ii) if Rule 430A under the Act is used, when the parties hereto have executed and delivered this Agreement. The obligations of the several Underwriters hereunder shall be subject to termination in the absolute discretion of you or any group of Underwriters (which may include you) which has agreed to purchase in the aggregate at least 50% of the Firm Shares, if, since the time of execution of this Agreement or the respective dates as of which information is given in the Registration Statement and Prospectus, (i) there has been any material adverse and unfavorable change, financial or otherwise (other than as referred to in the Registration Statement and Prospectus), in the operations, business, condition or prospects of the Company and its Subsidiaries taken as a whole, which would, in your judgment or in the judgment of such group of Underwriters, make it impracticable to market the Shares; or (ii) there shall have occurred any 20 downgrading, or any notice shall have been given of (x) any intended or potential downgrading or (y) any review or possible change that does not indicate an improvement, in the rating accorded any securities of or guaranteed by the Company or any of its Subsidiaries by any "nationally recognized statistical rating organization" as that term is defined in Rule 436(g)(2) under the Act; or (iii) if, at any time prior to the Time of Purchase or, with respect to the purchase of any Additional Shares, the Additional Time of Purchase, as the case may be, trading in securities on the New York Stock Exchange, the American Stock Exchange or the Nasdaq Stock Market shall have been suspended or limitations or minimum prices shall have been established on the New York Stock Exchange, the American Stock Exchange or the Nasdaq Stock Market, or if a banking moratorium shall have been declared either by the United States or New York State authorities; or (iv) if the United States shall have declared war in accordance with its constitutional processes or there shall have occurred any material outbreak or escalation of hostilities or other national or international calamity or crisis of such magnitude in its effect on the financial markets of the United States as, in your judgment or in the judgment of such group of Underwriters, to make it impracticable to market the Shares. If you or any group of Underwriters elects to terminate this Agreement as provided in this Section 7, the Company and each other Underwriter shall be notified promptly by letter, facsimile or email. If the sale to the Underwriters of the Shares, as contemplated by this Agreement, is not carried out by the Underwriters for any reason permitted under this Agreement or if such sale is not carried out because the Company shall be unable to comply with any of the terms of this Agreement, the Company shall not be under any obligation or liability under this Agreement (except to the extent provided in Sections 4(q), 5 and 9 hereof), and the Underwriters shall be under no obligation or liability to the Company under this Agreement (except to the extent provided in Section 9 hereof) or to one another hereunder. 8. Increase in Underwriters' Commitments. Subject to Sections 6 and 7, if any Underwriter shall default in its obligation to take up and pay for the Firm Shares to be purchased by it hereunder (otherwise than for reasons sufficient to justify the termination of this Agreement under the provisions of Section 7 hereof) and if the number of Firm Shares which all Underwriters so defaulting shall have agreed but failed to take up and pay for does not exceed 10% of the total number of Firm Shares, the non-defaulting Underwriters shall take up and pay for (in addition to the number of Firm Shares they are obligated to purchase pursuant to Section 1 hereof) the number of Firm Shares agreed to be purchased by all such defaulting Underwriters, as hereinafter provided. Such Shares shall be taken up and paid for by such non-defaulting Underwriter or Underwriters in such amount or amounts as you may designate with the consent of each Underwriter so designated or, in the event no such designation is made, such Shares shall be taken up and paid for by all non-defaulting Underwriters pro rata in proportion to the aggregate number of Firm Shares set opposite the names of such non-defaulting Underwriters in Schedule A. 21 Without relieving any defaulting Underwriter from its obligations hereunder, the Company agrees with the non-defaulting Underwriters that they will not sell any Firm Shares hereunder unless all of the Firm Shares are purchased by the Underwriters (or by substituted Underwriters selected by you with the approval of the Company or selected by the Company with your approval). If a new Underwriter or Underwriters are substituted by the Underwriters or by the Company for a defaulting Underwriter or Underwriters in accordance with the foregoing provision, the Company or you shall have the right to postpone the Time of Purchase for a period not exceeding five business days in order that any necessary changes in the Registration Statement and Prospectus and other documents may be effected. The term Underwriter as used in this Agreement shall refer to and include any Underwriter substituted under this Section 8 with like effect as if such substituted Underwriter had originally been named in Schedule A. If the aggregate number of Shares which the defaulting Underwriter or Underwriters agreed to purchase exceeds 10% of the total number of Shares which all Underwriters agreed to purchase hereunder, and if neither the non-defaulting Underwriters nor the Company shall make arrangements within the five business day period stated above for the purchase of all the Shares which the defaulting Underwriter or Underwriters agreed to purchase hereunder, this Agreement shall be terminated without further act or deed and without any liability on the part of the Company to any non-defaulting Underwriter except for the expenses to be borne by the Company pursuant to Section 4 (q) above and without any liability on the part of any non-defaulting Underwriter to the Company. Nothing in this paragraph, and no action taken hereunder, shall relieve any defaulting Underwriter from liability in respect of any default of such Underwriter under this Agreement. 9. Indemnity and Contribution. (a) The Company agrees to indemnify, defend and hold harmless each Underwriter, its partners, directors and officers, and any person who controls any Underwriter within the meaning of Section 15 of the Act or Section 20 of the Exchange Act, and the successors and assigns of all of the foregoing persons from and against any loss, damage, expense, liability or claim (including the reasonable cost of investigation) which, jointly or severally, any such Underwriter or any such person may incur under the Act, the Exchange Act, common law or otherwise, insofar as such loss, damage, expense, liability or claim arises out of or is based upon any untrue statement or alleged untrue statement of a material fact contained in the Registration Statement (or in the Registration Statement as amended by any post-effective amendment thereof by the Company) or in a Prospectus (the term Prospectus for the purpose of this Section 9 being deemed to include any Preliminary Prospectus, the Prospectus and the Prospectus as amended or supplemented by the Company), or arises out of or is based upon any omission or alleged omission to state a material fact required to be stated in either such Registration Statement or Prospectus or necessary to make the statements made therein not 22 misleading, except insofar as any such loss, damage, expense, liability or claim arises out of or is based upon any untrue statement or alleged untrue statement of a material fact contained