424B3 1 FINAL PROSPECTUS PROSPECTUS ENTERACTIVE, INC. [LOGO OF ENTERACTIVE, INC. APPEARS HERE] 2,021,468 COMMON STOCK PURCHASE WARRANTS 740,734 SHARES OF COMMON STOCK This Prospectus relates to the possible sale for the accounts of 28 selling securityholders ("Selling Securityholders") of up to 2,021,468 Common Stock Purchase Warrants ("IPO Warrants") and 740,734 shares of the Company's Common Stock ("Common Stock") consisting of Conversion Shares (as defined herein) issued to them by Enteractive, Inc. ("Company") upon the closing of the Company's public offering for which the registration statement was declared effective on May 15, 1996 ("Public Offering"), whereby the Company registered in part: (i) 740,734 Conversion Shares (as defined herein); (ii) 1,481,468 Conversion Warrants (as defined herein); and (iii) 540,000 IPO Warrants which were issued in exchange for January 1996 Warrants (as defined herein). The shares of Common Stock underlying the IPO Warrants received by the Selling Securityholders are registered under the Registration Statement of which this Prospectus forms a part. Each IPO Warrant, including the Conversion Warrants, entitles the holder to purchase one share of Common Stock for $4.00 until October 20, 1997. The IPO Warrants are not redeemable by the Company. See "Description of Securities." The IPO Warrants, the Conversion Warrants and the Conversion Shares which are subject to this Prospectus are sometimes collectively referred to herein as the "Securities." Without the consent of the GKN Securities Corp. ("Underwriter"), the Securities may not be sold by the Selling Securityholders for a period of one year from the date of the Public Offering. Immediately after the Public Offering, there were 7,341,435 shares of Common Stock outstanding, assuming that the over-allotment option in the Public Offering was not exercised. In the Public Offering, the Company also registered 2,100,000 shares of Common Stock, exclusive of 315,000 shares of Common Stock subject to an over-allotment option. The Common Stock and the IPO Warrants are currently traded on the Nasdaq SmallCap Market under the symbols "ENTR" and "ENTRW," respectively. On May 15, 1996, the closing sales price of the Common Stock and the IPO Warrants was $3.875 and $1.0625, respectively. See "Selling Securityholders; Plan of Distribution" for information relating to the factors considered in determining the exercise price of the IPO Warrants. ---------------- THE SECURITIES OFFERED HEREBY ARE SPECULATIVE IN NATURE AND INVOLVE A HIGH DEGREE OF RISK. SEE "RISK FACTORS" AT PAGE 8 HEREOF. ---------------- THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. ---------------- Neither the Company nor the Selling Securityholders have employed an underwriter for the sale of the Securities. The Company will bear all expenses of the offering other than discounts, concessions or commissions on the sale of the Securities. The Securities may be offered by or for the account of the Selling Securityholders from time to time on the Nasdaq SmallCap Market or The Boston Stock Exchange or in negotiated transactions, or a combination of such methods of sale, at fixed prices which may be changed or at negotiated prices. The Selling Securityholders may effect such transactions by selling the Securities to or through broker-dealers, including GKN Securities Corp., who may receive compensation in the form of discounts, concessions or commissions from the Selling Securityholders and/or the purchasers of the Securities for whom such broker-dealer may act as agent or to whom they sell as principal, or both which compensation as to a particular broker-dealer may be in excess of customary commissions). Any broker-dealer acquiring the Securities from the Selling Securityholders may sell such securities in its normal market making activities, through other brokers on a principal or agency basis, in negotiated transactions, to its customers or through a combination of such methods. See "Selling Securityholders; Plan of Distribution." May 15, 1996. [INSERT PHOTO] IN CONNECTION WITH THIS OFFERING, THE UNDERWRITER MAY OVER-ALLOT OR EFFECT TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE COMMON STOCK AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN MARKET. SUCH STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME. This prospectus includes references to trademarks of entities other than the Company, which have reserved all rights with respect to their respective trademarks. 2 PROSPECTUS SUMMARY The following summary is qualified in its entirety by reference to, and should be read in conjunction with, the more detailed information and the financial statements (including the notes thereto) appearing elsewhere in this Prospectus. Each prospective investor is urged to read this Prospectus in its entirety. THE COMPANY The Company designs, develops, publishes and markets interactive multimedia titles to the home and school markets. The Company believes that it has been a pioneer in the development and production of interactive new media titles having entertainment and educational content, based upon its introduction in 1991 of one of the industry's first titles for the CD-I format. Prior to 1995, the Company's focus was on the development of titles on a work-for-hire basis. From 1991 to 1994, the Company developed 11 CD-I titles for Philips Interactive of America, a division of N.V. Philips ("Philips"). Toward the end of 1994, the Company shifted its focus to being a developer and publisher of titles in which the Company maintains significant ownership interests and distribution rights. Since adopting this strategy, the Company has published four titles: Cities Under the Sea: Coral Reefs, the first of up to three titles to be developed in collaboration with Jean-Michel Cousteau, a noted sea explorer and the son of Jacques Cousteau; The Alchemist, a fortune-telling game, the first in the Mystic Messenger series; Ask Isaac Asimov . . . About Space, the first title of a multimedia series based on the respected series of children's science books written by scientist and author Isaac Asimov, and PIGS, the first in a collection of animated interactive stories for children. The Company has established its own marketing and distribution capability and a presence on the Internet to market its titles. Recently, in order to expand its library of titles and broaden its product line, the Company acquired Lyriq International Corporation ("Lyriq"), a developer and publisher of interactive multimedia products for the education, game and recreation markets. Lyriq has developed and published, among other things, the Picture Perfect Golf series of interactive media titles and several Crosswords puzzle titles. It is the Company's belief that the Lyriq acquisition will provide the Company with rights to valuable multimedia titles, access to significant creative and technical talent and expanded research and development abilities. The Company also believes that the combined product lines and development and marketing expertise will facilitate greater access to sales channels and a more widely available offering of software titles for the home and educational markets. See "Business--Titles" and "Title Development." The Company has in-house multimedia development facilities with computer graphics, animation, video and audio capabilities, including professional video production equipment, lighting and fully digital audio studios. The Company's strategy is to develop high quality interactive new media titles on all popular platforms, with a current emphasis on CD-ROM, the Internet and commercial on- line services. The Company will continue to focus on strategic acquisitions in order to increase its product offerings and market penetration. It anticipates that future product development will center on building a catalog of titles with strong educational content and entertainment value. See "Business--Company Strategy." Since shifting its strategy, the Company has incurred significant losses and expects that losses will increase and continue until such time, if ever, as the Company can successfully and profitably develop and distribute a broad line of interactive multimedia titles. The Company's experience has been that it takes between nine months to one year to develop each multimedia title and anticipates that a broad line of products could take two or more years to develop, depending upon market acceptance, if any, of the Company's products. There can be no assurance that the Company's strategy will be successful or that it will become profitable in the future. See "Risk Factors--History of Losses; Change in Strategy; Continuing Net Losses" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." 3 RECENT DEVELOPMENTS In its initial public offering consummated in October 1994 ("IPO"), the Company received $7,579,900 in net proceeds by selling 2,300,000 units, each unit consisting of one share of Common Stock and one warrant to purchase one share of Common Stock ("IPO Warrant"). The IPO Warrants are currently exercisable at any time until October 20, 1997 at an exercise price of $4.00 per share. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." In January 1996, the Company consummated a $2,700,000 bridge financing ("January 1996 Bridge Financing") of 54 Units ("Bridge Units") at a purchase price of $50,000 per Bridge Unit, each Bridge Unit consisting of a $50,000 principal amount unsecured convertible promissory note ("Convertible Note") of the Company and 10,000 warrants ("January 1996 Warrants"), each to purchase one share of Common Stock at a purchase price of $4.00 per share. Upon the consummation of this Offering, the January 1996 Warrants will be exchanged for 540,000 IPO Warrants. The Convertible Notes bear interest at the rate of ten percent (10%) per annum through June 30, 1996, and thereafter until the Convertible Notes are paid in full at a rate equal to fifteen percent (15%) per annum with principal and interest due on the earlier of July 23, 1997 or the closing of this Offering. Investors in the January 1996 Bridge Financing were given the option to receive, in lieu of the repayment of the principal of their Convertible Notes, the following: (a) a number of Conversion Shares equal to the principal amount of the Convertible Notes divided by ninety percent (90%) of the per share offering price of the Common Stock in this Offering and (b) a number of IPO Warrants ("Conversion Warrants") equal to two times the number of Conversion Shares. Investors holding an aggregate of $2,250,000 of Convertible Notes have elected to convert their Convertible Notes which, based on the Offering price of $3.375 per share, would convert at the closing of this Offering into 740,734 Conversion Shares and 1,481,468 Conversion Warrants. See "Use of Proceeds." The Conversion Shares and Conversion Warrants issuable upon conversion of certain Convertible Notes and the IPO Warrants, are being registered for resale by the Selling Securityholders under a second prospectus which forms a part of this Registration Statement. Without the prior consent of the Underwriter, the Selling Securityholders may not sell the Conversion Shares, the Conversion Warrants or the IPO Warrants issued in exchange for the January 1996 Warrants or the Common Stock underlying the Conversion Warrants or the IPO Warrants for a period of one year from the date of this Prospectus. The Company has been advised by the Underwriter that in determining whether to give or withhold its consent to any sale within the applicable lock-up periods, it will consider whether such sale would have an adverse effect on the market for the Common Stock. No shareholder subject to any lock-up agreement has requested to be released from such shareholder's lock-up. See "Description of Securities--IPO Warrants and Conversion Warrants" and "Shares Eligible for Future Sale." In connection with the January 1996 Bridge Financing, the Company entered into an agreement with certain executive officers of the Company pursuant to which the Company will repurchase, simultaneously with the closing of this Offering, an aggregate of 1,000,000 shares of Common Stock ("Contribution Shares") at a purchase price of $1 per share, or an aggregate of $1,000,000, of which $333,334 will be payable on the closing of this Offering, with the balance payable in two equal installments of $333,333 each on the first and second anniversaries of the date of this Prospectus. Interest will accrue at the prime rate and is payable quarterly. The Company entered into the agreement to purchase the Contribution Shares in connection with its negotiations with the Underwriter regarding the terms of the January 1996 Bridge Financing and this Offering. In the quarter in which the Offering occurs, the Company will incur one-time charges for the write-off of debt acquisition costs and the discount on the Convertible Notes totalling $736,700, based on the balances at February 29, 1996. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Certain Transactions." On February 29, 1996, Lyriq merged into a wholly-owned subsidiary of the Company pursuant to an Agreement and Plan of Merger ("Lyriq Acquisition"). As consideration for this transaction, the Company issued an aggregate of 725,212 shares of Common Stock, including 303,651 and 310,867 shares of Common Stock, 4 respectively, to Messrs. Randal Hujar and Gary Skiba, former principals of Lyriq, both of whom entered into employment contracts with the Company. The Company has agreed to register the Common Stock issued to Messrs. Hujar and Skiba in connection with the Lyriq Acquisition after February 28, 1997, with certain exceptions. The transfer of such shares is subject to lock-up restrictions. See "Shares Eligible for Future Sale." THE OFFERING Securities Offered.................................. 2,100,000 shares of Common Stock. See "Description of Securities." Common Stock Outstanding Prior to the Offering...... 5,500,701 shares(1) Common Stock to be Outstanding After the Offering... 7,341,435 shares(2) Nasdaq SmallCap Market Symbol....................... ENTR The Boston Stock Exchange Symbol.................... ENT
-------- (1) Excludes 740,734 Conversion Shares which will be issued simultaneously with the closing of this Offering. Includes 725,212 shares of Common Stock issued in connection with the Lyriq Acquisition. See "Principal Securityholders." (2) Reflects the issuance of 740,734 Conversion Shares and the repurchase of 1,000,000 Contribution Shares. USE OF PROCEEDS The Company intends to apply the net proceeds of this Offering to research and product development; payment for Contribution Shares; the repayment of certain of the Convertible Notes and the payment of interest due and owing on all of the Convertible Notes; and for working capital and general corporate purposes. See "Use of Proceeds." RISK FACTORS The securities offered hereby involve a high degree of risk, including without limitation: history of losses and expected continuing net losses; possible need for additional financing; absence of credit facilities; change in business strategy; dependence on new titles; rapid technological changes; intense competition and control by management. See "Risk Factors" immediately following this Prospectus Summary. 5 SUMMARY FINANCIAL INFORMATION The summary financial information set forth below is derived from the financial statements of Enteractive and Lyriq appearing elsewhere in this Prospectus. This information should be read in conjunction with such financial statements, including the notes thereto. Enteractive's historical information presented for the fiscal years ended May 31, 1995 and 1994 and the nine months ended February 29, 1996 and February 28, 1995 include the historical results of Sonic (as defined herein) through May 10, 1994, the date of the Merger (as defined herein), and the combined results of Enteractive and Sonic thereafter. The Balance Sheet Data at February 29, 1996 includes the consolidated accounts of Enteractive and Lyriq. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Overview." The unaudited pro forma information is presented for illustrative purposes only and is not necessarily indicative of the operating results or financial position that would have occurred if the Lyriq Acquisition had been consummated as of such date nor is it necessarily indicative of future operating results or financial position. The Lyriq Acquisition has been accounted for under the purchase method of accounting. ENTERACTIVE SUMMARY FINANCIAL INFORMATION
PRO FORMA YEAR ENDED PRO FORMA NINE MONTHS ENDED NINE MONTHS MAY 31, YEAR ENDED ------------------------- ENDED --------------------- MAY 31, FEBRUARY 29, FEBRUARY 28, FEBRUARY 29, 1995 1994 1995(1) 1996 1995 1996(1) ---------- --------- ---------- ------------ ------------ ------------ STATEMENT OF OPERATIONS DATA: Product sales........... $ -- $ -- $ 617,500 $ 324,800 $ -- $ 842,200 Product development revenue................ 365,600 2,371,500 527,700 257,700 292,600 378,700 Royalty and other revenue................ 3,500 10,700 468,400 103,300 2,400 327,300 Operating loss.......... (3,969,800) (382,100) (4,617,900) (6,435,500) (2,409,300) (5,086,400) Net loss................ (3,997,400) (373,200) (4,656,900) (6,378,800) (2,512,600) (5,060,600) Net loss per common share.................. $ (0.93) $ (0.11) $ (0.93) $ (1.34) $ (0.62) $ (0.92) Weighted average shares................. 4,275,908 3,419,409 5,001,120 4,775,489 4,057,812 5,500,701
FEBRUARY 29, 1996 -------------------------- ACTUAL AS ADJUSTED(2) ---------- -------------- BALANCE SHEET DATA: Total assets......................................... $4,558,200 $9,395,200 Working capital (deficit)............................ (537,900) 6,185,700 Total liabilities.................................... 3,632,200 2,078,900 Stockholders' equity................................. $ 926,000 $7,316,300
-------- (1) The pro forma Statement of Operations Data for May 31, 1995 and February 29, 1996 reflects the effect of the Lyriq Acquisition, including the amortization of capitalized software acquired in connection therewith and excluding the non-recurring in-process research and development charge of $1,915,100. (2) Reflects (i) the sale by the Company of the Common Stock offered hereby and the application of the estimated net proceeds therefrom, (ii) the conversion of $2,250,000 principal amount of Convertible Notes into Conversion Shares and Conversion Warrants and (iii) the repurchase of the Contribution Shares. See "Use of Proceeds." 6 LYRIQ SUMMARY FINANCIAL INFORMATION
YEAR ENDED NINE MONTHS ENDED JUNE 30, ------------------------- ------------------- FEBRUARY 29, FEBRUARY 28, 1995 1994 1996 1995 --------- -------- ------------ ------------ STATEMENT OF OPERATIONS DATA: Product sales................... $ 617,536 $206,339 $ 517,444 $607,760 Product development revenue..... 162,132 171,262 121,000 125,487 Royalty and other revenue....... 464,906 47,031 223,961 303,053 Operating income (loss)......... (219,998) (8,661) (352,011) 49,539 Net income (loss)............... $(231,457) $(15,013) $(382,902) $ 46,592
Unless otherwise indicated, the information in this Prospectus does not give effect to the exercise of the Underwriter's over-allotment option or the Underwriter's Purchase Option, and does not include (i) 1,500,000 shares of Common Stock reserved for issuance upon exercise of stock options which may be granted under the Company's 1994 Incentive and Non-Qualified Stock Option Plan ("1994 Plan"), of which options to purchase 597,770 shares of Common Stock have been granted; (ii) 1,000,000 shares of Common Stock reserved for issuance upon exercise of stock options which may be granted under the Company's 1994 Consultant Stock Option Plan ("Consultant Plan"), of which options to purchase 250,000 shares of Common Stock have been granted; (iii) 150,000 shares of Common Stock reserved for issuance under the Company's 1995 Directors Stock Option Plan ("Directors Plan"), of which options to purchase 30,000 shares of Common Stock have been granted; (iv) 282,000 shares of Common Stock reserved for issuance upon exercise of certain other outstanding non-qualified stock options; (v) 340,000 shares of Common Stock reserved for issuance upon exercise of warrants ("January 1994 Warrants") issued in connection with a private placement in January 1994 ("January 1994 Private Placement"); (vi) 5,121,468 shares of Common Stock reserved for issuance upon the exercise of IPO Warrants, including (a) 800,000 IPO Warrants issued in exchange for warrants to purchase 800,000 shares of Common Stock ("May 1994 Warrants") issued in connection with a bridge financing in May 1994 ("May 1994 Bridge Financing"), (b) 540,000 IPO Warrants issued upon exchange of 540,000 January 1996 Warrants and (c) the conversion of the Convertible Notes into 1,481,468 Conversion Warrants; and (vii) 400,000 shares of Common Stock reserved for issuance upon the exercise of the underwriter's unit purchase option granted to the underwriters of the IPO ("Underwriter's UPO"). See "Management -- Executive Compensation," and " -- Stock Option Plans and Other Options," "Certain Transactions," "Principal Securityholders" and "Description of Securities -- IPO Warrants and Conversion Warrants" and " -- Other Warrants." 7 THE COMPANY The Company, a Delaware corporation incorporated in December 1993, is the successor to Sonic Images Productions, Inc. ("Sonic"), a District of Columbia corporation incorporated in 1979 which was merged with and into the Company in May 1994 ("Merger"). The Company, as the surviving entity of the Merger, continued its existence following the Merger as a Delaware corporation. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Overview" for a description of the accounting treatment of the Merger. In February 1996, Lyriq merged into a wholly-owned subsidiary of the Company. Unless otherwise indicated, references to the Company also includes its wholly-owned subsidiaries. The Company's executive offices are located at 110 West 40th Street, Suite 2100, New York, New York 10018, its Worldwide Web site address is http://www.enteractive.com, and its telephone number is (212) 221-6559. RISK FACTORS The securities offered hereby are speculative in nature and involve a high degree of risk. Accordingly, in analyzing an investment in these securities, prospective investors should carefully consider, along with the other matters referred to herein, the following risk factors. History of Losses; Change in Strategy; Continuing Net Losses. The Company has incurred significant losses since the Merger. At the end of 1994, the Company shifted its focus from being primarily a provider of product development services for others to being a developer and publisher of titles in which the Company maintains a significant ownership interest and, in many cases, distribution rights. However, the Company continues to incur significant losses. For the fiscal year ended May 31, 1995 and the nine months ended February 29, 1996, the Company had net losses of $3,997,400 and $6,378,800, respectively. The net loss for the nine months ended February 29, 1996 includes a non-recurring charge of $1,915,100 for acquired in-process research and development in connection with the Lyriq Acquisition. The Company expects that losses will increase and continue until such time, if ever, as the Company can successfully and profitably develop, produce and distribute a broad line of interactive multimedia titles. The Company's experience has been that it takes between nine months to one year to develop each multimedia title and anticipates that a broad line of products could take two or more years to develop, depending upon market acceptance, if any, of the Company's products. The operating results of the Company will continue to be adversely affected since the Company will incur additional expenses to implement its strategy, particularly expenses in research and development and distribution and marketing operations, which are expected to be in excess of anticipated product sales. Accordingly, the Company anticipates that should its products not meet with, or be delayed in obtaining, market acceptance, the Company will explore various alternatives to achieve profitability including, but not limited to, reducing personnel, performing product development services for third parties, acquiring existing titles from third parties or seeking partners to participate in development and marketing. The Company does not believe it will generate taxable income during the period ending May 31, 1997. Beyond such time, using the standards set forth in Financial Accounting Standard No. 109, management cannot currently determine whether the Company will generate taxable income during the period that the Company's net operating loss carry forward may be applied towards the Company's taxable income, if any. There can be no assurance that the Company's strategy will be successful or that the Company will become profitable in the future. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Possible Need for Additional Financing; Absence of Credit Facility. Management believes that the net proceeds of this Offering, together with the Company's existing resources and cash generated from future revenues, if any, will be adequate for the Company's cash requirements for at least 12 months from the date of this Prospectus. However, these funds may not be sufficient to meet the Company's longer term cash requirements for operations. If necessary, the Company may return to performing product development for third parties in order to help meet its cash requirements or if the Company otherwise deems it appropriate while continuing to develop and market several of its own production titles. The Company may also be required to obtain additional financing to continue to operate its business. The Company does not currently have a line of credit. There can be no assurance that any additional financing, if required, will be available to the Company on acceptable terms, if at all. Any inability by the Company to obtain additional financing, if required, will have a 8 material adverse effect on the operations of the Company. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources" and "Use of Proceeds." Uncertain Sources of Revenue. Prior to fiscal 1996, the Company's revenues were primarily derived from development projects provided for other entities and grants received for development work. For the fiscal years ended May 31, 1994 and May 31, 1995, the Company had product development revenue of $2,371,500 and $365,600, respectively, representing a substantial portion of the Company's total revenue for such fiscal years. As a result of the Company's new strategy, the Company has shifted away from externally-funded development work and anticipates that a majority of its revenues in the future will be generated from sales of its titles. The Company is actively marketing four of its own interactive multimedia titles and, as a result of the Lyriq Acquisition, seven additional Company-owned titles. While the Company generated revenues of $324,800, or 47% of total revenues, from title sales during the nine months ended February 29, 1996, there can be no assurance that revenues from titles sales will continue, increase or exceed operating expenses in the future. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Overview." Dependence on New Titles; Short Title Life Cycles; Market Acceptance; Families of Titles. The nature of the interactive multimedia publishing industry is such that a significant number of titles will be unsuccessful and that the revenues derived from the successful titles will be used to cover the costs of the failures. The Company's success depends on the timely introduction of successful new titles and sequels or updates to existing titles to replace declining revenues from older titles. The life cycle of a successful title is difficult to predict and may be as short as three months. In addition, each title is an individual artistic work and its commercial success is primarily determined by consumer taste, which is unpredictable and constantly changing. Few consumer software products achieve sustained market acceptance. The Company believes that a title achieves market acceptance if it is widely purchased by consumers. There can be no assurance that any of the Company's new titles will achieve market acceptance or that, if accepted, such acceptance will be sustained for a period long enough to recoup costs or realize profits. If market acceptance is not sustained, the Company may be required to write-down unsold excess inventory and/or accept substantial product returns to maintain its access to distribution channels and accordingly, the Company's results of operations could be materially adversely affected. In addition, part of the Company's business strategy is to create families of titles through the use of similar characters, themes, titles and educational approaches throughout a product line. When the Company chooses to develop a family of titles, it may make a substantial development investment before the Company can assess whether a family of titles will be successful. Accordingly, if a family of titles is unsuccessful, it could have a material adverse effect on the results of operations of the Company. See "Use of Proceeds" and "Business -- Company Strategy," "-- Title Development," "-- Marketing and Distribution" and "-- Competition." Rapid Technological Change; Competing Computer Platforms; Emphasis on CD- ROM. The market for educational and entertainment multimedia titles is subject to frequent and rapid changes in technology resulting in short title life cycles and rapid price declines. The Company's success is dependent upon, among other things, the ability of the Company to achieve and maintain technological expertise and to continue to introduce quality titles by anticipating and reacting to new technologies. There are multiple platforms and technologies on which interactive multimedia titles can be based. Each of these platforms and technologies have been developed and produced by third party hardware manufacturers. These platforms are not compatible with each other and, consequently, interactive multimedia titles developed for one platform cannot be used on other platforms. The titles released by the Company in 1995 were for CD-ROM. Titles currently being developed by the Company are for the CD-ROM, the Internet or commercial on-line platforms, which the Company believes are currently the dominant platforms in the industry. There can be no assurance, however, that such platforms will continue to be the dominant industry platforms or that the Company will successfully integrate its products into the Internet or commercial on-line platforms. While the Company anticipates developing titles for other platforms that achieve market acceptance, because the development of titles for a new platform, as well as the migration of a title from one platform to another, is time consuming and expensive, a leveling off or decline in CD-ROM, the Internet or commercial on- line services or any subsequent change in the dominant industry platforms could have a material adverse effect on the Company. In addition, uncertainty over which platforms will become dominant may impede product sales, and the emergence of a dominant platform other than CD-ROM, the Internet or 9 commercial on-line services could severely reduce sales of the Company's titles. The Company's success in marketing its titles will depend upon its ability to anticipate and respond to trends in the emergence of these platforms. See "Business -- Company Strategy" and "-- Title Development." Marketing and Distribution Arrangements; Competition for Shelf Space. The Company has only recently begun to distribute its own titles. The Company generally sells its titles to distributors who then distribute such titles to retailers or sell its titles directly to retailers. These distributors typically can return the Company's product at any time for credit without an offsetting order. Accordingly, the Company may experience substantial product returns which could have a material adverse affect on its revenues. Since retailers typically have a limited amount of shelf space and promotional resources and there is intense competition among multimedia software producers, there can be no assurance that the Company will gain adequate levels of shelf space and promotional support for its titles to generate sales volume. Due to increased competition for limited shelf space, retailers and distributors are increasingly in a better position to negotiate favorable terms of sale, including price discounts and product return policies. The Company may be competing in distribution against much larger organizations with more influence over retailers and distributors and greater marketing and distribution resources. In addition, other types of retail outlets and methods of product distribution, such as Internet or on-line services, will become increasingly important and accordingly, the success of the Company will depend on its ability to gain access to these channels of distribution. There can be no assurance that the Company will be successful in the development of its distribution networks or gain such access, and if the Company is unsuccessful in such development it will have a material adverse effect on the results of operations of the Company. See "Business -- Marketing and Distribution" and "-- Competition." Intense Competition. The home education and entertainment software industry is intensely competitive, and market acceptance for the Company's titles may be adversely affected by the introduction of similar titles by competitors. The Company competes, in both the home education and entertainment and the school markets, against a large number of other companies of varying sizes and resources. Many of these competitors have substantially greater financial, technical and marketing resources than the Company and may be more successful in securing shelf space for their titles. Existing competitors may continue to broaden their product lines and new competitors, including large computer or software manufacturers, entertainment companies and educational publishers, are entering or increasing their focus on the home education and entertainment and the school markets, resulting in increased competition for the Company. Increased competition may result in loss of shelf space for the Company's titles at retail stores, loss of or difficulty in recruiting key employees and significant price competition, any of which could adversely affect the Company's operating results. The Company also faces intense competition for a finite amount of discretionary consumer spending for other forms of entertainment offered by film companies, record companies, video companies and others. See "Business -- Competition." Seasonal Business; Quarterly Fluctuations. The home education and entertainment software business is highly seasonal. Typically, net revenues are highest during the last calendar quarter, decline in the first calendar quarter and are lowest in the second and third calendar quarters. This seasonal pattern is due primarily to the increased demand for home education and entertainment software products during the year-end holiday buying season. With respect to the school market, sales are highest during June (the end of the budget period for most schools) and from August through October (the beginning of the school year). Accordingly, the Company's revenues will reflect these seasonal patterns and will vary within a particular year depending on whether its sales mix is more heavily weighted toward the home education and entertainment or the school markets. In addition, quarterly fluctuations in operating results will be exacerbated by delays in new product introductions, the introduction of competitive products, the popularity of particular multimedia platforms and a variety of other factors relating to the distribution and development process for the products involved, including software malfunctions in title offerings. A significant portion of the Company's operating expenses are relatively fixed, and certain expenditures are based on sales forecasts. If net sales do not meet the Company's expectations in a given quarter, the Company's operating results or financial condition could be adversely affected. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Lyriq's Dependence on a Significant Customer. The Princeton Review accounted for $265,500, or 21%, and $211,500, or 25%, of Lyriq's total revenues for the fiscal year ended June 30, 1995 and the nine months 10 ended February 29, 1996, respectively. On a pro forma basis reflecting the Lyriq Acquisition, such customer would have accounted for 16% and 14%, respectively, of the Company's total revenues for the fiscal year ended May 31, 1995 and the nine months ended February 29, 1996. Accordingly, the loss of such customer or a significant decrease in the royalties the Company receives from The Princeton Review could have a material adverse effect on the financial condition and results of operations of the Company. See "Business -- Dependence on a Significant Customer." Dependence on Third Party Manufacturers. The Company's titles are manufactured by third-party manufacturers and therefore the Company does not have direct control over the quality of manufacturing. Additionally, some of the third party manufacturers may publish competitive titles of their own, to which preferential treatment may be given. Any of the foregoing would adversely affect the Company's revenues from the sale of its titles. Management believes that current arrangements for the manufacture of the Company's titles are satisfactory for the Company's anticipated requirements. Nevertheless, there can be no assurance that in the future these third parties' manufacturing capacities will be sufficient to satisfy the Company's requirements, that interruptions or delays in manufacturing will not adversely affect the Company's operations, or that alternative manufacturing sources will be available to the Company on commercially reasonable terms or at all. In particular, the Company frequently packages and sells titles in its Picture Perfect Golf series together with an infrared golf club, which is currently available from only one independent third party manufacturer. Occasionally, the Company has postponed delivery of titles in its Picture Perfect Golf series as a result of the manufacturer's inability to timely deliver the infrared golf club. While the Company is seeking to establish alternative sources which can produce the infrared golf club or acquire the rights to manufacture the infrared golf club currently utilized in the Picture Perfect Golf series, there can be no assurance that such efforts will be successful. If the Company does not receive infrared golf clubs on a timely basis, it could have a material adverse effect on the Company's results of operations. See "Business -- Manufacturing." Availability and Restrictive Nature of Licenses. The Company currently licenses a wide variety of intellectual property from others for use in its titles. There can be no assurance that the terms of these licenses will survive the marketing lives of the titles to which they relate or that the Company will be able to renew such licenses on commercially reasonable terms, if at all. The Company expects to continue to incorporate the intellectual property of others into the titles it develops in the future. As such it will need to obtain licenses to use such intellectual property. The Company will attempt to obtain future licenses on commercially reasonable terms and with terms of duration which will survive the lives of the titles to which they relate. However, there can be no assurance that the Company will be able to obtain licenses of sufficient duration on commercially reasonable terms or will be able to renew existing licenses on commercially reasonable terms. The inability to obtain or renew such licenses, as the case may be, could have an adverse effect on the business of the Company. See "Business -- Company Strategy" and " -- Title Development." Software Technology; Lack of Patent Protection. The Company's future success will be heavily dependent upon its software technology; and the Company will rely on a combination of contractual rights, trade secrets and copyright laws to establish or protect its technology in the countries where it will conduct business. The Company currently does not possess any patent or other registered intellectual property rights with respect to its software technology, other than copyrights with respect to the overall content of completed titles developed by the Company. There can be no assurance that the steps taken by the Company to protect its rights will be adequate to deter misappropriation, especially since the Company operates in an industry in which revenues are adversely affected by the unauthorized reproduction of products for commercial sale, commonly referred to as "piracy." Moreover, although the Company does not believe that it is infringing on the intellectual property rights of others, there can be no assurance that such infringement claims will not be asserted against the Company in the future and if an infringement claim is successful, it could have a material adverse effect on the Company. Copyright and other proprietary rights to material licensed for use on CD-ROM and other multimedia platforms is a relatively new area of the law. Although the Company is not a party to any such claim, there is the possibility of legal challenges in respect of all such rights. See "Business -- Protection of Proprietary Rights." Control by Officers and Directors and Principal Stockholder; Stockholders Agreement. The Company's officers and directors and their affiliates will own approximately 30.3% of the outstanding Common Stock 11 immediately after this Offering (after giving effect to the repurchase by the Company of 1,000,000 Contribution Shares) and will have significant influence over the outcome of all matters submitted to the stockholders for approval, including the election of directors of the Company. Moreover, a stockholder of the Company will individually and through related entities beneficially own 27.9% of the Company's Common Stock (consisting of (i) 760,093 shares of Common Stock, including 592,593 Conversion Shares, and (ii) 1,790,186 shares of Common Stock underlying presently exercisable options and warrants) and accordingly if the presently exercisable options and warrants are exercised, that stockholders will also have significant influence over the outcome of all matters submitted to the stockholder for approval, including the election of Directors. In addition, the Company, John Ramo, Jolie Barbiere, Michael Alford, Zenon Slawinski and Andrew Gyenes have entered into a Stockholders' Agreement which terminates in August 1997 with respect to the election of directors and provides for a seven-member Board of Directors consisting of three nominees designated by Andrew Gyenes and three nominees designated by John Ramo (provided that such nominees are reasonably acceptable to each of Mr. Gyenes and Mr. Ramo) and one person mutually agreed upon by Mr. Ramo and Mr. Gyenes. Each of John Ramo, Jolie Barbiere, Michael Alford and Zenon Slawinski have agreed to vote all of their shares in favor of the election of such seven persons. The Company has also agreed to use its best efforts to elect one designee selected jointly by Randal Hujar and Gary Skiba to be a member of the Board of Directors until the earlier of February 28, 1998 or the termination of the lock-up agreement between the Company and Messrs. Hujar and Skiba. See "Principal Securityholders" and "Description of Securities -- Stockholders Agreement." Dependence on Management; Need to Attract Additional Personnel. The Company is dependent upon the business and technical expertise of its executive and creative personnel. In particular, the loss of the services of Andrew Gyenes, the Chairman of the Board and Chief Executive Officer, could have a material adverse effect upon the Company. There can be no assurance that an adequate replacement could be found if the Company were to lose the services of Mr. Gyenes. The Company has an employment agreement with Mr. Gyenes which expires in October 1997. The Company has obtained a "key person" insurance policy on the life of Mr. Gyenes in the amount of $1,000,000 under which the Company is the beneficiary. In addition, the Company's ability to develop its business will depend upon its ability to recruit and retain additional personnel, including engineering, marketing and management personnel. Competition for qualified personnel is intense and accordingly, there can be no assurance that the Company will be able to retain or hire all of the necessary personnel or that the Company may not otherwise need to change its personnel to compete in its rapidly changing market. See "Management -- Executive Officers and Directors" and "-- Employment Agreements." Dilution. This Offering involves immediate dilution to investors of $2.54 per share, or 75%, representing the difference between the pro forma net tangible book value per share of the Common Stock immediately after the completion of this Offering and the offering price per share of Common Stock. See "Dilution." Portion of Proceeds Used to Satisfy Indebtedness, Including Indebtedness Owed to 5% Stockholders and Pay for Contribution Shares Owned by Officers and/or Directors of the Company. Approximately 27% of the net proceeds received by the Company from this Offering will be used to (i) repay $540,000 of the Convertible Notes including accrued interest, including approximately $308,000 which will be repaid to entities affiliated with 5% stockholders of the Company and (ii) pay $1,075,000 including interest, to certain executive officers of the Company to repurchase the Contribution Shares owned by them. Broad Discretion in Application of Proceeds by Management, Including Payment of Salaries. Approximately $1,822,000 or 31%, of the estimated net proceeds of the Offering have been allocated to working capital and general corporate purposes. The Company will have broad discretion as to the application of such proceeds and will use a portion of such proceeds to pay salaries, including salaries of its executive officers. See "Use of Proceeds." No Dividends. The Company has never paid cash dividends on the Common Stock. The Company intends to retain any future earnings to finance its growth. Accordingly, any potential investor who anticipates the need for current dividends from an investment in the Common Stock should not purchase any of the shares of Common Stock offered hereby. See "Dividend Policy." 