in and in conformity with information furnished in writing by or on behalf of any Underwriter through you to the Company expressly for use with reference to such Underwriter in such Registration Statement or such Prospectus or arises out of or is based upon any omission or alleged omission to state a material fact in connection with such information required to be stated in such Registration Statement or such Prospectus or necessary to make such information not misleading. If any action, suit or proceeding (together, a "Proceeding") is brought against an Underwriter or any such person in respect of which indemnity may be sought against the Company pursuant to the foregoing paragraph, such Underwriter or such person shall promptly notify the Company in writing of the institution of such Proceeding and the Company shall assume the defense of such Proceeding, including the employment of counsel reasonably satisfactory to such indemnified party and payment of all fees and expenses; provided, however, that the omission to so notify the Company shall not relieve the Company from any liability which the Company may have to any Underwriter or any such person or otherwise. Such Underwriter or such controlling person shall have the right to employ its or their own counsel in any such case, but the fees and expenses of such counsel shall be at the expense of such Underwriter or of such person unless the employment of such counsel shall have been authorized in writing by the Company in connection with the defense of such Proceeding or the Company shall not have, within a reasonable period of time in light of the circumstances, employed counsel to have charge of the defense of such Proceeding or such indemnified party or parties shall have reasonably concluded that there may be defenses available to it or them which are different from, additional to or in conflict with those available to the Company (in which case the Company shall not have the right to direct the defense of such Proceeding on behalf of the indemnified party or parties), in any of which events such fees and expenses shall be borne by the Company and paid as incurred (it being understood, however, that the Company shall not be liable for the expenses of more than one separate counsel (in addition to any local counsel) in any one Proceeding or series of related Proceedings in the same jurisdiction representing the indemnified parties who are parties to such Proceeding). The Company shall not be liable for any settlement of any such Proceeding effected without its written consent but if settled with the written consent of the Company, the Company agrees to indemnify and hold harmless any Underwriter and any such person from and against any loss or liability by reason of such settlement. Notwithstanding the foregoing sentence, if at any time an indemnified party shall have requested an indemnifying party to reimburse the indemnified party for fees and expenses of counsel as contemplated by the second sentence of this paragraph, then the indemnifying party agrees that it shall be liable for any settlement of any Proceeding effected without its written consent if (i) such settlement is entered into more than 10 business days after receipt by such indemnifying party of the aforesaid request, (ii) such indemnifying party shall not have reimbursed the indemnified party in accordance with such request prior to the date of such settlement and (iii) such indemnified party shall have given the indemnifying party at least 30 days' prior notice of its intention to settle. No indemnifying party shall, without the prior written consent of the indemnified party, effect any settlement of any pending or threatened Proceeding 23 in respect of which any indemnified party is or could have been a party and indemnity could have been sought hereunder by such indemnified party, unless such settlement includes an unconditional release of such indemnified party from all liability on claims that are the subject matter of such Proceeding and does not include an admission of fault, culpability or a failure to act, by or on behalf of such indemnified party. (b) Each Underwriter, severally and not jointly, agrees to indemnify, defend and hold harmless the Company, its directors and officers who have signed the registration statement, and any person who controls the Company within the meaning of Section 15 of the Act or Section 20 of the Exchange Act from and against any loss, damage, expense, liability or claim (including the reasonable cost of investigation) which, the Company or any such person may incur under the Act, the Exchange Act, common law or otherwise, insofar as such loss, damage, expense, liability or claim arises out of or is based upon any untrue statement or alleged untrue statement of a material fact contained in and in conformity with information furnished in writing by or on behalf of such Underwriter through you to the Company expressly for use with reference to such Underwriter in the Registration Statement (or in the Registration Statement as amended by or on behalf of any post-effective amendment thereof by the Company) or in the Prospectus, or arises out of or is based upon any omission or alleged omission to state a material fact in connection with such information required to be stated in such Registration Statement or Prospectus or necessary to make such information not misleading. If any Proceeding is brought against the Company or any such person in respect of which indemnity may be sought against any Underwriter pursuant to the foregoing paragraph, the Company or such person shall promptly notify such Underwriter in writing of the institution of such Proceeding and such Underwriter shall assume the defense of such Proceeding, including the employment of counsel reasonably satisfactory to such indemnified party and payment of all fees and expenses, provided, however, that the omission to so notify such Underwriter shall not relieve such Underwriter, from any liability which such Underwriter may have to the Company or any such person or otherwise. The Company or such person shall have the right to employ its own counsel in any such case, but the fees and expenses of such counsel shall be at the expense of the Company or such person unless the employment of such counsel shall have been authorized in writing by such Underwriter in connection with the defense of such Proceeding or such Underwriter shall not have employed counsel to have charge of the defense of such Proceeding or such indemnified party or parties shall have reasonably concluded that there may be defenses available to it or them which are different from or additional to or in conflict with those available to such Underwriter (in which case such Underwriter shall not have the right to direct the defense of such Proceeding on behalf of the indemnified party or parties, but such Underwriter may employ counsel and participate in the defense thereof but the fees and expenses of such counsel shall be at the expense of such Underwriter), in any of which events such fees and expenses shall be borne by such Underwriter and paid as incurred (it being understood, however, that such Underwriter shall not be liable for the expenses of more than one separate counsel (in addition to any local counsel) in any one Proceeding or series of related Proceedings in the same jurisdiction representing the indemnified parties who are parties to such Proceeding). No Underwriter shall be liable for any settlement of any such Proceeding effected without the 24 written consent of such Underwriter but if settled with the written consent of such Underwriter, such Underwriter agrees to indemnify and hold harmless the Company and any such person from and against any loss or liability