12 Effect of Outstanding Options and Warrants. Immediately after this Offering, not including the Underwriter's UPO and the Underwriter's Purchase Option, there will be outstanding options and warrants to purchase, in the aggregate, 6,389,770 shares of Common Stock at per share exercise prices ranging from $1.71 to $4.00. In addition to the Underwriter's Purchase Option and the Underwriter's UPO, there are outstanding options to purchase an aggregate of 1,159,770 shares of Common Stock consisting of (i) options to purchase 597,770 shares of Common Stock at exercise prices ranging from $1.71 to $3.75 per share granted under the 1994 Plan, of which options to purchase 319,925 shares of Common Stock are currently exercisable; (ii) options to purchase 250,000 shares of Common Stock at exercise prices ranging from $2.35 to $3.00 per share granted under the Consultant Plan, all of which are currently exercisable; (iii) options to purchase 30,000 shares of Common Stock at exercise prices of $3.00 and $3.75 per share granted under the Directors Plan, all of which are currently exercisable; and (iv) options to purchase 282,000 shares of Common Stock at exercise prices of $2.35 and $3.00, all of which are currently exercisable. In addition to the Underwriter's UPO, upon the consummation of this Offering there will be outstanding warrants to purchase an aggregate of 5,230,000 shares of Common Stock consisting of (i) IPO Warrants to purchase 5,121,468 shares of Common Stock including (a) 800,000 IPO Warrants issued in exchange for 800,000 May 1994 Warrants, (b) 540,000 IPO Warrants issued in exchange for 540,000 January 1996 Warrants and (c) 1,481,468 Conversion Warrants, all of which will be currently exercisable at a price of $4.00 per share until October 20, 1997; and (ii) 340,000 January 1994 Warrants which are currently exercisable at a price of $2.35 per share until January 24, 1999. The exercise of the foregoing options and warrants and the Underwriter's UPO (and the warrants included therein) and the Underwriter's Purchase Option will dilute the percentage ownership of the Company's stockholders and any sales in the public market of shares of Common Stock underlying such securities may adversely effect prevailing market prices for the Common Stock. Moreover, the terms upon which the Company will be able to obtain additional equity capital may be adversely affected since the holders of the outstanding securities will, to the extent they are able, likely exercise them at a time when the Company could, in all likelihood, obtain any needed capital on terms more favorable to the Company than those provided in the options and the warrants. Registration Rights. The sale of 740,734 Conversion Shares, 1,481,468 Conversion Warrants, 540,000 IPO Warrants issuable in exchange for the January 1996 Warrants and the issuance of the shares of Common Stock underlying such warrants is being registered under the Registration Statement of which this Prospectus forms a part. The Selling Securityholders have agreed not to sell any of such securities for a period of one year from the date of this Prospectus without the Underwriter's consent. In addition, the Company has entered into a registration rights agreement under which the Company provides each of certain shareholders ("Sonic Group") with (i) "demand" registration rights whereby each can, with certain exceptions, on two occasions require the Company to register under the Securities Act the Common Stock held by the Sonic Group and (ii) "piggyback" registration rights whereby each can, with certain exceptions, require the Company to include the Common Stock it holds in any registration statement filed by the Company. All of such rights have been waived with respect to this Offering. In addition, the Company has entered into a registration rights agreement with Randal Hujar and Gary Skiba providing for (i) "demand" registration rights whereby Messrs. Hujar and Skiba can after February 28, 1997, with certain exceptions, require the Company to register under the Securities Act the Common Stock they hold and (ii) "piggyback" registration rights whereby Messrs. Hujar and Skiba can after February 28, 1997, with certain exceptions, require the Company to include the Common Stock they hold in any registration statement filed by the Company. The Company has also entered into a registration rights agreement with other former shareholders of Lyriq (holding in aggregate 110,694 shares of Common Stock) providing for "piggyback" rights whereby such individuals, with certain exceptions, can require the Company to include the Common Stock they hold in any registration statement filed by the Company pursuant to the "demand" registration rights of Messrs. Hujar and Skiba. The registration rights of any of the holders could result in substantial future expense to the Company and could adversely affect any future equity or debt financings by the Company. Furthermore, the sale of the Common Stock or other securities held by or issuable to the holders, or merely the potential of such sales, could have an adverse effect on the market prices of the Company's securities. In addition, the Company has granted certain demand and piggy-back registration rights to the Underwriter with respect to the securities issuable upon exercise of the Underwriter's UPO and the Underwriter's Purchase Option. See "Management -- Stock Option Plans and Other Options," "Certain Transactions," "Description of Securities" and "Underwriting." 13 Future Sales of Common Stock. Of the 7,341,435 shares of Common Stock outstanding upon consummation of the Offering, 4,300,000 have been registered (2,100,000 of which have been registered in this Offering) and therefore are "freely tradeable." In addition, 740,734 Conversion Shares, which have been registered by means of the Registration Statement of which this Prospectus forms a part, may be sold by the Selling Securityholders if at the time of such sale there is a current prospectus relating to the Conversion Shares (subject to the lock-up period described below). The remaining 2,200,701 shares of Common Stock are "restricted securities" as that term is defined in Rule 144 under the Securities Act, and under certain circumstances may be sold without registration pursuant to such rule. Of such outstanding shares, 1,400,489 (of which 1,353,512 shares are subject to the lock-up period described below) will be available for sale pursuant to Rule 144 commencing May 1996, 75,000 shares will be available for sale pursuant to Rule 144 commencing August 1996 and 725,212 shares (614,618 of which shares are subject to the lock-up period described below) will be available for sale pursuant to Rule 144 commencing February 1998. All officers and directors of the Company as of the date of this Prospectus (who hold in the aggregate 1,976,130 shares) have agreed that until the earlier of two years from the date of this Prospectus or the 20th day after the end of the second consecutive whole fiscal quarter after the date of this Prospectus during which the Company had positive net income on a consolidated basis (each of such quarters being referred to as a "Positive Quarter"), they will not sell any of their shares without the prior consent of the Underwriter, provided, however, that each officer and director of the Company who was a stockholder of record as of December 29, 1995 and Randal Hujar and Gary Skiba shall be permitted to sell at the earlier of one year after the date of this Prospectus or any time after the 20th day after the end of the first Positive Quarter, up to 15% of the shares owned by such holder on the date hereof. In addition, prior to February 28, 1997, Mr. Hujar may pledge up to fifty percent of his Common Stock to cover personal expenses. The Selling Securityholders have agreed that they will not sell the Conversion Shares, the Conversion Warrants and the IPO Warrants they received in exchange for the January 1996 Warrants until twelve months after the date of this Prospectus without the Underwriter's consent. The Company is unable to predict the effect that sales made under Rule 144 or otherwise may have on the market price of the Common Stock prevailing at the time of any such sales. See "Description of Securities" and "Shares Eligible for Future Sale." Possible Volatility of Securities Prices. The market price of Common Stock has in the past been, and may in the future continue to be, volatile. A variety of events, including quarter to quarter variations in operating results, news announcements or the introduction of new products by the Company or its competitors, as well as market conditions in the interactive multimedia industry or changes in earnings estimates by securities analysts may cause the market price of the Common Stock to fluctuate significantly. In addition, the stock market in recent years has experienced significant price and volume fluctuations which have particularly affected the market prices of equity securities of many companies that service the software industry and which often have been unrelated to the operating performance of such companies. These market fluctuations may adversely affect the price of the Common Stock. See "Price Range of the Common Stock" and "Dividend Policy." Qualification Requirements for Nasdaq Securities. The Common Stock is presently quoted on Nasdaq, which is administered by the National Association of Securities Dealers, Inc. (the "NASD"). For the Company's Common Stock to continue to be eligible for inclusion on Nasdaq, the Company must, among other things, maintain at least $2,000,000 in total assets and have at least $1,000,000 of capital and surplus and the bid price of the Common Stock must be at least $1.00 per share, provided, however, that, if the Company's Common Stock falls below such minimum bid price, it will remain eligible for continued inclusion if the market value of the public float is at least $1,000,000 and the Company has at least $2,000,000 in capital and surplus. While the Company presently meets the required standards, there can be no assurance that it will continue to be able to do so. If it should fail to meet one or more of such standards, its Common Stock would be subject to deletion from Nasdaq. If this should occur, trading, if any, in the Common Stock, would then continue to be conducted in the over-the-counter market on the OTC Bulletin Board, an NASD-sponsored inter-dealer quotation system, or in what are commonly referred to as "pink sheets." As a result, an investor may find it more difficult to dispose of or to obtain accurate quotations as to the market value of, the Company's Common Stock. In addition, if the Company's Common Stock ceases to be quoted on Nasdaq and the Company fails to meet certain other criteria, they would be subject to a Commission rule (Rule 15g- 9) that imposes additional sales practice requirements on 14 broker-dealers who sell such Common Stock to persons other than established customers and accredited investors. For transactions covered by this rule, the broker-dealer must make a special suitability determination for the purchaser and have received the purchaser's written consent to the transaction prior to sale. Consequently, if the Company's Common Stock were no longer quoted on Nasdaq, the rule may affect the ability of broker-dealers to sell the Company's Common Stock and the ability of purchasers in this offering to sell their Common Stock in the secondary market. Issuance of Preferred Stock; Anti-Takeover Provisions. Pursuant to its Certificate of Incorporation, as amended, the Company has an authorized class of 2,000,000 shares of Preferred Stock which may be issued by the Board of Directors on such terms and with such rights, preferences and designations as the Board may determine without any vote of the stockholders. Issuance of such preferred stock, depending upon the rights, preferences and designations thereof, may have the effect of delaying, deterring or preventing a change in control of the Company. Issuance of additional shares of Common Stock could result in the dilution of the voting power of the Common Stock purchased in this Offering. In addition, certain "anti-takeover" provisions of the Delaware General Corporation Law, among other things, may restrict the ability of the stockholders to approve a merger or business combination or obtain control of the Company. See "Description of Securities--Preferred Stock" and "-- Delaware Law." 15 USE OF PROCEEDS The net proceeds to the Company from the sale of the Common Stock offered hereby are estimated to be approximately $5,937,000 (approximately $6,872,550 if the Underwriter's over-allotment option is exercised in full). The Company intends to apply the net proceeds approximately as follows:
APPLICATION OF PROCEEDS AMOUNT PERCENT ----------------------- ---------- ------- Research and product development(1)................. $2,500,000 42% Repurchase of Common Stock(2)....................... 1,075,000 18 Repay certain Convertible Notes and related accrued interest(3)........................................ 540,000 9 Working capital and general corporate purposes(4)... 1,822,000 31 ---------- --- Total............................................. $5,937,000 100% ========== ===
-------- (1) Research and product development includes internal development of new titles and expansion of existing product lines. Costs included are salaries of design, development and end-user testing personnel as well as other costs associated with (i) market analysis and product concept, (ii) product design, storyboarding and technical analysis and (iii) product creation and may include the acquisition of additional content licenses and the employment of technical and creative personnel. See "Business-- Titles." (2) Of the $1,000,000 to be paid to repurchase the Contribution Shares, $333,334 will be payable simultaneously with the closing of this Offering, $333,333 of the principal will be payable on the first anniversary of the date of this Prospectus and $333,333 of the principal will be payable on the second anniversary of the date of this Prospectus. Interest will accrue at the prime rate and is payable quarterly. All of the Contribution Shares are held by directors, executive officers, and/or 5% stockholders of the Company. The interest payments will aggregate approximately $75,000 based on the prime rate as of April 18, 1996. (3) In connection with the January 1996 Bridge Financing, the Company issued the Convertible Notes, and the January 1996 Warrants to purchase up to 540,000 shares of Common Stock. The Convertible Notes are in the aggregate principal amount of $2,700,000, bear interest at the rate of 10% per annum and are payable upon the consummation of this Offering. Holders of an aggregate of $2,250,000 Convertible Notes have elected to convert their Convertible Notes; which would convert the principal of such Convertible Notes at the closing of this Offering into 740,734 Conversion Shares and 1,481,468 Conversion Warrants. The remaining principal of such Convertible Notes ($450,000), together with accrued interest thereon and the interest on the $2,250,000 Convertible Notes, will be repaid with a portion of the proceeds of this Offering. If the Offering is consummated on or about May 20, 1996, the interest to be paid on the Convertible Notes will be approximately $90,000. Approximately $308,000 of the principal and interest to be repaid on the Convertible Notes are held by entities affiliated with 5% stockholders of the Company. The net proceeds from the sale of the Convertible Notes have been or will be used primarily for working capital purposes and for research and product development; and (4) Working capital and general corporate purposes may include, among other things, salaries of additional financial and management personnel, salaries of executive officers (which are anticipated to aggregate approximately $765,000 over the 12-month period following this Offering), marketing, sales and advertising activities, including the salaries of additional marketing and sales personnel and the costs of possible acquisitions of fully-developed products or businesses complementary to the Company's operations. The Company is not currently negotiating to acquire any other product or business and has no commitments, understandings or arrangements with respect to any such acquisition. If the Underwriter exercises the over-allotment option in full, the Company will realize additional net proceeds of $935,550, which will also be added to the Company's working capital. The Company anticipates, based on current plans and assumptions relating to its operations, that the proceeds of the Offering, together with existing resources and cash generated from future revenues, if any, will be sufficient to satisfy the Company's contemplated cash requirements for at least the next 12 months. There can be no assurance, however, that the Company's cash requirements during this period will not exceed its available resources. In addition, these funds may not be sufficient to meet the Company's longer term cash requirements for operations. In the event the Company's plans or assumptions change or prove to be inaccurate, or the proceeds of the Offering together with cash generated from future revenues, if any, prove to be insufficient to fund operations (due to unanticipated expenses, problems or otherwise), the Company may find it necessary and/or advisable to reallocate some of the proceeds within the above-described categories or to use portions thereof for other purposes and therefore management will have significant discretion regarding how and when such proceeds will be applied. Proceeds not immediately required for the purposes described above will be invested in United States government securities, short-term certificates of deposit, money market funds or other investment grade, short-term interest- bearing investments. 16 DILUTION The difference between the public offering price per share of Common Stock and the pro forma net tangible book value per share of Common Stock after this Offering constitutes the dilution per share of Common Stock to investors in this Offering. Net tangible book value per share is determined by dividing the net tangible book value (total tangible assets less total liabilities) by the number of outstanding shares of Common Stock. As of February 29, 1996, the Company had a pro forma net tangible book value of $201,500, or approximately $.04 per share of Common Stock (based on 5,241,435 shares of Common Stock outstanding) and after giving effect to (i) the conversion of $2,250,000 of Convertible Notes into 740,734 Conversion Shares and (ii) the repurchase of the Contribution Shares. After giving effect to the sale of the Common Stock offered hereby (less underwriting discounts and estimated expenses of this Offering) and the application of the net proceeds therefrom, the pro forma net tangible book value at that date would have been $6,138,500,or approximately $.84 per share. This represents an immediate increase in net tangible book value of approximately $.80 per share to existing stockholders and an immediate dilution of approximately $2.54 per share to new investors or 75%. The following table illustrates the per share dilution without giving effect to results of operations of the Company subsequent to February 29, 1996: Public offering price........................................... $3.375 Pro forma net tangible book value before Offering............. $.04 Increase attributable to new investors........................ .80 ---- Adjusted pro forma net tangible book value after Offering....... .84 ------ Dilution to new investors....................................... $ 2.54 ======
17 CAPITALIZATION The following table sets forth the capitalization of the Company (i) at February 29, 1996, and (ii) as adjusted to give effect to (a) the sale of the 2,100,000 shares of Common Stock offered hereby and the application of the estimated net proceeds therefrom, (b) the repurchase of the Contribution Shares and (c) the conversion of the Convertible Notes into Conversion Shares. See "Use of Proceeds."