by reason of such settlement. Notwithstanding the foregoing sentence, if at any time an indemnified party shall have requested an indemnifying party to reimburse the indemnified party for fees and expenses of counsel as contemplated by the second sentence of this paragraph, then the indemnifying party agrees that it shall be liable for any settlement of any Proceeding effected without its written consent if (i) such settlement is entered into more than 10 business days after receipt by such indemnifying party of the aforesaid request, (ii) such indemnifying party shall not have reimbursed the indemnified party in accordance with such request prior to the date of such settlement and (iii) such indemnified party shall have given the indemnifying party at least 30 days' prior notice of its intention to settle. No indemnifying party shall, without the prior written consent of the indemnified party, effect any settlement of any pending or threatened Proceeding in respect of which any indemnified party is or could have been a party and indemnity could have been sought hereunder by such indemnified party, unless such settlement includes an unconditional release of such indemnified party from all liability on claims that are the subject matter of such Proceeding and does not include an admission of fault, culpability or a failure to act, by or on behalf of such indemnified party. (c) If the indemnification provided for in this Section 9 is unavailable to an indemnified party under subsections (a) and (b) of this Section 9 in respect of any losses, damage, expenses, liabilities or claims referred to therein, then each applicable indemnifying party, in lieu of indemnifying such indemnified party, shall contribute to the amount paid or payable by such indemnified party as a result of such losses, damages, expenses, liabilities or claims (i) in such proportion as is appropriate to reflect the relative benefits received by the Company on the one hand and the Underwriters on the other hand from the offering of the Shares or (ii) if the allocation provided by clause (i) above is not permitted by applicable law, in such proportion as is appropriate to reflect not only the relative benefits referred to in clause (i) above but also the relative fault of the Company on the one hand and of the Underwriters on the other in connection with the statements or omissions which resulted in such losses, damages, expenses, liabilities or claims, as well as any other relevant equitable considerations. The relative benefits received by the Company on the one hand and the Underwriters on the other shall be deemed to be in the same respective proportion as the total proceeds from the offering (net of underwriting discounts and commissions but before deducting expenses) received by the Company and the total underwriting discounts and commissions received by the Underwriters, bear to the aggregate public offering price of the shares. The relative fault of the Company on the one hand and of the Underwriters on the other shall be determined by reference to, among other things, whether the untrue statement or alleged untrue statement of a material fact or omission or alleged omission relates to information supplied by the Company or by the Underwriters and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission. The amount paid or payable by a party as a result of the losses, damages, expenses, liabilities and claims referred to in this subsection shall be deemed to include any legal or other fees or expenses reasonably incurred by such party in connection with investigating, preparing to defend or defending any claim or Proceeding. 25 (d) The Company and the Underwriters agree that it would not be just and equitable if contribution pursuant to this Section 9 were determined by pro rata allocation (even if the Underwriters were treated as one entity for such purpose) or by any other method of allocation that does not take account of the equitable considerations referred to in subsection (c) above. Notwithstanding the provisions of this Section 9, no Underwriter shall be required to contribute any amount in excess of the amount by which the total price at which the Shares underwritten by such Underwriter and distributed to the public were offered to the public exceeds the amount of any damage which such Underwriter has otherwise been required to pay by reason of such untrue statement or alleged untrue statement or omission or alleged omission. No person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Act) shall be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation. The Underwriters' obligations to contribute pursuant to this Section 9 are several in proportion to their respective underwriting commitments and not joint. (e) The indemnity and contribution agreements contained in this Section 9 and the covenants, warranties and representations of the Company contained in this Agreement shall remain in full force and effect regardless of any investigation made by or on behalf of any Underwriter, its partners, directors or officers or any person (including each partner, officer or director of such person) who controls any Underwriter within the meaning of Section 15 of the Act or Section 20 of the Exchange Act, or by or on behalf of the Company, its directors or officers or any person who controls the Company within the meaning of Section 15 of the Act or Section 20 of the Exchange Act, and shall survive any termination of this Agreement or the issuance and delivery of the Shares. The Company and each Underwriter agree promptly to notify each other commencement of any Proceeding against it and, in the case of the Company, against any of the Company's officers or directors in connection with the issuance and sale of the Shares, or in connection with the Registration Statement or Prospectus. 10. Notices. Except as otherwise herein provided, all statements, requests, notices and agreements shall be in writing or by telegram and, if to the Underwriters, shall be sufficient in all respects if delivered or sent to Jefferies & Company, Inc., 299 Park Avenue, New York, N.Y. 10171-0026, Attention: Syndicate Department and, if to the Company, shall be sufficient in all respects if delivered or sent to the Company at the offices of the Company at 333 West Santa Clara Street, Suite 960, Attention: Chief Financial Officer. 11. Governing Law; Construction. This Agreement and any claim, counterclaim or dispute of any kind or nature whatsoever arising out of or in any way relating to this Agreement ("Claim"), directly or indirectly, shall be governed by, and construed in accordance with, the laws of the State of New York. The Section headings in this Agreement have been inserted as a matter of convenience of reference and are not a part of this Agreement. 12. Submission to Jurisdiction. Except as set forth below, no Claim may be commenced, prosecuted or continued in any court other than the courts of the State of New York located in the City and County of New York or in the United States District Court for the Southern District of New York, which courts shall have jurisdiction over the adjudication of such 26 matters, and the Company consents to the jurisdiction of such courts and personal service with respect thereto. The Company hereby consents to personal jurisdiction, service and venue in any court in which any Claim arising out of or in any way relating to this Agreement is brought by any third party against Jefferies & Company, Inc. or any indemnified party. Each of Jefferies & Company, Inc. and the Company (on its behalf and, to the extent permitted by applicable law, on behalf of its stockholders and affiliates) waives all right to trial by jury in any action, proceeding or counterclaim (whether based upon contract, tort or otherwise) in any way arising out of or relating to this Agreement. The Company agrees that a final judgment in any such action, proceeding or counterclaim brought in any such court shall be conclusive and binding upon the Company and may be enforced in any other courts in the jurisdiction of which the Company is or may be subject, by suit upon such judgment. 