FEBRUARY 29, 1996 ------------------------ ACTUAL AS ADJUSTED ----------- ----------- Short-term debt...................................... $ 2,315,000 $ 458,300 Long-term obligations................................ -- 333,300 Stockholders' equity: Preferred Stock, $.01 par value; 2,000,000 shares authorized; no shares issued or outstanding....... -- -- Common Stock, $.01 par value; 30,000,000 shares authorized(/1/); 5,500,701 shares issued and outstanding, actual; 7,341,435 shares issued and outstanding as adjusted........................... 55,000 73,400 Additional paid-in capital......................... 11,563,900 18,732,500 Accumulated deficit................................ (10,692,900) (11,489,600) ----------- ----------- Total stockholders' equity....................... 926,000 7,316,300 ----------- ----------- Total capitalization............................. $ 3,241,000 $ 8,107,900 =========== ===========
-------- (/1/Such)amount reflects the filing of an amendment to the Company's Certificate of Incorporation increasing the authorized Common Stock to 30,000,000. DIVIDEND POLICY The Company has never paid any cash dividends on the Common Stock and it is currently the intention of the Company not to pay cash dividends on its Common Stock in the foreseeable future. Management intends to reinvest earnings, if any, in the development and expansion of the Company's business. Any future declaration of cash dividends will be at the discretion of the Board of Directors and will depend upon the earnings, capital requirements and financial position of the Company, general economic conditions and other pertinent factors. 18 PRICE RANGE OF THE COMMON STOCK The Common Stock has been quoted on the Nasdaq SmallCap Market and The Boston Stock Exchange since October 20, 1994 under the symbols "ENTR" and "ENT," respectively. The Nasdaq SmallCap Market is the principal trading market for the Company's securities. The following table sets forth the ranges of the high and low closing bid prices for the Common Stock since October 20, 1994, the effective date of the IPO, as reported on the Nasdaq SmallCap Market. The quotations are interdealer prices without adjustment for retail markups, markdowns or commissions, and do not necessarily represent actual transactions.
COMMON STOCK ------------- PERIOD HIGH LOW ------ ------ ------ FISCAL YEAR ENDED MAY 31, 1995 First Quarter................................................ N/A N/A Second Quarter (commencing October 20, 1994 through November 30, 1994)................................................... 4 1/4 3 3/4 Third Quarter (December 1, 1994 through February 28, 1995)... 3 3/4 3 1/8 Fourth Quarter (March 1, 1995 through May 31, 1995).......... 3 3/4 3 FISCAL YEAR ENDING MAY 31, 1996 First Quarter (June 1, 1995 through August 31, 1995)......... 4 3 Second Quarter (September 1, 1995 through November 30, 1995)....................................................... 3 7/8 3 3/4 Third Quarter (December 1, 1995 through February 29, 1996)... 4 1/8 3 5/8 Fourth Quarter (March 1, 1996 through May 14, 1996).......... 4 3 5/8
On May 14, 1996 the last sale price for the Common Stock as reported on the Nasdaq SmallCap Market was $3.625. As of May 14, 1996 there were 27 record holders of the Common Stock. The Company believes that at such date, there were more than 300 beneficial holders of the Common Stock. The IPO Warrants are also traded on the Nasdaq SmallCap Market and The Boston Stock Exchange. 19 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ENTERACTIVE The discussion and analysis below should be read in conjunction with the Financial Statements of Enteractive and the Notes to Financial Statements included elsewhere in this Prospectus. OVERVIEW Enteractive was formed in December 1993 to develop, publish and market interactive multimedia software products, and consummated the Merger with Sonic, an established multimedia software developer, in May 1994. The Merger was accounted for under the purchase method of accounting with Sonic as the acquiring entity, since the former shareholders of Sonic received approximately 80% of the then-outstanding common stock of Enteractive. Accordingly, the financial statements of the Company, as the surviving entity, include the historical results of Sonic through the date of the Merger and the results of Enteractive and Sonic thereafter. Prior to the Merger, Enteractive had no operations and had only expenses related to administrative costs associated with formation, raising equity and debt financing and certain other merger activities and Sonic was engaged in the development of multimedia software products. Prior to fiscal 1996, the Company derived the majority of its revenues from grants or contracts to develop specific titles. The most significant grant was from the National Science Foundation ("NSF") for $2.9 million over the period December 1991 through May 1994. In the fiscal year ended May 31, 1995, the Company undertook a transition from such externally-funded development projects to developing, either by itself or with a co-publisher, its own titles and, accordingly, will derive its future revenues principally from product sales and royalties. The Company first generated revenues from title sales in fiscal 1996. For the first three quarters of fiscal 1996, the Company had title sales of $25,500, $204,100 and $95,200, respectively. As is typical in the interactive multimedia software industry, the Company depends on the introduction of new titles or sequels to existing titles to replace declining revenues from older titles. In order to generate revenues in the future, the Company believes it will be necessary to develop, or obtain rights to, new titles that are developed for the appropriate platforms, are introduced in a timely manner and are able to achieve market acceptance for a significant period of time. As a result of this new strategy, the Company will incur additional costs in connection with developing and marketing its own titles. Through February 29, 1996, approximately 56% of the expenses (exclusive of the $1,915,000 non-recurring expense related to the acquisition of in-process research and development incurred in connection with the Lyriq Acquisition) consisted principally of employee salaries and related costs as well as occupancy costs. The majority of the balance was incurred in connection with the development and/or marketing of specific titles. The Company's costs vary significantly based on the number of titles being developed for and marketed by the Company. Accordingly, adjustments in the level of expenditures can be readily implemented. The Company's quarterly operating results have in the past and are likely in the future to vary significantly depending on factors such as the timing of new hardware and software title introductions, the degree of market acceptance of such titles and the introduction of titles competitive with those of the Company. In addition, the home education and entertainment software business is highly seasonal. Typically, revenues are highest during the last calendar quarter (which includes the holiday buying season), decline in the first calendar quarter and are lowest in the second and third calendar quarters. This seasonal pattern is due primarily to the increased demand for home education and entertainment software titles during the year-end holiday buying season. With respect to the school market, sales are highest during June (the end of the budget period for most schools) and from August through October (the beginning of the school year). The Company expects its future revenues and operating results will reflect these seasonal factors. On February 29, 1996, the Company completed the Lyriq Acquisition, whereby Lyriq was merged into a wholly-owned subsidiary of the Company. The Lyriq Acquisition was accounted for under the purchase method of accounting with the Company as the acquiring entity. 20 RESULTS OF OPERATIONS Nine Months Ended February 29, 1996 Compared to Nine Months Ended February 28, 1995. The Company recognized $324,800 from sales of its published titles through independent distributors, net of estimated returns and exchanges, for the nine months ended February 29, 1996. Such amounts represent sales of new titles published by the Company and the Company had no similar titles for sale in any previous period. The most significant reason for the increase in the days' costs of products sales in inventories and days' revenues outstanding in accounts receivable relates to the Lyriq Acquisition. The Company's balance sheet at February 29, 1996 includes the accounts of Lyriq and Enteractive, while the statement of operations only includes the results of Enteractive. Product development revenue in the nine months ended February 29, 1996 was $257,700 compared to $292,600 in the nine months ended February 28, 1995. As discussed previously, the Company changed its focus from being a developer to a publisher, and development work will most likely decline in the future unless the Company finds it necessary or appropriate to perform such work to generate operating funds. Royalty revenue in the nine months ended February 29, 1996 was $103,300 compared to $2,400 for the nine months ended February 28, 1995. The increase is primarily due to $100,000 of royalty revenue earned from a license from one customer in the nine months ended February 29, 1995. The Company will not receive additional royalties from this license since the underlying licensing agreement has been terminated. Cost of product sales was $77,600 in the nine months ended February 29, 1996. There were no corresponding sales in the prior year. Gross margin was 76% for the nine months ended February 29, 1996. Cost of development revenue in the nine months ended February 29, 1996 was $225,500, or 88% of product development revenue compared to $237,600 in the nine months ended February 28, 1995, or 81% of product development revenue. The increase in the percentage of cost of product development revenue was the result of higher overhead costs. Research and development expense in the nine months ended February 29, 1996 was $2,301,500 compared to $1,592,900 in the same period ended February 28, 1995. The increase of $708,600, or 44%, is primarily related to the change in strategy from performing externally-funded development work to publishing its own titles. The fiscal 1996 amounts include a greater number of internal development staff than in the same period of the prior fiscal year, and the increased use of independent developers to supplement the internal staff. Marketing and selling expenses were $1,354,700 and $117,600, for the nine months ended February 29, 1996 and February 28, 1995, respectively. The significant increase relates to the change in the Company's strategy to market and sell its own titles. General and administrative expense increased by $490,700, or 65%, to $1,246,900 for the nine months ended February 29, 1996, from $756,200 for the nine months ended February 28, 1995. This increase reflects the costs associated with additional financial management, consulting and other related costs added in the third quarter of fiscal 1995 to implement the strategy previously discussed. The Company recorded a nonrecurring expense of $1,915,100 on February 29, 1996 for the acquired in-process research and development that will be used in the development of additional titles in the future. Pursuant to SFAS No. 86 and consistent with management's definition of internally developed software and its belief that the technologies have no alternative future use, the $1,915,100 charge equaled the estimated current fair value of the future related cash flows (discontinued at a risk-adjusted rate of 30%) to be derived from specifically identified technologies for which technological feasibility had not yet been established. The Company believes that it will need to invest approximately $2,000,000 over the next three years for the development and integration of content, and incremental marketing, to derive potentially commercially viable products from the acquired in-process research and development. 21 Interest expense decreased to $58,200 from $252,000 for the nine months ended February 29, 1996 and February 28, 1995, respectively. The interest expense in fiscal 1996 includes interest and other borrowing costs incurred on the Convertible Notes. The majority of the interest expense of $252,000 incurred in the nine months ended February 28, 1995 was due to interest and other borrowing costs incurred on the Company's convertible notes payable issued in May 1994 and repaid in October 1994. Interest income decreased to $110,000 for the nine months ended February 29, 1996, from $138,400 for the same period ended February 28, 1995, due to interest earned on the lower remaining cash proceeds from the IPO. The Company does not believe it will generate taxable income during the period ending May 31, 1997. Beyond such time, using the standards set forth in Financial Accounting Standard No. 109, management cannot currently determine whether the Company will generate taxable income during the period that the Company's net operating loss carry forward may be applied towards the Company's taxable income, if any. The Company reported a net loss of $6,378,800, or a per-share loss of $1.34, for the nine months ended February 29, 1996. This compares to a net loss of $2,512,600, or a per share loss of $0.62 for the period ended February 28, 1995. The increase in net loss of $3,866,200 from 1995 to 1996 is principally a result of the shift of the Company's strategy from performing externally- funded development work to publishing its own titles and the one time charge to operations of $1,915,100 on February 29, 1996, for the acquired in-process research and development as part of the Lyriq Acquisition. Fiscal Years Ended May 31, 1995 and May 31, 1994 Product development revenue for fiscal 1995 was $365,600 compared to $2,371,500 for the year ended May 31, 1994, a decrease of $2,005,900 or 85%. Revenue for fiscal 1995 does not include any product development revenues from Philips or the NSF, which accounts for the decline in product development revenue. Cost of development revenue as a percentage of product development revenue decreased to 78% for fiscal 1995, compared to 82% for fiscal 1994. Total cost of development revenue decreased $1,661,000 for fiscal 1995, compared to fiscal 1994, as a result of the change in the Company's strategy to produce its own titles rather than to perform development work for outside companies. Research and development expense increased by $2,314,400 from $173,200 for fiscal 1994 to $2,487,600 for fiscal 1995, due to the Company's business transition to developing its own titles. This increase in internal product development coupled with reduced product development contracts, resulted in the shift of the Company's product development expenditures from cost of revenues to research and development expense. In the second half of fiscal 1995, the Company developed a marketing and sales capability for selling and marketing its own titles. Such marketing and selling costs include salaries and marketing and advertising costs. There were no such costs in fiscal 1994. General and administrative expense increased by $399,700, or 62% to $1,044,200, for fiscal 1995 from $644,500 for fiscal 1994. This increase is primarily due to the inclusion of the Company's administrative costs for a full year, salaries for additional management personnel to implement the Company's strategy and increased professional fees as a result of the IPO. Interest income increased from $15,600 for fiscal 1994 to $214,300 for fiscal 1995, an increase of $198,700, due to interest earned on the proceeds from the January 1994 Private Placement, the May 1994 Bridge Financing and the IPO. Interest expense increased by $222,300 from $30,600 for fiscal 1994 to $252,900 for fiscal 1995, primarily due to interest and other borrowing costs incurred on the Company's notes issued in the May 1994 Bridge Financing and repaid in October 1994. The Company reported a net loss of $3,997,400 in fiscal 1995 and $373,200 in fiscal 1994, or a per share loss of $0.93 and $0.11, in fiscal 1995 and 1994, respectively. 22 LIQUIDITY AND CAPITAL RESOURCES Enteractive was formed in December 1993 and raised $1,531,100 from the sale of 600,000 shares of Common Stock in the January 1994 Private Placement. In the May 1994 Bridge Financing, the Company raised $2 million from the sale of notes and the May 1994 Warrants. Such notes were repaid with the proceeds of the IPO. In October 1994, the Company sold 2,300,000 units in the IPO, each unit consisting of one share of Common Stock and an IPO Warrant to purchase one share of Common Stock. The net proceeds from the IPO were $7,579,900. In the January 1996 Bridge Financing, the Company received approximately $2,460,000 in net proceeds from the sale of the Convertible Notes and the January 1996 Warrants. The Convertible Notes will be repaid from the proceeds of this Offering, unless the Convertible Notes are converted into Conversion Shares and Conversion Warrants. Investors holding an aggregate principal amount of $450,000 of Convertible Notes have elected to have the Company repay such Convertible Notes, together with accrued interest thereon, with a portion of the proceeds of this Offering. In the quarter in which the Offering occurs, the Company will incur one-time charges for the write-off of debt acquisition costs and the discount on the Convertible Notes totalling $736,700, based on the balances at February 29, 1996. See "Prospectus Summary -- Recent Developments" and "Use of Proceeds." At May 31, 1995, the Company had cash and equivalents of $2,932,400 and investments of $1,116,100. The increase of $1,256,000 in cash and equivalents and investments from May 31, 1994 is primarily a result of the net proceeds from the IPO of $7,579,900, offset by the $2,000,000 repayment of the notes issued in May 1994 and $3,433,000 used to fund operating activities. At February 29, 1996, the Company had cash and equivalents of $1,842,000 and investments of $30,400. The decrease of $1,090,400 in cash and equivalents and $1,085,700 in investments from May 31, 1995, is primarily a result of funding the $4,307,800 cash used in operating activities partially offset by $2,460,000 in proceeds from the issuance of Convertible Notes. The Company had negative working capital of $537,900 at February 29, 1996, primarily as a result of utilizing $4,307,800 of cash to fund its operating activities for the nine months ended February 29, 1996. Investors holding an aggregate of $2,250,000 of Convertible Notes, which are included in current liabilities, have elected to convert their Convertible Notes into Conversion Shares and Conversion Warrants at the closing of this Offering. Capital expenditures for purchases of property and equipment were $223,200 for fiscal 1995 as compared to $80,000 for fiscal 1994. The Company expects capital expenditures in the fiscal year ending May 31, 1996 to be consistent with fiscal 1995 and may increase depending on product development needs and changes in technology. In December 1995, the Company entered into an agreement with certain of its officers pursuant to which the Company will repurchase 1,000,000 Contribution Shares at $1.00 per share as of the closing of this Offering. Under the purchase agreement, one third of the purchase price is required to be paid at the closing of this Offering and at each of the first two anniversaries of the closing of the Offering. Interest will accrue at the prime rate and is payable quarterly. See "Prospectus Summary--Recent Developments." The Company believes that proceeds of this Offering, together with its existing cash and equivalents, investments and anticipated revenues will be sufficient to meet its liquidity and cash requirements for at least the next 12 months. However, these funds may not be sufficient to meet the Company's longer term cash requirements for operations. Since the Company's costs vary significantly based on the number of titles being developed and marketed by the Company, adjustments in the level of expenditures can be readily implemented. Based on management's assessment of the future marketability of its titles, the Company may significantly alter the level of expenses both within the next 12 months and thereafter. If necessary, the Company may return to performing product development for third party companies in order to maintain its infrastructure while continuing with several of its own titles. INFLATION The past and expected future impact of inflation on the financial statements is not significant. 