13. Parties at Interest. The Agreement herein set forth has been and is made solely for the benefit of the Underwriters and the Company and to the extent provided in Section 9 hereof the controlling persons, directors and officers referred to in such section, and their respective successors, assigns, heirs, pursuant representatives and executors and administrators. No other person, partnership, association or corporation (including a purchaser, as such purchaser, from any of the Underwriters) shall acquire or have any right under or by virtue of this Agreement. 14. Counterparts. This Agreement may be signed by the parties in one or more counterparts which together shall constitute one and the same agreement among the parties. 15. Successors and Assigns. This Agreement shall be binding upon the Underwriters and the Company and their successors and assigns and any successor or assign of any substantial portion of the Company's and any of the Underwriters' respective businesses and/or assets. 27 If the foregoing correctly sets forth the understanding among the Company and the Underwriters, please so indicate in the space provided below for the purpose, whereupon this letter and your acceptance shall constitute a binding agreement among the Company and the Underwriters, severally. Very truly yours, BAM! ENTERTAINMENT, INC. By: --------------------------------- Name: Title: Accepted and agreed to as of the date first above written, on behalf of themselves and the other several Underwriters named in Schedule A JEFFERIES & COMPANY, INC. MORGAN KEEGAN & CO., INC. By: JEFFERIES & COMPANY, INC. By: ------------------------------- Title: By: ------------------------------- Title: 28 SCHEDULE A Underwriter Number of Firm Shares ----------- --------------------- JEFFERIES & COMPANY, INC. [___________] MORGAN KEEGAN & CO., INC. [___________] ----------- Total..................... 4,000,000 =========== EX-10.49 4 v72115a3ex10-49.txt EXHIBIT 10.49 EXHIBIT 10.49 BAM! ENTERTAINMENT, INC. 2001 EMPLOYEE STOCK PURCHASE PLAN This 2001 Employee Stock Purchase Plan (the "Plan") of BAM! Entertainment, Inc., a Delaware corporation (the "Company"), was adopted by the Board of Directors and shareholders of the Company as of August 9, 2001. 1. Purpose. The purpose of the Plan is to provide employees of the Company and its Designated Subsidiaries with an opportunity to purchase Common Stock of the Company through accumulated payroll deductions. It is the intention of the Company to have the Plan qualify as an "Employee Stock Purchase Plan" under Section 423 of the Internal Revenue Code of 1986, as amended. The provisions of the Plan, accordingly, shall be construed so as to extend and limit participation in a manner consistent with the requirements of that section of the Code. 2. Definitions. (a) "Board" shall mean the Board of Directors of the Company. (b) "Code" shall mean the Internal Revenue Code of 1986, as amended. (c) "Common Stock" shall mean the Common Stock of the Company. (d) "Company" shall mean BAM! Entertainment, Inc., a Delaware corporation, and any Designated Subsidiary of the Company. (e) "Compensation" shall mean all base straight time gross earnings including commissions, payments for overtime, incentive payments and performance bonuses. (f) "Designated Subsidiary" shall mean (i) any Subsidiary which has been designated by the Board from time to time in its sole discretion as eligible to participate in the Plan, (ii) BAM Entertainment Limited and (iii) BAM Studios (Europe) Limited. (g) "Employee" shall mean any individual who is an Employee of the Company or a Designated Subsidiary, for tax purposes whose customary employment with the Company is at least twenty (20) hours per week and more than five (5) months in any calendar year. For purposes of the Plan, the employment relationship shall be treated as continuing intact while the individual is on sick leave or other leave of absence approved by the Company. Where the period of leave exceeds 90 days and the individual's right to reemployment is not guaranteed either by statute or by contract, the employment relationship shall be deemed to have terminated on the 91st day of such leave. (h) "Enrollment Date" shall mean the first Trading Day of each Offering Period. (i) "Exercise Date" shall mean the last Trading Day of each Purchase Period. (j) "Fair Market Value" shall mean, as of any date, the value of Common Stock determined as follows: (1) If the Common Stock is listed on any established stock exchange or a national market system, including without limitation the Nasdaq National Market or The Nasdaq SmallCap Market of The Nasdaq Stock Market, its Fair Market Value shall be the closing sales price for such stock (or the closing bid, if no sales were reported) as quoted on such exchange or system for the last market trading day on the date of such determination, as reported in The Wall Street Journal or such other source as the Board deems reliable, or; (2) If the Common Stock is regularly quoted by a recognized securities dealer but selling prices are not reported, its Fair Market Value shall be the mean of the closing bid and asked prices for the Common Stock on the date of such determination, as reported in The Wall Street Journal or such other source as the Board deems reliable, or; (3) In the absence of an established market for the Common Stock, the Fair Market Value thereof shall be determined in good faith by the Board. (k) "Offering Periods" shall mean the periods of approximately twelve (12) months during which an option granted pursuant to the Plan may be exercised, commencing on the first Trading Day on or after March 1 and September 1 of each year and terminating on the last Trading Day in the periods ending twelve months later, except as provided in Section 4 of this Plan. The first Offering Period under the Plan shall commence with the first Trading Day on or after the date on which the Securities and Exchange Commission declares the Company's Registration Statement effective and ending on the last Trading Day on or before February 28, 2002. The duration and timing of Offering Periods may be changed pursuant to Section 4 of this Plan. (l) "Plan" shall mean this Employee Stock Purchase Plan. (m) "Purchase Period" shall mean the approximately six month period commencing after one Exercise Date and ending with the next Exercise Date, except that the first Purchase Period of any Offering Period shall commence on the Enrollment Date and end with the next Exercise Date; provided, however, the first Purchase Period under the Plan shall commence with the first Trading Day on or after the date on which the Securities and Exchange Commission declares the Company's Registration Statement effective and shall end on the last trading day on or before February 28, 2002. (n) "Purchase Price" shall mean an amount equal to 85% of the Fair Market Value of a share of Common Stock on the Enrollment Date or on the Exercise Date, whichever is lower; provided, however, that the Purchase Price may be adjusted by the Board pursuant to Section 20. (o) "Registration Statement" shall mean the Registration Statement filed by the Company on Form S-1 as of June 6, 2001, and all amendments thereto. (p) "Reserves" shall mean the number of shares of Common Stock covered by each option under the Plan which have not yet been exercised and the number of shares of -2- Common Stock which have been authorized for issuance under the Plan but not yet placed under option. (q) "Subsidiary" shall mean a corporation, domestic or foreign, of which not less than 50% of the voting shares are held by the Company or a Subsidiary, whether or not such corporation now exists or is hereafter organized or acquired by the Company or a Subsidiary. (r) "Trading Day" shall mean a day on which national stock exchanges and the Nasdaq System are open for trading. 