23 LYRIQ The discussion and analysis below should be read in conjunction with the Financial Statements of Lyriq and the Notes to Financial Statements included elsewhere in this Prospectus. OVERVIEW Lyriq was formed in December 1991 to develop, publish and market interactive multimedia software products. Lyriq's revenues have primarily been generated from the sale of Picture Perfect Golf, Lyriq Crosswords and Discover Endangered Wildlife. Lyriq has developed these series of titles for the home recreation and education markets. In order to increase revenues, Lyriq believes it must introduce new titles within the existing series in a timely and cost effective manner as well as introduce new titles or series. Lyriq has made substantial investments in the proprietary software engines underlying the existing Picture Perfect Golf and Crosswords titles, which should enable it to develop and release new products, based upon these engines, faster and at lower costs than developing new titles. Lyriq's products are currently distributed in the United States through major software distributors and licensed for sale in many European and Asian markets. As is typical of the multimedia publishing industry, Lyriq's expenses are based, in part, on expected future revenues. Many of Lyriq's expenses are fixed and certain overhead and product development expenses do not vary directly in relation to revenues. Consequently, if net revenues are below expectations, Lyriq's operating results are likely to be materially and adversely affected. Lyriq expects that its revenues and operating results will continue to fluctuate significantly in the future. RESULTS OF OPERATIONS Nine Months Ended February 29, 1996 Compared to Nine Months Ended February 28, 1995 Product sales, net of estimated returns and exchanges, for the nine months ended February 29, 1996 were $517,444 compared to $607,760 for the nine months ended February 28, 1995, a decrease of $90,316 or 15%. During the nine months ended February 28, 1995, the Company released Picture Perfect Golf, which resulted in significant introductory orders. A heavily promoted upgrade to the product line was not complete until February 1996, resulting in lower unit shipments for the nine months ended February 29, 1996 as compared to the same period in the prior year. Product development revenue for the nine months ended February 29, 1996 was $121,000, compared to $125,487 for the nine months ended February 28, 1995, a decrease of $4,487 or 4%. Royalty and other revenue for the nine months ended February 29, 1996 was $223,961, compared to $303,053 for the nine months ended February 28, 1995, a decrease of $79,092 or 26%. The decrease primarily relates to lower international royalties due to a delay in the completion of the Windows 95 version of Picture Perfect Golf. For the nine months ended February 29, 1996 and February 28, 1995 approximately 25% and 18% of total revenue was derived from one customer, respectively. This revenue comprises all of the product development revenue in both years ($121,000 in 1996 and $125,487 in 1995) as well as approximately $90,500 and $61,900 of the royalty and other revenue in the 1996 and 1995 periods, respectively. Although the Company expects to continue performing development work for this customer and earning royalties from sales of the related product, there can be no assurance that this will occur or if it does, at what level. Cost of product revenues for the nine months ended February 29, 1996 was $182,104 compared to $232,488 for the nine months ended February 28, 1995, a decrease of $50,384 as a result of lower unit sales in the period. The gross margin percentage was essentially unchanged. Cost of product development revenue was $131,020 for the nine months ended February 29, 1996 compared to $119,571 for the nine months ended February 28, 1995, an increase of $11,449. The increase relates to the 24 higher volume of development work during the nine months ended February 29, 1996 as compared to the same period in the prior year. Research and development expense for the nine months ended February 29, 1996 was $386,887 as compared to $234,260 for the nine months ended February 28, 1995, an increase of $152,627. The increase was a result of the Company's investments in developing new software, particularly for the Windows and Windows 95 version of Picture Perfect Golf. Marketing and selling expenses were $360,114 for the nine months ended February 29, 1996 as compared to $285,775 for the nine months ended February 28, 1995, an increase of $74,339. The increase is the result of the hiring of a marketing professional and the related salary costs, and the promotional activities to launch the Windows and Windows 95 versions of Picture Perfect Golf. General and administrative expense were $154,291 for the nine months ended February 29, 1996 as compared to $114,667 for the nine months ended February 28, 1995, an increase of $39,624. This increase is primarily due to the management and support costs of the actual and planned growth in sales and product development. Other income and expense included interest expense of $32,632 on borrowings made in the nine months ended February 29, 1996. Borrowings or any other expenses in the nine months ended February 28, 1995 were insignificant. Fiscal Years Ended June 30, 1995 and 1994 Product revenues, net of estimated returns and exchanges, for the year ended June 30, 1995 were $617,536 compared to $206,339 for the year ended June 30, 1994, an increase of $411,197 or 199%. The increase results from the release of the initial two titles in the Picture Perfect Golf series and Discovering Endangered Wildlife during the year ended June 30, 1995. At June 30, 1994, Lyriq had $20,500 of accounts receivable for which subsequent credits were issued for product returns. At June 30, 1995, Lyriq had a reserve of $68,000 for product returns and price adjustments, and also had an $85,000 reserve for specific bad debts, which was primarily related to a dispute between Lyriq and an international distributor. Product development revenue for the year ended June 30, 1995 was $162,132, or 13% of total revenue, compared to $171,262, or 40% of total revenue, for the year ended June 30, 1994. Royalty and other revenue for the year ended June 30, 1995 was $464,906 compared to $47,031 for the year ended June 30, 1994, an increase of $417,875. During 1995 Lyriq generated international royalties of approximately $240,000 related primarily to Picture Perfect Golf, which was released in the fiscal year ending June 30, 1995. The balance of the increase relates to higher royalties from sales of other products developed by Lyriq. In the years ended June 30, 1995 and June 30, 1994, approximately 21% and 49% of total revenue was derived from one customer. This revenue comprises all of the product development revenue in both years ($162,100 in 1995 and $171,262 in 1994) as well as approximately $103,400 and $38,000 of royalty and other revenues in the 1995 and 1994 periods, respectively. Although Lyriq expects to continue performing development work for this customer and earning royalties from sales of the related product, there is no assurance that this will occur or if it does at what level. Lyriq's strategy is currently focused on generating revenues from sales of titles it develops and markets and as a result it expects that these revenues as a percentage of total revenues will increase. Cost of product revenues for the year ended June 30, 1995 was $250,932 compared to $51,098 for the year ended June 30, 1994, an increase of $199,834. Cost of product sales as a percentage of product sales increased to 41% from 25%. This is primarily attributable to higher unit costs associated with the package design and related packaging of Picture Perfect Golf and Discovering Endangered Wildlife. 25 Cost of development revenue was $185,225 for the year ended June 30, 1995 compared to $65,806 for the year ended June 30, 1994, an increase of $119,419. The increase in costs relates to the higher level of work-for-hire activity during the 1995 period and a significant reduction in gross margin relating to certain unusually profitable projects in fiscal 1994. Research and development expense for the year ended June 30, 1995 was $342,444 as compared to $175,103 for the year ended June 30, 1994, an increase of $167,341. The increase was a result of Lyriq's development of Discovering Endangered Wildlife and Picture Perfect Golf. Marketing and selling expenses were $431,077 for the year ended June 30, 1995 as compared to $52,858 for the year ended June 30, 1994, an increase of $378,219. In fiscal year 1995 Lyriq had a total of three products in the market as compared to one the prior year. To support its additional titles and future releases, the Company expanded its marketing and sales capabilities. General and administrative expenses were $254,894 for the year ended June 30, 1995 as compared to $88,428 for the year ended June 30,1994, an increase of $166,466. This increase is primarily due to the management and support costs related to the actual and planned growth in sales and product development. Other income and expense was insignificant in fiscal 1995 and 1994. LIQUIDITY AND CAPITAL RESOURCES At June 30, 1995, Lyriq had deficits in working capital and stockholders' equity of $155,882 and $131,492, respectively. Subsequent to June 30, 1995, Lyriq borrowed $272,500 from Enteractive and $125,000 from the Princeton Review. The Enteractive loan was made concurrently with the signing of a letter of intent to merge Enteractive and Lyriq. Effective, February 29, 1996, Lyriq merged with and into a wholly-owned subsidiary of Enteractive. The majority of the remaining increase in short-term borrowings was provided by an independent company and is repayable in monthly installments through November 1996, bearing interest at 9% and secured by future royalties, if any, from products developed by Lyriq for the lender, as well as the assets of the principals of Lyriq. Lyriq does not have any material commitments for capital expenditures. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Enteractive." INFLATION The past and expected future impact of inflation on the financial statements is not significant. 26 BUSINESS GENERAL The Company designs, develops, publishes and markets interactive multimedia titles to the home and school markets. The Company believes that it has been a pioneer in the development and production of interactive new media titles having entertainment and educational content, based upon its introduction in 1991 of one of the industry's first titles for the CD-I format. Prior to 1995, the Company's focus was on the development of titles on a work-for-hire basis. From 1991 to 1994, the Company developed 11 CD-I titles for Philips. Toward the end of 1994, the Company shifted its focus to being a developer and publisher of titles in which the Company maintains significant ownership interests and distribution rights. Since adopting this strategy, the Company has published four titles: Cities Under the Sea: Coral Reefs, the first of up to three titles to be developed in collaboration with Jean-Michel Cousteau, a noted sea explorer and the son of Jacques Cousteau; The Alchemist, a fortune- telling game, the first in the Mystic Messenger series; Ask Isaac Asimov . . . About Space, the first title of a multimedia series based on the respected series of children's science books written by scientist and author Isaac Asimov, and PIGS, the first in a collection of animated interactive stories for children. The Company has established its own marketing and distribution capability and a presence on the Internet to market its titles. Recently, in order to expand its library of titles and broaden its product line, the Company acquired Lyriq, a developer and publisher of interactive multimedia products for the education, games and recreation markets. Lyriq has developed and published, among other things, the Picture Perfect Golf series of interactive media titles and several Crosswords puzzle titles. It is the Company's belief that the Lyriq Acquisition will provide the Company with rights to valuable multimedia titles, access to significant creative and technical talent and expanded research and development abilities. The Company also believes that the combined product lines and development and marketing expertise will facilitate greater access to sales channels and a more widely available offering of software titles for the home and educational markets. The Company has in-house multimedia development facilities with computer graphics, animation, video and audio capabilities, including professional video production equipment, lighting and fully digital audio studios. The Company's strategy is to develop high quality interactive new media titles on all popular platforms, with a current emphasis on CD-ROM, the Internet and commercial on-line services. The Company will continue to focus on strategic acquisitions in order to increase its product offerings and market penetration. It anticipates that future product development will center on building a catalog of titles with strong educational content and entertainment value. INDUSTRY BACKGROUND The market for the Company's titles and the technology on which they are based have their genesis in the evolution of home-based electronic interactive entertainment and the development of the personal computer. Traditionally, mass market entertainment has been predominantly produced for and delivered through television, motion pictures, radio and records, as well as more recently through videocassette tapes, audio compact discs and cassettes. All of these entertainment media may be thought of as "linear," in that they are designed generally to communicate content to a viewer or listener in a sequential fashion. One result of linear forms of entertainment is that the same content is delivered to each recipient in the same form. Recent improvements in computer technology have presented an opportunity to fundamentally change the user's entertainment and educational experience by introducing an interactive element to audio and visual entertainment. The enormous popularity of interactive hardware platforms developed by Atari, Nintendo and Sega in the 1980s and the introduction and rapid acceptance of CD-ROMs in the early 1990s demonstrate the appeal of interactive entertainment, which allows the participant to influence the entertainment experience. The Company believes that rapidly declining prices of microprocessors and CD-ROM drives have made multimedia personal computers more affordable and will positively impact the growth in sales of interactive multimedia titles. These computers, generally configured with enhanced memory, high speed processors, high resolution color monitors, sound boards, stereo speakers and high capacity CD-ROM drives, are able to deliver 27 an engaging entertainment experience that combines text, realistic sound, advanced graphics and animation. At average retail selling prices currently below $1,900 and expected to decrease slightly over the next several years, multimedia personal computers are gaining widespread acceptance by consumers for use in homes and businesses. A report published in June 1995 by Link Resources Corporation, a leading industry source, states that the domestic installed base of multimedia personal computers has grown from being almost nonexistent five years ago to over eight million units as of the end of 1994 and was projected to more than double to approximately 17 million units by the end of 1995. Moreover, by 1997, approximately 95% of all personal computers shipped are projected to be multimedia personal computers. The Company believes that the information in the Link Resources Corporation report remains accurate as of the date of this Prospectus. This significant growth in the installed base is expected to drive equally significant growth in multimedia software revenues. In 1994, the multimedia entertainment and education software market generated approximately $700 million in revenue and was projected to double to over $1.5 billion in 1995. By the turn of the century, such industry sources project the installed base of multimedia personal computers will exceed 60 million units with corresponding multimedia entertainment and education software revenues of approximately $5 billion. With this large and growing base of multimedia personal computers, a significant market opportunity has been created for companies that can provide entertainment to the consumer in the form of high quality interactive software titles. The market for educational software in schools and homes has also grown rapidly in recent years. According to the Software Publishers Association, the market for educational software for the home exceeded $500 million at retail in 1994. The factors driving the growth in the market include increasing numbers of young children, increasing penetration of personal computers into homes, expanding distribution channels for educational software, growth in consumer and educational publications featuring educational software, increasing interest from parents in supplementing children's education and increasing awareness of the potential of multimedia as an effective educational tool. Link Resources Corporation estimates that in 1994, 42% of households with children owned personal computers and that by 1998 the penetration of personal computers into households with children will rise to 55%. CD-ROM has been the dominant industry platform for multimedia titles. However, the various multimedia platforms are not compatible with each other (i.e., the Macintosh-based CD-ROM is not compatible with the Windows-based CD- ROM). In addition, delivery systems have evolved so that new media platforms such as the Internet and commercial on-line services are becoming increasingly more important platforms. Once there is an adequate installed base of a platform, interactive multimedia titles need to be developed so that they can be delivered through these platforms. TITLES In order to establish itself as a leading publisher of interactive multimedia titles for the home education, entertainment and recreation markets, Enteractive intends to increase the number of its internally developed titles; acquire companies that expand the scope of its product line and extend its distribution in traditional, mass market and educational channels; develop strategic partnerships; and develop titles that exploit emerging digital distribution channels, including the Internet and on-line services. The Company has released four titles since May 1995 for which it retains significant ownership rights that consist of the right to directly exhibit or license to others the product and with respect to the content, typically to control the electronic distribution. In addition, through the Lyriq Acquisition, the Company has acquired ownership rights to seven titles in the popular areas of educational games and recreation and the underlying content. The Company believes that acquiring ownership rights, as opposed to being primarily a provider of product development services for others, should enable the Company to increase its potential revenues. However, the ownership of rights to titles increases the Company's financial exposure since the Company, as opposed to a third party, is primarily responsible for development costs. In addition, with respect to the titles for which the Company licenses content or the name and likeness of a celebrity, the Company typically pays the licensor royalties, which range from 7% to 25% of revenues. The Company believes it has established a reputation for developing titles which have high quality content and design. 28 The titles released by the Company since May 1995 are as follows: Cities Under the Sea: Coral Reefs, the first of up to three titles in the Company's Jean-Michel Cousteau's World series, was developed in collaboration with Jean-Michel Cousteau, who provides content and acts as the host of the title. The agreement with Mr. Cousteau also provides that he is involved in creative decisions relating to the titles. Titles in the Jean-Michel Cousteau World series involve educational adventures relating to natural wonders of the earth and ocean. Cities Under the Sea: Coral Reefs is designed to appeal to all interest levels and transports users to a "city" of coral reefs and demonstrates how this ecosystem works. Users travel via 3-D animated virtual submarine to seven underwater laboratories. Cities Under the Sea includes all original full color photos, video and graphics, and two "Hot Topics" thinking games--farming giant clams and ecotourism--in which people of a fictional Pacific Island prepare for the 21st Century. Cities Under the Sea: Coral Reefs is available for Windows/Windows 95. The Alchemist, the first title in the Company's Mystic Messenger series, is designed to bring the ancient arts of divination into the 21st Century through a series of interactive titles embodying text and art created by Monte Farber and Amy Zerner. The Alchemist, in an interactive multimedia format, provides teens and adults with answers to personal questions relating to relationships, careers, finances and other personal issues. Original text, music and animated graphics based on original art by Amy Zerner are designed to create a memorable sensory experience. Mr. Farber and Ms. Zerner are available for creative consultations and to furnish creative services. The Alchemist is available for Windows/Windows 95 and Macintosh. Ask Isaac Asimov. . . About Space is the first title in the Company's Ask Isaac Asimov series, which is based on the 25 children's science book series written by scientist and author Isaac Asimov and licensed from Gareth Stevens. In the title, Ask Isaac Asimov. . . About Space, the user explores astronomical events and basic science concepts through a game-like interface. Children delve into Asimov's world of discovery, filled with replayable interactive simulations. Asimov's name and holographic image (which are licensed from the Estate of Isaac Asimov) on the disc distinguish this product from other science titles. Ask Isaac Asimov. . . About Space is available for Windows/Windows 95 and Macintosh. PIGS is the first title in the Company's children's musical adventure Stomped-On Fairy Tales series. In PIGS, the classic Three Little Pigs is retold by contemporary storytellers and musicians. Children interactively guide the plot in this animated storybook, creating new stories from nearly 200 variations on the classic tale. A computerized jukebox includes a ball bouncing over lyrics, helping kids sing in time to memorable, original music. PIGS is available for Windows/Windows 95. Titles currently released by Lyriq are as follows: The Picture Perfect Golf series uses both CD-ROM and virtual reality technology for a computer golf experience. Golfers play on well-known courses using real course photography. The software can be purchased bundled with a specially designed infrared golf club, scaled to the confines of indoor space, that accurately mirrors the head weight, speed and feel of a full-sized club. This product takes the results of swinging the club and instantly projects golf shots flying three-dimensionally through color photographs simulating the experience of actually playing a full eighteen-hole round of golf. Titles released under this series include Picture Perfect Golf: Coeur D'Alene and Picture Perfect Golf: Harbour Town and are available for Windows/Windows 95. The Players' Choice, Washington Post and Crosswords For Kids make up the Lyriq Crosswords series. The Players' Choice contains more than 250 puzzles from THE WASHINGTON POST, CROSSWORD MAGAZINE and PENNY PRESS. This title allows players to time and score their games, receive hints from a built-in directory, enlarge puzzles for easier viewing, and see the current clue enlarged. Washington Post provides one hundred puzzles edited by William Lutwiniak and William B. MacKaye and created by such top crossword puzzle constructors as Alfio Micci, S.E. Booker, Louis Sabin and Louis Baron. Crosswords For Kids provides state-of-the-art crossword puzzle technology and 50 age-appropriate puzzles, 30 with double clues and includes: hints to solve letters, words or even the whole puzzle; on-line help; and the ability to print a new or started puzzle. The software engine underlying these titles has been licensed by The New York Times to enable it to offer the daily crossword puzzles for down- loading from the Internet. 