3. Eligibility. (a) Any Employee who shall be employed by the Company on a given Enrollment Date shall be eligible to participate in the Plan. (b) Any provisions of the Plan to the contrary notwithstanding, no Employee shall be granted an option under the Plan (i) to the extent that, immediately after the grant, such Employee (or any other person whose stock would be attributed to such Employee pursuant to Section 424(d) of the Code) would own capital stock of the Company and/or hold outstanding options to purchase such stock possessing five percent (5%) or more of the total combined voting power or value of all classes of the capital stock of the Company or of any Subsidiary, or (ii) to the extent that his or her rights to purchase stock under all employee stock purchase plans of the Company and its subsidiaries accrues at a rate which exceeds Twenty-Five Thousand Dollars ($25,000) worth of stock (determined at the fair market value of the shares at the time such option is granted) for each calendar year in which such option is outstanding at any time. 4. Offering Periods. (a) The first Offering Period under the Plan shall commence on the first Trading Day on or after the date on which the Securities and Exchange Commission declares the Company's Registration Statement effective and ending on the last Trading Day on or before February 28, 2002, and the Plan shall continue to be implemented with consecutive, Offering Periods that are exclusively twelve (12) months in duration, commencing on the first Trading Day on or after March 1 and September 1 of each year thereafter, or on such other date as the Board shall determine, and continuing thereafter until terminated in accordance with Section 20 hereof. (b) The Board shall have the power to change the duration of Offering Periods (including the commencement dates thereof) with respect to future offerings without stockholder approval if such change is announced at least five (5) days prior to the scheduled beginning of the first Offering Period to be affected thereafter. 5. Participation. (a) An eligible Employee may become a participant in the Plan by completing a subscription agreement authorizing payroll deductions in the form of Exhibit A to this Plan and filing it with the Company's payroll office not later than two (2) weeks prior to -3- the applicable Enrollment Date. Eligible employees who begin employment with the Company within two weeks of an Enrollment Date may file a subscription agreement with the Company's payroll office up to one day prior to the applicable Enrollment Date. With respect to the first Enrollment Date, eligible Employees may file a subscription agreement up to one day prior to the Enrollment Date. An eligible Employee may participate in only one Offering Period at a time. (b) Payroll deductions for a participant shall commence on the first payroll following the Enrollment Date and shall end on the last payroll in the Offering Period to which such authorization is applicable, unless sooner terminated by the participant as provided in Section 10 hereof. 6. Payroll Deductions. (a) At the time a participant files his or her subscription agreement, he or she shall elect to have payroll deductions made on each pay day during the Offering Period in an amount not exceeding 15% of the Compensation which he or she receives on each pay day during the Offering Period. The maximum calendar year contribution shall not exceed $25,000 worth of stock (determined at the fair market value of the shares at the time such option is granted). (b) All payroll deductions made for a participant shall be credited to his or her account under the Plan and shall be withheld in whole percentages only. A participant may not make any additional payments into such account. (c) A participant may discontinue his or her participation in the Plan as provided in Section 10 hereof, or may decrease the rate of his or her payroll deductions during the Offering Period by completing or filing with the Company a new subscription agreement authorizing a change in payroll deduction rate. The Board may, in its discretion, limit the number of participation rate changes during any Offering Period. The change in rate shall be effective with the first full payroll period following five (5) business days after the Company's receipt of the new subscription agreement unless the Company elects to process a given change in participation more quickly. A participant's subscription agreement shall remain in effect for successive Offering Periods unless terminated as provided in Section 10 hereof. (d) Notwithstanding the foregoing, to the extent necessary to comply with Section 423(b)(8) of the Code and Section 3(b) hereof, a participant's payroll deductions may be decreased to zero percent (0%) at any time during a Purchase Period. Payroll deductions shall recommence at the rate provided in such participant's subscription agreement at the beginning of the first Purchase Period which is scheduled to end in the following calendar year, unless terminated by the participant as provided in Section 10 hereof. (e) At the time the option is exercised, in whole or in part, or at the time some or all of the Company's Common Stock issued under the Plan is disposed of, the participant must make adequate provision for the Company's federal, state, or other tax withholding obligations, if any, which arise upon the exercise of the option or the disposition of the Common Stock. At any time, the Company may, but shall not be obligated to, withhold -4- from the participant's compensation the amount necessary for the Company to meet applicable withholding obligations, including any withholding required to make available to the Company any tax deductions or benefits attributable to sale or early disposition of Common Stock by the Employee. 7. Grant of Option. On the Enrollment Date of each Offering Period, each eligible Employee participating in such Offering Period shall be granted an option to purchase on each Exercise Date during such Offering Period (at the applicable Purchase Price) up to a number of shares of the Company's Common Stock determined by dividing such Employee's payroll deductions accumulated prior to such Exercise Date and retained in the Participant's account as of the Exercise Date by the applicable Purchase Price; provided that in no event shall an Employee be permitted to purchase during each Offering Period more than a number of Shares determined by dividing $25,000 by the Fair Market Value of a share of the Company's Common Stock (subject to any adjustment pursuant to Section 19) on the Enrollment Date, and provided further that such purchase shall be subject to the limitations set forth in Sections 3(b) and 12 hereof. The Board may, for future Offering Periods and in its absolute discretion, set a maximum number of shares of the Company's Common Stock an Employee may purchase during each Purchase Period of such Offering Period and increase or decrease such maximum. Exercise of the option shall occur as provided in Section 8 hereof, unless the participant has withdrawn pursuant to Section 10 hereof. The option shall expire on the last day of the Offering Period. 8. Exercise of Option. (a) Unless a participant withdraws from the Plan as provided in Section 10 hereof, his or her option for the purchase of shares shall be exercised automatically on the Exercise Date, and the maximum number of full shares subject to option shall be purchased for such participant at the applicable Purchase Price with the accumulated payroll deductions in his or her account. No fractional shares shall be purchased; any payroll deductions accumulated in a participant's account which are not sufficient to purchase a full share shall be retained in the participant's account for the subsequent Purchase Period or Offering Period, subject to earlier withdrawal by the participant as provided in Section 10 hereof. During a participant's lifetime, a participant's option to purchase shares hereunder is exercisable only by him or her. (b) If the Board determines that, on a given Exercise Date, the number of shares with respect to which options are to be exercised may exceed (i) the number of shares of Common Stock that were available for sale under the Plan on the Enrollment Date of the applicable Offering Period, or (ii) the number of shares available for sale under the Plan on such Exercise Date, the Board may in its sole discretion (x) provide that the Company shall make a pro rata allocation of the shares of Common Stock available for purchase on such Enrollment Date or Exercise Date, as applicable, in as uniform a manner as shall be practicable and as it shall -5- determine in its sole discretion to be equitable among all participants exercising options to purchase Common Stock on such Exercise Date, and continue all Offering Periods then in effect, or (y) provide that the Company shall make a pro rata allocation of the shares available for purchase on such Enrollment Date or Exercise Date, as applicable, in as uniform a manner as shall be practicable and as it shall determine in its sole discretion to be equitable among all participants exercising options to purchase Common Stock on such Exercise Date, and terminate any or all Offering Periods then in effect pursuant to Section 20 hereof. The Company may make pro rata allocation of the shares available on the Enrollment Date of any applicable Offering Period pursuant to the preceding sentence, notwithstanding any authorization of additional shares for issuance under the Plan by the Company's stockholders subsequent to such Enrollment Date. 9. Delivery. As promptly as practicable after each Exercise Date on which a purchase of shares occurs, the Company shall arrange the delivery, either electronically or manually, to each participant, as appropriate, or to a designated broker as chosen by the Company in its discretion, of a certificate representing the shares purchased upon exercise of his or her option. 10. Withdrawal. (a) A participant may withdraw all but not less than all the payroll deductions credited to his or her account and not yet used to exercise his or her option under the Plan at any time by giving written notice to the Company in the form of Exhibit B to this Plan. All of the participant's payroll deductions credited to his or her account shall be paid to such participant promptly after receipt of notice of withdrawal and such participant's option for the Offering Period shall be automatically terminated, and no further payroll deductions for the purchase of shares shall be made for such Offering Period. If a participant withdraws from an Offering Period, payroll deductions shall not resume at the beginning of the succeeding Offering Period unless the participant delivers to the Company a new subscription agreement. (b) A participant's withdrawal from an Offering Period shall not have any effect upon his or her eligibility to participate in any similar plan which may hereafter be adopted by the Company or in succeeding Offering Periods which commence after the termination of the Offering Period from which the participant withdraws. 11. Termination of Employment. Upon a participant's ceasing to be an Employee, for any reason, he or she shall be deemed to have elected to withdraw from the Plan and the payroll deductions credited to such participant's account during the Offering Period, but not yet used to exercise the option, shall be returned to such participant or, in the case of his or her death, to the person or persons entitled thereto under Section 15 hereof, and such participant's option shall be automatically terminated. The preceding sentence notwithstanding, a participant who receives payment in lieu of notice of termination of employment shall be treated as continuing to be an Employee for the participant's customary number of hours per week of employment during the period in which the participant is subject to such payment in lieu of notice. 12. Interest. No interest shall accrue on the payroll deductions of a participant in the Plan. 13. Stock. -6- (a) Subject to adjustment upon changes in capitalization of the Company as provided in Section 19 hereof, the maximum number of shares of the Company's Common Stock which shall be made available for sale under the Plan shall be 150,000 shares. (b) The participant shall have no interest or voting right in shares covered by his option until such option has been exercised. (c) Shares to be delivered to a participant under the Plan shall be registered in the name of the participant or in the name of the participant and his or her spouse. 14. Administration. The Plan shall be administered by the Board or a committee of members of the Board appointed by the Board. The Board or its committee shall have full and exclusive discretionary authority to construe, interpret and apply the terms of the Plan, to determine eligibility and to adjudicate all disputed claims filed under the Plan. Every finding, decision and determination made by the Board or its committee shall, to the full extent permitted by law, be final and binding upon all parties. 15. Designation of Beneficiary. (a) A participant may file a written designation of a beneficiary who is to receive any shares and cash, if any, from the participant's account under the Plan in the event of such participant's death subsequent to an Exercise Date on which the option is exercised but prior to delivery to such participant of such shares and cash. In addition, a participant may file a written designation of a beneficiary who is to receive any cash from the participant's account under the Plan in the event of such participant's death prior to exercise of the option. If a participant is married and the designated beneficiary is not the spouse, spousal consent shall be required for such designation to be effective. (b) Such designation of beneficiary may be changed by the participant at any time by written notice. In the event of the death of a participant and in the absence of a beneficiary validly designated under the Plan who is living at the time of such participant's death, the Company shall deliver such shares and/or cash to the executor or administrator of the estate of the participant, or if no such executor or administrator has been appointed (to the knowledge of the Company), the Company, in its discretion, may deliver such shares and/or cash to the spouse or to any one or more dependents or relatives of the participant, or if no spouse, dependent or relative is known to the Company, then to such other person as the Company may designate. 16. Transferability. Neither payroll deductions credited to a participant's account nor any rights with regard to the exercise of an option or to receive shares under the Plan may be assigned, transferred, pledged or otherwise disposed of in any way (other than by will, the laws of descent and distribution or as provided in Section 15 hereof) by the participant. Any such attempt at assignment, transfer, pledge or other disposition shall be without effect, except that the Company may treat such act as an election to withdraw funds from an Offering Period in accordance with Section 10 hereof. -7- 17. Use of Funds. All payroll deductions received or held by the Company under the Plan may be used by the Company for any corporate purpose, and the Company shall not be obligated to segregate such payroll deductions. 