29 Crossword America, a site accessible through America Online, features, on a daily basis, different high quality puzzles and offers users the ability to chat with puzzle constructors and fellow puzzle enthusiasts. Through the site, users can purchase additional crosswords, for use in the proprietary software engine, directly from the Company. Discovering Endangered Wildlife is designed for children ages 9 and up and takes the user on a mission to help save endangered animals. Discovering Endangered Wildlife has been endorsed by the National Wildlife Federation and allows children to experience nature photography, wildlife sounds, film clips and narrated text as they absorb information about the habits, diets, daily routines and threats to endangered species. Future titles and titles currently being developed are as follows: The Company is currently developing titles with prominent personalities such as Terry Gilliam and Richie Sambora. The Company also intends to continue to add to its current series or families of titles as well as families of titles which were started by Lyriq. Animations of Mortality. The Company expects to release Animations of Mortality in collaboration with Terry Gilliam, the Monty Python animator, who is the director of the title and will be involved in all key creative decisions. Mr. Gilliam is the director of feature films including 12 Monkeys, Brazil, and The Fisher King. Animations of Mortality is intended to be an interactive game for general audiences in which the player uses the 1,000-plus images to create collages and animations from Mr. Gilliam's library, and solves quirky, humorous puzzles and games. The Company licenses all electronic rights to the book Animations of Mortality for use in interactive programs. Interactive Rock Guitar. The Company intends to release Interactive Rock Guitar in collaboration with Richie Sambora, lead guitarist of Bon Jovi. This title will provide guitar lessons from Mr. Sambora and explore his musical style. The disc will include a "musician's toolbox" of reference material and rhythmic accompaniment and a "portfolio" of personality information including video, photos and interviews with Mr. Sambora. Mr. Sambora has approval rights over the significant creative elements of this title and Mr. Sambora and the Company mutually select compositions for the title. Mr. Sambora cannot be involved in any other educational/instructional program for three years. Picture Perfect Golf. The Company intends to release titles for several other prominent golf courses and is also evaluating several on-line extensions of this product. Mystic Messenger. The Company intends to release The Enchanted Tarot in the CD-ROM format as the second title in its Mystic Messenger series. The Enchanted Tarot is designed to provide insight into the user's future based on Tarot readings. Jean-Michel Cousteau's World. The Company intends to release additional titles relating to natural wonders of the earth and ocean. Crosswords Plus. The Company expects to release Lyriq's Crosswords Plus, an upgrade of the Players Choice featuring new puzzles, the ability to construct puzzles and a direct interface to Lyriq's Internet site--Wordgames.com, which will provide automated daily download of a crossword Crossword America puzzle and access to other word game activities. Titles released or developed by the Company prior to May 1995 include the following: The Earth Explorer, released in February 1995, is an original, interactive multimedia encyclopedia developed by the Company for classroom use by children ages 10 through 15, as well as general home use for the entire family. The Earth Explorer was the first product in which the Company maintained a significant ownership interest. The Earth Explorer's content is specific to the environment and environmental matters and covers those matters in much more significant depth than a traditional encyclopedia. The user initially chooses 30 an available topic, and as that topic is being described textually, is able to "click" onto significant words and explore different aspects of that topic and related topics in greater depth supported by graphics, photographs, slide shows and full motion videos. Users also interact in a multimedia game which emphasizes analysis and critical thinking. The Earth Explorer provides lesson plans and teacher guides for classroom use. Enteractive owns the content and controls the rights to Earth Explorer and has licensed the content to Homework Helper, an on-line service. Enteractive is also considering other opportunities for on-line distribution. The CD-ROM distribution rights are currently licensed to Claris Corp., a wholly-owned subsidiary of Apple Computer Corp. The Company is negotiating the return of such distribution rights. The Company also developed 11 titles for the CD-1 format through an arrangement with Philips. Philips retained full ownership of these titles and distributed such titles through its distribution channels. The Company receives royalties based on product sales. The titles developed by the Company for Philips include (i) Children's Musical Theater, in which children become composers, producers, arrangers and performers of musical compositions; (ii) Private Lesson Series, in which users are provided with instruction in beginning intermediate level classical, jazz and rock guitar playing and music theory; (iii) The Rhythm Maker which allows the user to create and store originally crafted rhythms from a palette of percussion instruments; and (iv) The Gershwin Connection which is an adaptation of the Grammy Award winning musical CD featuring Dave Grusin, Chic Corea, Gary Burton, John Patatuci and other well-known jazz artists. ON-LINE ACTIVITIES The Company recognizes the potential of on-line activity in marketing and distribution. It also recognizes that the development of on-line access features may enhance the marketability of the Company's interactive multimedia titles. The Company has begun to market its titles on-line. Its Worldwide Web site, http://www.enteractive.com, is designed to attract and encourage Internet users to visit and allows interactive trials of the Company's titles. Several methods of purchase are being developed, both off-line (traditional toll-free calling and a printout of an automatically-generated order form that may be faxed or mailed) and, eventually, on-line ordering. On-line delivery of interactive multimedia titles may become a significant source of revenue in the future. The Internet and commercial on-line services could provide revenue to the Company through access to the Company's titles on a pay-for-play basis, for delivery of content updates, and could also support multiple participant and team play opportunities. Concurrent with on-line marketing of its titles, the Company intends to build-on-line access features into its future CD-ROM based titles, where appropriate, to enhance the marketability of these titles. COMPANY STRATEGY The Company's goal is to become a leading developer and publisher of a broad range of interactive multimedia titles for the home education and entertainment and school markets. The Company believes that this diversified approach to its product line will enable it to achieve a broad market penetration, and minimize risk of reduced sales in any one particular segment. The Company believes that its experience in the development of interactive multimedia software gained over the past ten years, combined with the rapid evolution and high growth rate of the multimedia software industry, creates an opportunity for the Company to enhance its brand name and expand its catalog of titles and its library of digital content in which it maintains a significant ownership interest. The Company believes that the elements required to achieve this goal are titles with significant educational and/or entertainment value based on credible intellectual property, either original or licensed, as well as high quality creative talent to successfully develop titles and the capability to distribute and market those titles both in the United States and abroad to the home and school markets. The Company believes that there will continue to be consolidation opportunities among the producers and developers of interactive multimedia products. Accordingly, in addition to the Lyriq Acquisition, the Company intends to accelerate its growth and increase its market penetration by acquiring other developers and publishers of interactive multimedia titles. The Company also intends to take advantage of opportunities in new interactive electronic 31 media by participating in publishing and marketing opportunities on commercial on-line services and on the Internet. Key elements of the Company's strategy are: . Continue to Develop High Quality Titles. The Company intends to develop additional titles through internal development and in collaboration with recognized content providers. The Company has sought to enter into agreements which provide it with either access to marketable content or a credible name to add stature to its products. The Company believes that its relationships with Jean-Michel Cousteau, Richie Sambora and Terry Gilliam will enhance the marketability of its titles. The Company intends to continue the process of entering into agreements to obtain intellectual property from entities recognized in particular areas and to collaborate with recognized artists and personalities. In addition, the Company's product development strategy may include joint ventures with strategic partners to minimize up-front development costs or to expand its distribution capabilities. . Expand Distribution. The Company sells its titles to distributors who redistribute such titles to retailers, and also sells its titles directly to retailers. The Company intends to direct significant marketing resources toward establishing greater market penetration in the mass market channel. Such efforts will include the use of in store merchandising, in-store promotion and consumer advertising. The Company will also seek to expand its sales directly to end users through the use of the Internet and other new media. In addition, the Company intends to continue to pursue international opportunities with English language or localized versions of its titles. The Company also intends to sell its educational titles directly to the school market and to allocate marketing resources toward penetrating this market. . Expand Title Line by Acquisition or External Development. The Company believes that there will be many potential product acquisition opportunities, particularly since there are many independent developers and producers of interactive multimedia who lack financing and/or access to retail shelf space. Currently, however, the Company has no commitments or agreements with respect to acquisitions of specific products, publishing arrangements or the acquisition of related businesses. The Company may also publish titles developed by other multimedia developers. The Company may also contract with independent software developers to create titles that the Company will publish. . Create Families of Titles. The Company seeks to develop families of titles to help achieve brand name recognition, enhance customer loyalty and extend product life cycle. The Company creates families of titles through the use of similar characters, themes, titles and marketing approaches throughout a product line. To date, the Company is developing or has developed several families of titles including the Mystic Messenger series and Jean-Michel Cousteau's World. . Exploit Digital Network Delivery Systems. The Company believes that the increasing ease and decreasing cost of accessing the Internet and commercial on-line services may create opportunities for on-line access to the Company's software titles in the future. The Internet and commercial on-line services could provide revenue to the Company through access to the Company's games and other titles on a pay-for-play basis, delivery of content updates, and could also support multiple player and team play opportunities. In addition, the Company believes that broadband and interactive television may emerge as a significant factor in the multimedia industry. In order to ensure that the Company will benefit from the potential future growth of these delivery systems, the Company acquires, whenever possible, all electronic rights to existing and future delivery systems such as digital video disk ("DVD") and interactive television in its licensing agreements. The Company intends to make its titles available for all delivery systems if and when justified by consumer demand. . Develop and Market Proprietary Characters. The Company seeks to develop internally-created characters who will achieve market recognition. One of the Company's objectives is to exploit the potential for its internally-generated characters to be marketed through other entertainment channels, such as home video, motion pictures and television, and to merchandise these characters through toys, apparel and other products. Certain characters created for interactive software have already crossed over to such platforms, and the Company expects this trend to continue as the market for multimedia titles expands. 32 TITLE DEVELOPMENT The Company develops titles through internal and external resources. The Company may also acquire titles through co-publishing arrangements and/or the acquisition of other software companies and content licenses. Internal Development The Company has in-house multimedia development facilities to create all original material, with computer graphics, animation, video and audio capabilities, including professional video production equipment, lighting and fully digital audio studios. The Company owns a wide range of computers, software tools, video and sound equipment, computer peripherals and test equipment, all selected to enable the efficient development and production of interactive multimedia titles and services. The Company upgrades and enhances this equipment on a regular basis. The Company believes that on-going investment in title development is required to remain competitive in the home and school interactive multimedia marketplace, and it has invested continuously in the necessary development tools, library and techniques that allow for technical innovation, increased efficiency and product quality in its finished titles. The titles that have been developed and published are designed either for immediate or eventual release on both Macintosh-and Windows-based CD-ROM platforms. The Company is currently developing its software for the CD-ROM platform, as well as the Internet and commercial on-line services. These platforms are currently the dominant platforms in the industry and the Company believes that they will remain so for the near term. If there is a shift in the industry's dominant platform away from CD-ROM, the Internet or commercial on-line services to DVD or interactive television, or if the Company perceives market demand for an alternative platform, the Company believes it will be in a position to "migrate" its existing titles to other platforms or to develop new titles for such other platform. Such migration or new development, however, is a time-consuming and costly process. As of February 29, 1996, the Company employed 40 persons dedicated to product development, testing and technical support activities. This staff includes multimedia project management personnel with extensive creative backgrounds and expertise in educational product design. The Company also employs specialists in product research, graphic arts, animation, software engineering, music and video production, CD-ROM engineering, game design, programming, local area network engineering, digitized voice technology, quality assurance and technical writing. The Company's title development process involves multi-disciplinary product teams. Each product team has responsibility for designing, planning and creating the product. Products evolve through four phases of development: (i) market analysis and product concept, (ii) product design, storyboarding and technical analysis, (iii) product creation and (iv) end-user testing and release. Where appropriate, the Company solicits input from consumers and/or experts regarding the product's desirability and effectiveness in achieving stated objectives. The Company's testing team tests each title for technical quality, adherence to user-interface standards and operability on a wide variety of hardware configurations within the same platform. The Company's products require varying periods of development time depending upon the technical complexity of the title. The development period for titles that are designed for multiple platforms for both the school and the home markets generally ranges from 10 to 14 months. The Company expects to invest substantial resources in its product development efforts, and there can be no assurance that marketable titles will result from its efforts. Using its multimedia studio, the Company has developed interactive titles incorporating graphics, animation, speech, sound and music. The Company's proprietary software development library of tools and content includes animation, sophisticated imaging and networking capability. The Company believes that the use of these tools streamlines the development process, allowing members of the development team to focus their efforts on the play and simulation aspects of the product under development. To supplement its internal research and development effort, the Company also has entered into collaborative arrangements with such entities as Microsoft to create development tools and content for animation. 33 External Development To supplement its internal development teams, the Company may continue to contract with independent software developers. The Company's strategy in hiring third-party developers is to attract the broadest base of available talent for creating new products and supplementing its production capabilities. The Company may continue to engage in consulting or development agreements with independent software developers, and manage the development process by establishing budget schedules and milestones. In addition, the Company may continue to provide its third-party developers with access to its library of tools and content as well as audio visual displays, artwork, musical work, sound recordings and other components for the developer's use in creating the product. The Company has less control over the scheduling and the quality of work of independent contractors, than it has over its own employees, and its success in its external development efforts depends in part on its continued ability to effectively manage the third-party development effort to ensure adherence to its quality standards, schedules and budgets. Compensation of outside developers includes payment of development costs and possibly royalties. Additional Sources of New Titles Publishing and Acquisitions. The Company also may extend its title offerings through relationships with outside developers from whom it may acquire the rights to finished titles or with whom it may enter into publishing agreements. The Company may enter into publishing agreements which would provide the Company with the rights to publish, market and sell a title for certain identified platforms, over a specific length of time in a specific territory, in exchange for royalties based on sales of the title. In addition, the Company may increase its product line by acquiring other developers of multimedia titles. The Company from time to time evaluates potential acquisition opportunities of related businesses. Currently, the Company has no commitments or agreements with respect to any acquisition of products, publishing agreements or acquisition of related businesses. Licenses. In the normal course of its business, the Company acquires various licenses to content created and owned by others for use in the Company's own products. The Company has sought and obtained licenses from publishers, popular authors, artists and film and television companies as part of its strategy to create titles containing high quality and recognizable content. Such licenses have been necessary to permit the Company to use various songs, characters, content and references in its products. For instance, with respect to Earth Explorer, the Company has licensed a wide variety of photographs, film and video clips from many sources. Due to the multimedia nature of the Company's titles, licenses are required for audio, video, and written materials to supplement original content provided by the Company. For each particular title being developed, the Company seeks to obtain content licenses from various authors and other rights holders as the development of the title progresses. Licenses typically run for the life of the Company's title, cover world rights, and may provide for an up-front payment to the rights holder and/or royalties based on sales of the Company's title containing the licensed material. Licensing expenses are expected to rise significantly as the Company develops more titles, and as competition increases in interactive software publishing. MARKETING AND DISTRIBUTION The Company's sales and marketing efforts are designed to broaden product distribution, increase the number of first time and repeat purchasers, promote brand-name recognition, assist retailers and properly position, package and merchandise the Company's products. The Company utilizes various marketing techniques designed to promote brand awareness and recognition and to maximize the acquisition of shelf space in retail outlets, including in-store promotions, publicity campaigns and press tours, advertising, direct mail, trade shows and selective "bundling arrangements." Interactive multimedia software is sold primarily by large computer and software specialty retailers, as well as by mass merchants and warehouse club stores. All of the Company's titles are or will be sold through some or all of the following retail channels, some of which are not currently significant distributors of interactive multimedia software products: (i) computer and software retail stores; (ii) traditional and discount department 34 and consumer electronics stores; (iii) book stores, video stores and music stores; (iv) on-line services; and (v) mail order and catalog. The Company believes that book stores, video stores and music stores may become strong sales channels in the future as the market for multimedia software broadens to a wider group of consumers. The Company may also sell certain of its titles such as the Picture Perfect Golf series in specialty retail outlets. It has already secured distribution of Cities Under the Sea in dive shops, zoos, aquariums and museum gift shops. The Company sells its titles both to distributors who then distribute such titles to retailers and directly to retailers. The Company's titles are distributed through the interactive multimedia industry's primary wholesale distributors, including Ingram Micro, ABCO, Tech Data, American Hardware and Software, Micro Central, Navarre and Baker & Taylor. These distributors typically can return the Company's product at any time for credit without an offsetting order. In order to expand sales, the Company has hired distribution and marketing personnel to enable the Company to assess the most effective means of distributing its titles and develop and manage strong relationships with distributors, thereby ensuring more exposure of its products. The Company has also hired an independent sales representation organization, Channel Sources, to take advantage of retail channels of distribution by using its contacts and experience with major retail buyers. The Company may distribute its titles from time to time through OEM (Original Equipment Manufacturers) bundling arrangements. These arrangements may be made with companies who wish to bundle a particular software title with other titles, multimedia computers, CD-ROM drives, sound cards and other peripherals. Under such arrangements, the Company would receive a royalty for the incorporation of its titles into these bundles. These arrangements would generally involve a prepaid royalty, guaranteed minimum purchase or a minimum royalty to be paid to the Company over a specified term. The Company distributes the English language version of its titles in certain western European countries and intends to increase such distribution and to distribute its titles internationally through agreements providing for the production of localized versions of its titles. The Company's marketing strategy and activities support market recognition and sales in the distribution channels described above. The Company intends to continue its corporate and product advertising in trade and general consumer media. The Company also intends to continue its corporate and product publicity efforts, resulting in articles and title reviews in trade and general consumer media. The Company or its titles have been profiled in such magazines and newspapers as People Magazine, USA Today and The Wall Street Journal. In the past year, reviews have been an important method of establishing the Company's credibility in the retail channel and among consumers. The Company intends to continue participating in in-store promotional opportunities and programs in selected retail outlets. The Company intends to continue its direct marketing through third-party catalog resellers including Tiger Direct, PC Zone and Mac Zone, as well as enhancing its own efforts to market titles directly to its customer base, in addition to direct marketing through the use of direct mail lists. Electronic direct marketing is a strategy the Company intends to pursue via promotion and publicity on the Internet and commercial on-line services. The Company also exhibits its titles at recognized industry trade shows. Through these exhibits, the Company enhances its exposure to the retail markets and gains information about the technology, needs, and desires of the marketplace. MANUFACTURING AND SHIPPING The production of the Company's software includes CD-ROM pressing, assembly of purchased product components, printing of product packaging and user manuals and shipping of finished goods, which is performed by third-party vendors in accordance with the Company's specifications and forecasts. Except as provided herein the Company believes that there are alternate sources for these services that could be implemented without delay and to date, the Company has not experienced any material difficulties or delays in the production of its titles, or any material returns due to title defects. Delivery times are typically six weeks, allowing the Company to maintain reasonable inventory levels. The Company frequently packages and sells titles in its Picture Perfect Golf series together with an infrared golf club, which is currently available from only one independent third party manufacturer. Occasionally, the Company has postponed delivery of titles in its Picture Perfect Golf series as a result of the manufacturer's 35 inability to timely deliver the infrared golf club. While the Company is seeking to establish alternative sources which can produce the infrared golf club or acquire the rights to manufacture the infrared golf club currently utilized in the Picture Perfect Golf series, there can be no assurance that such efforts will be successful. If the Company does not receive infrared golf clubs on a timely basis, it could have a material adverse effect on the Company's results of operations. The Company warrants its titles to consumers for full functionality, in accordance with industry practice. The Company accepts returns of defective titles, if any, to maintain its credibility and build goodwill with customers. Although the Company provides reserves for returns that it believes are adequate, the Company could be forced to accept substantial product returns to maintain its access to distribution channels. Any significant amount of returns will have a material adverse effect on the Company's business, operating results and financial condition. PROTECTION OF PROPRIETARY RIGHTS The Company's future success will be heavily dependent upon its software technology and the Company will rely on a combination of contractual rights, trade secrets and copyright laws to establish or protect its technology in the countries where it will conduct business. The Company currently does not possess any patent or other registered intellectual property rights with respect to its software technology other than copyrights with respect to the overall content of its completed titles. The Company believes that its titles and other properties do not infringe upon the proprietary rights of third parties. The Company seeks whenever possible to obtain warranties and indemnifications from intellectual property licensors and third-party software developers to protect the Company from claims of infringement by third parties of their property rights. There can be no assurance that such warranties and indemnifications will protect the Company from liability arising from such claims or from a resultant material adverse effect to its business. DEPENDENCE ON A SIGNIFICANT CUSTOMER The Princeton Review accounted for $265,500, or 21%, and $211,500, or 25%, of Lyriq's total revenues for the fiscal year ended June 30, 1995 and the nine months ended February 29, 1996, respectively. On a pro forma basis reflecting the Lyriq Acquisition, such customer would have accounted for 16% and 14%, respectively of the Company's total for the fiscal year ended May 31, 1995 and the nine months ended February 29, 1996. Accordingly, the loss of such customer or a significant decrease in the revenues from The Princeton Review could have a material adverse effect on the financial condition and results of operations of the Company. COMPETITION Competition in the home education and entertainment market is based on brand name recognition, breadth of product line, title content, distribution strength and price. In the school market, brand name recognition and title content are the primary factors. The consumer entertainment software and educational software industries are intensely competitive. The Company's competitors range from small companies with limited resources to large companies with greater financial, technical and marketing resources than those of the Company. The Company considers the competitors in the interactive software markets to include Broderbund Software, Inc., Knowledge Adventure, Davidson & Associates, Inc., SoftKey International, Inc., Edmark Corporation and Microsoft Corporation, among others. Because the markets for interactive software titles are still emerging and the cost barriers to entry into these markets are relatively low, the Company expects the number of competitors to increase. Companies with greater financial resources than the Company may be able to make greater investments in research and development, carry larger inventories, undertake more extensive marketing campaigns, adopt more aggressive pricing policies and make higher offers or guarantees to licensors for commercially desirable characters and motion picture and 36 television properties than the Company. In addition, the Company believes that potential new competitors, including large software companies, media companies and film studios, are increasing their focus on the interactive entertainment and educational software markets. Competition for the Company's products is influenced by the timing of competitive product releases and the similarity of such titles to those of the Company, which may result in significant price competition, reduced profit margins, loss of shelf space or a reduction in sell-through of the Company's titles at retail stores, loss of or difficulty in recruiting new key employees and/or acquiring licenses, and significant price competition, any of which would adversely affect the Company's operating results. In addition, since the Company has begun to distribute products through its own third-party distribution channels, it will be competing for the attention of and service from these third-party distributors, who usually represent one or more of the Company's competitors. The Company's competitors, who may have more, or more highly recognized, products may find it easier to receive the necessary attention and service from these third-party distributors. The Company will attempt to differentiate itself from its competitors by the relationships it has fostered with prominent personalities, its focus on titles providing high-quality content with entertainment features, and the skill and creativity of its management and creative personnel. There can be no assurance that the Company will be able to successfully compete in the home, education and entertainment software industry or the school market in the future. EMPLOYEES As of May 1, 1996, the Company had 58 employees, 10 of whom are computer software engineers, 11 of whom are computer graphics artists, 14 of whom are production related personnel, five of whom are media developers and 18 of whom perform general and administrative and marketing and sales functions. The Company has never experienced a work stoppage and its employees are not covered by a collective bargaining agreement. The Company believes that its relations with its employees are good. PROPERTIES The Company owns no real property. The Company conducts its operations through two facilities. The Company leases approximately 2,000 square feet of office space in New York City at a current rental of $32,000 per year plus utilities. This lease is for a 35-month term and will expire April 30, 1997. The Company also leases approximately 8,480 square feet of space in Washington, D.C. at a rental of $130,000 per year including utilities plus taxes. This lease is for a five-year term expiring on March 31, 1997. Lyriq has leased approximately 4,900 square feet of office space in Cheshire, Connecticut on a month-to-month basis at an annualized rate of $27,000. The Company has not determined whether it will maintain such arrangement for the foreseeable future. LEGAL PROCEEDINGS The Company is not currently a party to any material legal proceedings. 37 MANAGEMENT EXECUTIVE OFFICERS AND DIRECTORS The executive officers and directors of the Company are as follows:
NAME AGE POSITION ---- --- -------- Andrew Gyenes..... 60 Chairman of the Board and Chief Executive Officer John Ramo......... 46 President, Chief Operating Officer and Director Jolie Barbiere.... 42 Vice President Creative Development and Director Michael Alford.... 50 Vice President Development and Director Rino Bergonzi..... 50 Director Peter Gyenes...... 51 Director Harrison Weaver... 62 Director Kenneth Gruber.... 44 Vice President, Chief Financial Officer and Secretary Zenon Slawinski... 40 Vice President Design/Production Randal Hujar...... 36 Vice President Marketing and Sales Gary Skiba........ 34 Vice President
Andrew Gyenes has been Chairman of the Board and Chief Executive Officer of the Company since May 1994. He was Chief Executive Officer, President and a director of Enteractive from January 1994 through May 1994. For more than five years before joining Enteractive, Mr. Gyenes was Vice President of Gyenes & Co., a computer software consulting company, and Marketing Manager of Ann-Mar Manufacturing, Inc. ("Ann-Mar"), a family owned textile company. Mr. Gyenes continued in such position on a part-time basis through January 1995, and since January 1995, has been a consultant to Ann-Mar (approximately 5% of his time). Mr. Gyenes can continue to serve in such capacity so long as it does not prevent him from performing his duties on behalf of the Company. Most of Mr. Gyenes' career has been in the computer industry, including positions with Warner Communications (most recently as an Assistant Vice President responsible for Worldwide Information Systems), with IBM Corporation (most recently as Eastern Regional Manager for Scientific Systems at Service Bureau Corporation, a former wholly-owned IBM subsidiary), and with Western Union (most recently as Assistant Vice President of Data Processing). John P. Ramo has been the President and Chief Operating Officer and a director of the Company since May 1994. Mr. Ramo was President and Chief Executive Officer of Sonic from its founding with Ms. Barbiere and Mr. Slawinski in 1979 until Sonic was merged into the Company in 1994. Mr. Ramo is the husband of Jolie Barbiere. Jolie Barbiere has been the Vice President Creative Development and a director of the Company since May 1994. From 1979 until the merger of Sonic into the Company in May 1994, Ms. Barbiere was Vice President Creative Development of Sonic, which she co-founded with Mr. Ramo and Mr. Slawinski. Ms. Barbiere is the wife of John Ramo. Michael Alford has been the Vice President Development and a director of the Company since May 1994. From 1992 through May 1994, he was the Vice President Development and a director of Sonic. Prior to 1992, Mr. Alford was department head of Versar Incorporated, an environmental consulting firm, for more than five years. Rino Bergonzi has served as a director of the Company since January 1995. Since November 1993, Mr. Bergonzi has served as Vice President and Division Executive of Corporate Information Technology Services at AT&T, and has 25 years of experience in the information services field that includes working for such companies as Western Union, United Parcel Service Information Services and EDS Corp. Peter Gyenes has served as a director of the Company since January 1995. Mr. Peter Gyenes has served as President and Chief Executive Officer of Racal InterLan, Inc., a leading supplier of local area networking products, since May 1995. Since January 1986 he also served as a director of Axis Computer Systems, Inc. From January 1994 to April 1994 he was President of the Americas Division of Fibronic International, Inc. and from 38 August 1990 to December 1993 Vice President and General Manager of Data General Corporation's international operations and mini-computer business unit. Mr. Peter Gyenes has also held management, marketing, sales and technical positions with Encore Computer, Prime Computer, Xerox and IBM. Mr. Peter Gyenes is the brother of Andrew Gyenes, Chairman of the Board and Chief Executive Officer of the Company. Harrison Weaver has been a director of the Company since December 1993. He was a Vice President of the Company from December 1993 through May 1994. He has been a director of The Continuum Group, Inc. ("Continuum") since 1987, the Chairman of the Board and Chief Executive Officer of Continuum since December 1991 and the President of Continuum since August 1994. In September 1995 Continuum applied for protection under Chapter 11 of the United States Bankruptcy Code. Mr. Weaver is the founder and President of Weaver Associates, a diversified printing concern located in Cranford, New Jersey, which has been in business for over 25 years. He served for thirteen years as President of the New Jersey State Opera, becoming President Emeritus in 1987. Mr. Weaver has received many distinguished achievement awards, including the Governor's Award Medal for outstanding contributions to the Arts for the State of New Jersey in 1978. Kenneth Gruber has been Vice President, Chief Financial Officer and Secretary of the Company since November 7, 1994. Prior to joining the Company, Mr. Gruber was employed by Children's Television Workshop ("CTW") since 1984, and served as CTW's Vice President and Chief Financial Officer from 1993 to November 1994, as CTW's Vice-President of Finance and Administration (1989- 1993) and as Vice-President of Finance (1988-1989). Zenon Slawinski has been Vice President Design/Production of the Company since May 1994 and prior thereto held a similar position with Sonic since its founding. Prior to founding Sonic, Mr. Slawinski was an animation camera-man and graphics artist. Randal Hujar has been a Vice President of the Company since February 29, 1996 and Vice President of Marketing and Sales since April 1996. Prior to joining the Company, Mr. Hujar was President and Chief Executive Officer of Lyriq since its founding in December 1991. From February 1991 to March 1991, Mr. Hujar was the Managing Director of the Lyriq Group, a marketing consulting firm. From January 1989 to January 1990 he was director of 1-2-3 Product Line Marketing at Lotus Development Corporation. Gary Skiba has been a Vice President of the Company since February 29, 1996. Prior to joining the Company, Mr. Skiba was Chairman and Chief Technical Officer of Lyriq since its founding in December 1991. From 1989 to 1991, he was manager of Advanced Word Processing Products at IBM Corporation. The Board of Directors has a Compensation and Stock Option Committee which administers the 1994 Plan and makes recommendations concerning salaries and incentive compensation for employees of and consultants to the Company and an Audit Committee which reviews the results and scope of the audit and other services provided by the Company's independent accountants. The Compensation and Stock Option Committee is composed of Messrs. Bergonzi and Weaver and the Audit Committee is composed of Messrs. Bergonzi and Weaver. See "Description of Securities -- Stockholders Agreement." See "Description of Securities -- Stockholders Agreement" for further information regarding the composition and election of the Board of Directors. EXECUTIVE COMPENSATION The following table sets forth, for fiscal 1995 and 1994, all compensation awarded to, earned by or paid to Andrew Gyenes, the Chairman of the Board and Chief Executive Officer of the Company and John Ramo, the only executive officer of the Company and its predecessor whose salary and bonus exceeded $100,000 with respect to the fiscal years ended May 31, 1995 and May 31, 1994 and, together with Mr. Gyenes, "Named Executive Officers." 39 SUMMARY COMPENSATION TABLE -------------------------------------------------------------------------------
LONG-TERM ANNUAL COMPENSATION COMPENSATION --------------------------------------------------------------------------------- BONUS OTHER ANNUAL NUMBER OF NAME AND PRINCIPAL POSITIONS YEAR SALARY ($) COMPENSATION(1) OPTIONS --------------------------------------------------------------------------------- Andrew Gyenes............... 1995 $100,000 -- -- -- Chairman of the Board and 1994 40,705 -- -- 225,000(2) Chief Executive Officer John Ramo................... 1995 $105,000 -- -- -- President and Chief 1994 104,331 -- -- -- Operating Officer(3)