18. Reports. Individual accounts shall be maintained for each participant in the Plan. Statements of account shall be given to participating Employees at least annually, which statements shall set forth the amounts of payroll deductions, the Purchase Price, the number of shares purchased and the remaining cash balance, if any. 19. Adjustments Upon Changes in Capitalization, Dissolution, Liquidation, Merger or Asset Sale. (a) Changes in Capitalization. Subject to any required action by the stockholders of the Company, the Reserves, the maximum number of shares each participant may purchase each Purchase Period (pursuant to Section 7), as well as the price per share and the number of shares of Common Stock covered by each option under the Plan which has not yet been exercised shall be proportionately adjusted for any increase or decrease in the number of issued shares of Common Stock resulting from a stock split, reverse stock split, stock dividend, combination or reclassification of the Common Stock, or any other increase or decrease in the number of shares of Common Stock effected without receipt of consideration by the Company; provided, however, that conversion of any convertible securities of the Company shall not be deemed to have been "effected without receipt of consideration." Such adjustment shall be made by the Board, whose determination in that respect shall be final, binding and conclusive. Except as expressly provided herein, no issuance by the Company of shares of stock of any class, or securities convertible into shares of stock of any class, shall affect, and no adjustment by reason thereof shall be made with respect to, the number or price of shares of Common Stock subject to an option. (b) Dissolution or Liquidation. In the event of the proposed dissolution or liquidation of the Company, the Offering Period then in progress shall be shortened by setting a new Exercise Date (the "New Exercise Date"), and shall terminate immediately prior to the consummation of such proposed dissolution or liquidation, unless provided otherwise by the Board. The New Exercise Date shall be before the date of the Company's proposed dissolution or liquidation. The Board shall notify each participant in writing, at least ten (10) business days prior to the New Exercise Date, that the Exercise Date for the participant's option has been changed to the New Exercise Date and that the participant's option shall be exercised automatically on the New Exercise Date, unless prior to such date the participant has withdrawn from the Offering Period as provided in Section 10 hereof. (c) Merger or Asset Sale. In the event of a proposed sale of all or substantially all of the assets of the Company, or the merger of the Company with or into another corporation, each outstanding option shall be assumed or an equivalent option substituted by the successor corporation or a Parent or Subsidiary of the successor corporation. In the event that the successor corporation refuses to assume or substitute for the option, any Purchase Periods then in progress shall be shortened by setting a new Exercise Date (the "New Exercise Date") and any Offering Periods then in progress shall end on the New -8- Exercise Date. The New Exercise Date shall be before the date of the Company's proposed sale or merger. The Board shall notify each participant in writing, at least ten (10) business days prior to the New Exercise Date, that the Exercise Date for the participant's option has been changed to the New Exercise Date and that the participant's option shall be exercised automatically on the New Exercise Date, unless prior to such date the participant has withdrawn from the Offering Period as provided in Section 10 hereof. 20. Amendment or Termination. (a) The Board of Directors of the Company may at any time and for any reason terminate or amend the Plan. Except as provided in Section 19 hereof, no such termination can affect options previously granted, provided that an Offering Period may be terminated by the Board of Directors on any Exercise Date if the Board determines that the termination of the Offering Period or the Plan is in the best interests of the Company and its stockholders. Except as provided in Section 19 and this Section 20 hereof, no amendment may make any change in any option theretofore granted which adversely affects the rights of any participant. To the extent necessary to comply with Section 423 of the Code (or any successor rule or provision or any other applicable law, regulation or stock exchange rule), the Company shall obtain stockholder approval in such a manner and to such a degree as required. (b) Without stockholder consent and without regard to whether any participant rights may be considered to have been "adversely affected," the Board (or its committee) shall be entitled to change the Offering Periods, limit the frequency and/or number of changes in the amount withheld during an Offering Period, establish the exchange ratio applicable to amounts withheld in a currency other than U.S. dollars, permit payroll withholding in excess of the amount designated by a participant in order to adjust for delays or mistakes in the Company's processing of properly completed withholding elections, establish reasonable waiting and adjustment periods and/or accounting and crediting procedures to ensure that amounts applied toward the purchase of Common Stock for each participant properly correspond with amounts withheld from the participant's Compensation, and establish such other limitations or procedures as the Board (or its committee) determines in its sole discretion advisable which are consistent with the Plan. (c) In the event the Board determines that the ongoing operation of the Plan may result in unfavorable financial accounting consequences, the Board may, in its discretion and, to the extent necessary or desirable, modify or amend the Plan to reduce or eliminate such accounting consequence including, but not limited to: (1) altering the Purchase Price for any Offering Period including an Offering Period underway at the time of the change in Purchase Price; (2) shortening any Offering Period so that Offering Period ends on a new Exercise Date, including an Offering Period underway at the time of the Board action; and (3) allocating shares. -9- Such modifications or amendments shall not require stockholder approval or the consent of any Plan participants. 21. Notices. All notices or other communications by a participant to the Company under or in connection with the Plan shall be deemed to have been duly given when received in the form specified by the Company at the location, or by the person, designated by the Company for the receipt thereof. 22. Conditions Upon Issuance of Shares. Shares shall not be issued with respect to an option unless the exercise of such option and the issuance and delivery of such shares pursuant thereto shall comply with all applicable provisions of law, domestic or foreign, including, without limitation, the Securities Act of 1933, as amended, the Securities Exchange Act of 1934, as amended, the rules and regulations promulgated thereunder, and the requirements of any stock exchange upon which the shares may then be listed, and shall be further subject to the approval of counsel for the Company with respect to such compliance. As a condition to the exercise of an option, the Company may require the person exercising such option to represent and warrant at the time of any such exercise that the shares are being purchased only for investment and without any present intention to sell or distribute such shares if, in the opinion of counsel for the Company, such a representation is required by any of the aforementioned applicable provisions of law. 23. Term of Plan. The Plan shall become effective upon the earlier to occur of its adoption by the Board of Directors or its approval by the stockholders of the Company. It shall continue in effect until August 8, 2011, unless sooner terminated under Section 20 hereof. -10- EXHIBIT A BAM! ENTERTAINMENT, INC. 2001 EMPLOYEE STOCK PURCHASE PLAN SUBSCRIPTION AGREEMENT [ ] Original Application Offering Period Beginning: ____________ [ ] Change in Payroll Deduction Rate [ ] Change of Beneficiary(ies) NAME (Please print): ___________________________________________________________ (First) (Middle) (Last) SOCIAL SECURITY NUMBER: __________-______-______ ADDRESS: _______________________________________________ PHONE: ________________________________________________________ (W)_______________ ________________________________________________________ (H)_______________ 1. ______________________________ hereby elects to participate in the BAM! Entertainment, Inc. 2001 Employee Stock Purchase Plan (the "Employee Stock Purchase Plan") and subscribes to purchase shares of the Company's Common Stock in accordance with this Subscription Agreement and the Employee Stock Purchase Plan. 2. I hereby authorize payroll deductions from each paycheck in the amount of % of my Compensation on each payday (from 1 to 15%) during the Offering Period in accordance with the Employee Stock Purchase Plan. (Please note that no fractional percentages are permitted.) 3. I understand that said payroll deductions shall be accumulated for the purchase of shares of Common Stock at the applicable Purchase Price determined in accordance with the Employee Stock Purchase Plan. I understand that if I do not withdraw from an Offering Period, any accumulated payroll deductions will be used to automatically exercise my option. 4. I have received a copy of the complete Employee Stock Purchase Plan. I understand that my participation in the Employee Stock Purchase Plan is in all respects subject to the terms of the Plan. I understand that my ability to exercise the option under this Subscription Agreement is subject to stockholder approval of the Employee Stock Purchase Plan. 5. Shares purchased for me under the Employee Stock Purchase Plan should be issued in the name(s) of (Employee or Employee and Spouse only): ______________ __________________________________________________________. 6. I understand that if I dispose of any shares received by me pursuant to the Plan within 2 years after the Enrollment Date (the first day of the Offering Period during which I purchased such shares) or 1 year after the Exercise Date, I will be treated for federal income tax purposes as having received ordinary income at the time of such disposition in an amount equal to the excess of the fair market value of the shares at the time such shares were purchased by me over the price which I paid for the shares. I hereby agree to notify the Company in writing within 30 days after the date of any disposition of my shares and I will make adequate provision for Federal, state or other tax withholding obligations, if any, which arise upon the disposition of the Common Stock. The Company may, but will not be obligated to, withhold from my compensation the amount necessary to meet any applicable withholding obligation including any withholding necessary to make available to the Company any tax deductions or benefits attributable to sale or early disposition of Common Stock by me. If I dispose of such shares at any time after the expiration of the 2-year and 1-year holding periods, I understand that I will be treated for federal income tax purposes as having received income only at the time of such disposition, and that such income will be taxed as ordinary income only to the extent of an amount equal to the lesser of (1) the excess of the fair market value of the shares at the time of such disposition over the purchase price which I paid for the shares, or (2) 15% of the fair market value of the shares on the first day of the Offering Period. The remainder of the gain, if any, recognized on such disposition will be taxed as capital gain. 7. I hereby agree to be bound by the terms of the Employee Stock Purchase Plan. The effectiveness of this Subscription Agreement is dependent upon my eligibility to participate in the Employee Stock Purchase Plan. 8. In the event of my death, I hereby designate the following as my beneficiary(ies) to receive all payments and shares due me under the Employee Stock Purchase Plan: Primary Beneficiary (please print):_____________________________________________ (First) (Middle (Last) Initial) Relationship: _______________ Percentage Distribution (if Applicable): _________ Beneficiary's Address: ____________________________________________________ (include City, State, Zip) ____________________________________________________ Contingent or Other Beneficiary (please print): ________________________________ (First) (Middle (Last) Initial) Relationship: _______________ Percentage Distribution (if Applicable): _________ Beneficiary's Address: ____________________________________________________ (include City, State, Zip) ____________________________________________________ SIGNATURE OF SPOUSE: ___________________________________________________________ (Required if spouse is not named beneficiary) I UNDERSTAND THAT THIS SUBSCRIPTION AGREEMENT SHALL REMAIN IN EFFECT THROUGHOUT SUCCESSIVE OFFERING PERIODS UNLESS TERMINATED BY ME. Dated: ______________________ ________________________________________ Signature of Employee EXHIBIT B BAM! ENTERTAINMENT, INC. 2001 EMPLOYEE STOCK PURCHASE PLAN NOTICE OF WITHDRAWAL The undersigned participant in the Offering Period of the BAM! Entertainment, Inc. 2001 Employee Stock Purchase Plan which began on ________________________ , (the "Enrollment Date") hereby notifies the Company that he or she hereby withdraws from the Offering Period. He or she hereby directs the Company to pay to the undersigned as promptly as practicable all the payroll deductions credited to his or her account with respect to such Offering Period. The undersigned understands and agrees that his or her option for such Offering Period will be automatically terminated. The undersigned understands further that no further payroll deductions will be made for the purchase of shares in the current Offering Period and the undersigned shall be eligible to participate in succeeding Offering Periods only by delivering to the Company a new Subscription Agreement. Name: ___________________________________ Address: ________________________________ Social Security #: ______________________ Signature: ______________________________ Date: ___________________________________ EX-23.1 5 v72115a3ex23-1.txt EXHIBIT 23.1 EXHIBIT 23.1 INDEPENDENT AUDITORS' CONSENT To the Board of Directors and Stockholders of BAM! Entertainment, Inc. We consent to the use in this Amendment No. 3 to Registration Statement No. 333-62436 of BAM! Entertainment, Inc. of our report dated August 15, 2001 (August 31, 2001 as to the last two paragraphs of Note 15), appearing in the Prospectus, which is a part of such Registration Statement, and of our report dated August 15, 2001 relating to the consolidated financial statement schedule appearing elsewhere in such Registration Statement. We also consent to the reference to us under the heading "Experts" in such Prospectus. DELOITTE & TOUCHE LLP San Jose, California October 26, 2001