(1) Certain of the officers of the Company routinely receive other benefits from the Company, including travel reimbursement, the amounts of which are customary in the industry. The Company has concluded, after reasonable inquiry, that the aggregate amounts of such benefits during fiscal 1995 and 1994, did not exceed the lesser of $50,000 and 10% of the compensation set forth above as to any named individual. (2) Represents 125,000 options granted on January 3, 1994 under the 1994 Plan, which became exercisable January 3, 1995 and 100,000 options granted on February 1, 1994 under the 1994 Plan, which became exercisable February 1, 1995. None of such options have been exercised. (3) Prior to the Merger, Mr. Ramo served as President and Chief Executive Officer of Sonic. STOCK OPTION PLANS AND OTHER OPTIONS 1994 Incentive and Non-Qualified Stock Option Plan The Company adopted the 1994 Plan to attract and retain employees. Under the 1994 Plan, options to purchase an aggregate of 1,500,000 shares of Common Stock may be granted from time to time to key employees of the Company or of any subsidiary. To date, options to purchase an aggregate of 597,770 shares of Common Stock (of which options to purchase 319,925 shares of Common Stock are currently exercisable) have been granted under the 1994 Plan as follows: (i) 125,000 shares exercisable at $2.35 per share and 200,000 shares exercisable at $3.00 per share to Andrew Gyenes, the Company's Chairman of the Board and Chief Executive Officer; (ii) 24,510 shares exercisable at $1.71 per share and 4,000 shares exercisable at $3.25 per share to an employee of the Company; (iii) an aggregate of 104,960 shares exercisable at $3.25 per share to employees of the Company; (iv) an aggregate of 75,000 shares exercisable at $3.75 per share to employees of the Company; (v) an aggregate of 40,000 shares at $3.00 per share to employees of the Company; and (vi) an aggregate of 24,300 shares at $3.50 per share to employees of the Company. The 1994 Plan is administered by the Compensation and Stock Option Committee. The Compensation and Stock Option Committee is generally empowered to interpret the 1994 Plan, prescribe rules and regulations relating thereto, determine the terms of the option agreements, amend them with the consent of the optionee, determine the employees to whom options are to be granted, and determine the number of shares subject to each option and the exercise price thereof. Under the 1994 Plan, the per-share exercise price for incentive stock options ("ISOs") will not be less than 100% of the fair market value of a share of Common Stock on the date the option is granted (110% of fair market value on the date of grant of an ISO if the optionee owns more than 10% of the Common Stock of the Company) and for non-qualified stock options ("NQSOs") will not be less than 55% of the fair market value of the Common Stock on the date of grant. Upon exercise of an option, the optionee may pay the purchase price with previously acquired securities of the Company, provided that with respect to incentive stock options applicable holding requirements under the Internal Revenue Code of 1986 ("Code") are satisfied. 40 Options will be exercisable for a term determined by the Compensation and Stock Option Committee, which will not be greater than ten years from the date of grant. Options may be exercised only while the original grantee has a relationship with the Company which confers eligibility to be granted options or within three months after termination of such relationship with the Company, or up to one year after death or total permanent disability. In the event of the termination of such relationship between the original grantee and the Company for cause (as defined in the 1994 Plan), all options granted to that original optionee terminate immediately. In the event of certain basic changes in the Company, including a merger or consolidation of the Company, the Compensation and Stock Option Committee shall make an appropriate and equitable adjustment in the number and kind of shares reserved for issuance under the 1994 Plan. ISOs are not transferable other than by will or the laws of descent and distribution. NQSOs may be transferred to the optionee's spouse or lineal descendants, subject to certain restrictions. Options may be exercised during the holder's lifetime only by the holder, his or her guardian or legal representative. Options granted pursuant to the 1994 Plan may be designated as ISOs, with the attendant tax benefits provided under Section 421 and 422 of the Code. Accordingly, the 1994 Plan provides that the aggregate fair market value (determined at the time an ISO is granted) of the Common Stock subject to ISOs exercisable for the first time by an employee during any calendar year (under all plans of the Company and its subsidiaries) may not exceed $100,000. The Compensation and Stock Option Committee may modify, suspend or terminate the 1994 Plan; provided, however, that certain material modifications affecting the 1994 Plan must be approved by the stockholders, and any change in the 1994 Plan that may adversely affect an optionee's rights under an option previously granted under the 1994 Plan requires the consent of the optionee. No stock options were granted to the Named Executive Officers during fiscal 1995. Fiscal Year End Option Values No options were exercised by the Named Executive Officers during fiscal 1995. The following table shows the number of shares covered by both exercisable and unexercisable employee stock options, as of May 31, 1995, and the values for "in-the-money" options, which represent the positive spread between the exercise price of any outstanding stock option and the price of the Common Stock as of May 31, 1995, which was $3.125. FISCAL YEAR END OPTION VALUES -------------------------------------------------------------------------------
NUMBER OF SECURITIES UNDERLYING VALUE OF UNEXERCISED IN-THE-MONEY UNEXERCISED OPTIONS AT FY-END (#) OPTIONS AT FY-END ($) NAME EXERCISABLE/UNEXERCISABLE EXERCISABLE/UNEXERCISABLE ---------------------------------------------------------------------------------------------- Andrew Gyenes........... 225,000/0 $109,375/0
Directors' Compensation and 1995 Directors' Stock Option Plan Directors serve until the next annual meeting of stockholders and until their successors are duly elected and shall have qualified. Except as otherwise set forth herein, executive officers serve at the discretion of the Board of Directors. Harrison Weaver, a director of the Company, has been granted options to purchase 20,000 shares of Common Stock at an exercise price of $2.35 per share, which are currently exercisable and expire in January 2004. See "1994 Consultant Stock Option Plan and Other Options." The Board of Directors has a Compensation and Stock Option Committee and there are no Board of Directors interlocks. For information concerning transactions with Harrison Weaver, who is a member of the Compensation and Stock Option Committee. See "Certain Transactions." In January 1995, the Board of Directors adopted, and in October 1995 the Company's Shareholders approved, the Directors Plan, which has subsequently been amended to provide for the issuance of options to 41 purchase up to 150,000 shares of Common Stock to non-employee directors ("Outside Directors") of the Company as follows: (a) Each Outside Director who was serving in such capacity on January 1, 1995 was granted on January 1, 1995 non-qualified stock options to purchase 5,000 shares of Common Stock at its fair market value on the date of grant. (b) Each person who is an Outside Director on January 1 of each calendar year subsequent to 1995 shall be granted on each such January 1 nonqualified stock options to purchase 5,000 shares of Common Stock. All options are exercisable on the date of grant. As of the date of this Prospectus, options to purchase an aggregate of 30,000 shares of Common Stock have been granted under the Directors Plan at exercise prices of $3.00 and $3.75 per share to Messrs. Bergonzi, Peter Gyenes and Weaver (being all of the Outside Directors). 1994 Consultant Stock Option Plan and Other Options In January 1994, in connection with services which had been or will be provided to the Company, various persons were granted non-qualified stock options to purchase an aggregate of 252,000 shares of Common Stock at an exercise price of $2.35 per share. Included in such grants were options to purchase 52,000 shares to various officers and/or employees of Continuum, including options to purchase 20,000 shares granted to Harrison Weaver, a director of the Company. The balance of such options were granted in connection with consulting or other services performed on behalf of the Company. All of such options are currently exercisable and expire in January 2004. In February 1994, an employee of Continuum was granted non-qualified stock options to purchase 30,000 shares of Common Stock at an exercise price of $3.00 per share. All of such options are exercisable commencing in February 1995 and expire in February 2004. The Company has been advised by Continuum that such options were acquired by Continuum. See "Certain Transactions." In August 1994, the Company adopted the Consultant Plan, which has subsequently been amended to provide for the issuance of options to purchase up to 1,000,000 shares of Common Stock to persons who perform consulting services for the Company. As of the date of this Prospectus, options to purchase 250,000 shares of Common Stock have been granted under the Consultant Plan, including options to purchase 125,000 shares of Common Stock granted to Barry Rubenstein. See "Certain Transactions." EMPLOYMENT CONTRACTS WITH NAMED EXECUTIVE OFFICERS The Company has entered into employment agreements with Mr. Gyenes and Mr. Ramo, each of which will expire on October 20, 1997. Mr. Gyenes has agreed to devote such of his working time and attention to the business of the Company as the Board of Directors deems necessary for him to effectively perform his duties under his agreement. Mr. Gyenes currently serves as a consultant to Ann-Mar Manufacturing Inc., a family-owned textile company, and is permitted by the terms of his agreement to continue to serve in such capacity so long as such activities will not prevent him from performing his duties on behalf of the Company. Mr. Ramo has agreed to devote his full time to the business of the Company during the term of his agreement. Mr. Gyenes and Mr. Ramo have also agreed not to compete with the business of the Company for a period of one year and eighteen months, respectively, following termination of their respective employment agreements. Pursuant to his employment agreement, Mr. Gyenes receives a salary of $100,000 per year. In addition, Mr. Gyenes received options to purchase 125,000 shares of Common Stock at an exercise price of $2.35 per share. Pursuant to his employment agreement, Mr. Ramo receives a salary of $105,000 per year. In addition, if Mr. Ramo's employment is terminated for any reason other than "cause," he is entitled to receive a severance payment equal to a minimum of six months salary. Additional severance payments, if any, will be determined by the Board of Directors. 42 PRINCIPAL SECURITYHOLDERS The information in the "After Offering" column has been adjusted to reflect (i) the sale of the Common Stock offered hereby, (ii) the conversion of the Convertible Notes into Conversion Shares and Conversion Warrants, (iii) the exchange of January 1996 Warrants into IPO Warrants, and (iv) the repurchase of the Contribution Shares, and sets forth information regarding beneficial ownership of the Common Stock as of May 1, 1996, by (a) each stockholder known by the Company to be the beneficial owner of five percent or more of the outstanding Common Stock, (b) each director and Named Executive Officer of the Company individually, and (c) all directors and executive officers as a group. Except as otherwise indicated in the footnotes below, (x) the Company believes that each of the beneficial owners of the Common Stock listed in the table, based on information furnished by such owner, has sole investment and voting power with respect to such shares, and (y) the address of the beneficial owner is the address of the principal executive offices of the Company.
BEFORE OFFERING AFTER OFFERING -------------------------- -------------------------- NUMBER OF NUMBER OF SHARES SHARES BENEFICIALLY BENEFICIALLY NAME OWNED(1) PERCENTAGE OWNED(1) PERCENTAGE ---- ------------ ---------- ------------ ---------- John Ramo............... 1,558,986(2) 28.3% 896,577(2) 12.2% Jolie Barbiere.......... 1,558,986(3) 28.3% 896,577(3) 12.2% Zenon Slawinski......... 510,621 9.3% 293,660(4) 4.0% Barry Rubenstein........ 352,500(5) 6.2% 2,550,279(6) 27.9% 68 Wheatley Road Brookville, New York 11545 Seneca Ventures......... 352,500(5) 6.2% 1,065,711(7) 13.2% c/o Barry Rubenstein 68 Wheatley Road Brookville, New York 11545 Woodland Venture Fund... 352,500(5) 6.2% 1,065,711(7) 13.2% c/o Barry Rubenstein 68 Wheatley Road Brookville, New York 11545 Woodland Services 352,500(5) 6.2% 1,065,711(7) 13.2% Corp................... c/o Barry Rubenstein 68 Wheatley Road Brookville, New York 11545 21st Century -- -- 1,484,568(8) 17.6% Communications Foreign Partners, L.P.......... c/o Fiduciary Trust (Cayman) Limited P.O. Box 1062 Grand Cayman, B.W.I. 21st Century -- -- 1,484,568(8) 17.6% Communications Partners, L.P.......... 767 Fifth Avenue--45th Floor New York, New York 10053 21st Century -- -- 1,484,568(8) 17.6% Communications T-E Partners, L.P.......... 767 Fifth Avenue--45th Floor New York, New York 10053 Randal Hujar............ 303,651 5.5% 303,651 4.1% Gary Skiba.............. 310,867 5.7% 310,867 4.2% Michael Alford.......... 283,905 5.2% 163,275(4) 2.2% Andrew Gyenes........... 258,333(9) 4.5% 258,333(9) 3.4% Harrison Weaver......... 30,000(10) * 30,000(10) * Rino Bergonzi........... 20,000(11) * 20,000(11) * Peter Gyenes............ 16,000(12) * 16,000(12) * All directors and executive officers as a group (10 persons)..... 3,325,696(13) 56.9% 2,325,696(14) 30.3%
43 -------- * less than 1% (1) Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission ("Commission") and generally includes voting or investment power with respect to securities. Shares of Common Stock issuable upon the exercise of options, warrants and convertible notes currently exercisable or convertible, or exercisable or convertible within 60 days, are deemed outstanding for computing the percentage ownership of the person holding such options or warrants or convertible notes but are not deemed outstanding for computing the percentage ownership of any other person. (2) Includes 741,993 shares of Common Stock owned by John Ramo and 816,993 shares of Common Stock owned by his wife, Jolie Barbiere. Upon consummation of this Offering, the Company will repurchase 315,271 and 347,138 Contribution Shares from Mr. Ramo and Ms. Barbiere, respectively. Mr. Ramo disclaims beneficial ownership of all shares held by Ms. Barbiere. (3) Includes 816,993 shares of Common Stock owned by Jolie Barbiere and 741,993 shares of Common Stock owned by John Ramo, husband of Jolie Barbiere. Upon consummation of this Offering, the Company will repurchase 315,271 and 347,138 Contribution Shares from Mr. Ramo and Ms. Barbiere, respectively. Ms. Barbiere disclaims beneficial ownership of all shares held by Mr. Ramo. (4) The Company is repurchasing 216,961 and 120,630 Contribution Shares from Messrs. Slawinski and Alford, respectively. (5) Based upon a Joint Schedule 13D filed on September 21, 1995 by Seneca Ventures ("Seneca"), Woodland Venture Fund ("Woodland Fund"), Woodland Services Corp. ("Woodland Corp.") and Barry Rubenstein with the Commission on September 21, 1995, such entities collectively beneficially hold 352,500 shares of Common Stock, of which Seneca and Woodland Fund have sole voting and dispositive power over 50,000 shares and 70,000 shares of Common Stock, respectively. Woodland Corp. and Barry Rubenstein are the general partners of Seneca and the Woodland Fund. Barry Rubenstein is also the President and sole director of Woodland Corp. and based upon the Schedule 13D, has sole power to vote and dispose of 47,500 shares of Common Stock, 10,000 shares of Common Stock issuable upon the exercise of IPO Warrants, which are presently exercisable, and 175,000 shares of Common Stock issuable upon the exercise of presently exercisable options. (6) The stock ownership for Barry Rubenstein includes Common Stock beneficially owned by Seneca, Woodland Fund, Woodland Corp., Applewood (as defined herein), the Foundation (as defined herein), Dalewood (as defined herein), 21st Foreign (as defined herein), 21st Partners (as defined herein) and 21st T-E (as defined herein). (7) In the January 1996 Bridge Financing, Applewood Associates, L.P. ("Applewood"), Seneca and the Woodland Fund purchased Convertible Notes which, upon the consummation of this Offering, will be converted into (a) 82,305; 32,922 and 65,844 Conversion Shares, respectively, and (b) 164,608; 65,844 and 131,688 Conversion Warrants, respectively. In addition, in the January 1996 Bridge Financing, Applewood, The Marilyn and Barry Rubenstein Family Foundation ("Foundation"), Seneca, the Woodland Fund and Dalewood Associates LP ("Dalewood") purchased 50,000; 20,000; 20,000; 40,000; and 40,000 January 1996 Warrants, respectively, all of which will be exchanged into a like number of IPO Warrants. Such IPO Warrants and the Conversion Warrants will be presently exercisable upon the consummation of this Offering and along with the Conversion Shares are being offered for resale for their own accounts pursuant to the Registration Statement of which this prospectus forms a part; however, the holders of such securities, the Common Stock underlying such securities and the Conversion Shares may not sell any of such securities until one year from the date of this Prospectus without the prior consent of the Underwriter. Barry Rubenstein is a trustee of the Foundation, a general partner of Applewood and is a 50% stockholder and an executive officer of the general partner of Dalewood. The information included herein does not include Common Stock beneficially held by 21st Foreign (as defined herein), 21st Partners (as defined herein) and 21st T-E (as defined herein). If the beneficial ownership of such entities is combined with the beneficial ownership of Seneca, Woodland Fund, Woodland Corp., the Foundation and Dalewood, then all of such entities would upon consummation of this Offering, collectively beneficially hold 2,550,279 shares of Common Stock (or 27.9%), including Common Stock underlying presently exercisable options and warrants. 44 (8) In the January 1996 Bridge Financing, 21st Century Communications Foreign Partners, L.P. ("21st Foreign"), 21st Century Communications Partners, L.P. ("21st Partners") and 21st Century Communications T-E Partners, L.P. ("21st T-E") purchased Convertible Notes which, upon the consummation of this Offering, will be converted into (a) 32,922; 279,835; and 98,765 Conversion Shares, respectively, and (b) 65,844; 559,671 and 197,531 Conversion Warrants, respectively. In addition, in the January 1996 Bridge Financing, 21st Foreign, 21st Partners and 21st T-E purchased 20,000; 170,000 and 60,000 January 1996 Warrants, respectively, all of which will be exchanged into a like number of IPO Warrants. Such IPO Warrants and the Conversion Warrants will be presently exercisable upon the consummation of this Offering and along with the Conversion Shares are being offered for resale for their own accounts pursuant to the Registration Statement of which this prospectus forms a part; however, the holders of such securities, the Common Stock underlying such securities and the Conversion Shares may not sell any of such securities until one year from the date of this Prospectus without the prior consent of the Underwriter. The general partners of each of 21st Foreign, 21st Partners and 21st T-E are Sandler Investment Partners, Ltd. and InfoMedia Associates Ltd. Barry Rubenstein is a principal shareholder and officer of InfoMedia Associates, Ltd. The information included herein does not include Common Stock beneficially held by Seneca, Woodland Fund, Woodland Corp., Barry Rubenstein, the Foundation and Dalewood. If the beneficial ownership of such entities is combined with 21st Foreign, 21st Partners and 21st T-E, then all of such entities would upon the consummation of this Offering, collectively beneficially hold 2,550,279 shares of Common Stock (or 27.9%), including Common Stock underlying presently exercisable options and warrants. (9) Consists of 258,333 shares of Common Stock issuable upon exercise of presently exercisable options. Excludes 66,667 shares of Common Stock issuable upon the exercise of presently non-exercisable options which become exercisable in 50% increments commencing June 12, 1997. (10) Consists of 20,000 shares of Common Stock issuable upon exercise of presently exercisable options and 10,000 shares of Common Stock issuable upon exercise of presently exercisable options granted pursuant to the Directors Plan. Excludes 50,000 presently exercisable options held by Continuum, which options Mr. Weaver disclaims beneficial ownership. (11) Consists of 5,000 shares of Common Stock owned by Mr. Bergonzi, 5,000 shares of Common Stock issuable upon exercise of presently exercisable warrants and 10,000 shares of Common Stock issuable upon exercise of presently exercisable options granted pursuant to the Directors Plan. (12) Consists of 3,000 shares of Common Stock owned by Mr. Peter Gyenes, 3,000 shares of Common Stock issuable upon exercise of presently exercisable warrants and 10,000 shares of Common Stock issuable upon exercise of presently exercisable options granted pursuant to the Directors Plan. (13) Also, includes presently exercisable options to purchase 25,000 shares of Common Stock held by certain executive officers of the Company who are not Named Executive Officers. (14) Also, includes presently exercisable options to purchase 25,000 shares of Common Stock held by certain executive officers who are not Named Executive Officers and reflects the repurchase of an aggregate of 1,000,000 Contribution Shares from directors and executive officers. 45 CERTAIN TRANSACTIONS The Company was formed in December 1993 as a wholly-owned subsidiary of Continuum. In January 1994, the Company issued 600,000 shares of Common Stock to Continuum for an aggregate consideration of $1,531,000, including $781,000 contributed in the January 1994 Private Placement. In January 1994, the Company and Continuum consummated the January 1994 Private Placement of 200,000 units, each unit consisting of one share of common stock of Continuum and a January 1994 Warrant to purchase 1.7 shares of Common Stock of the Company (or an aggregate of 340,000 shares of Common Stock), at an exercise price of $2.35 per share. The January 1994 Warrants are currently exercisable and expire on January 24, 1999. The shares of Common Stock underlying the January 1994 Warrants were registered in connection with the IPO. Continuum contributed the net proceeds of the January 1994 Private Placement and additional funds totalling $1,531,100 to the Company in exchange for 600,000 shares of Common Stock of the Company. At the time the Company consummated the merger with Sonic, Continuum, the Company and the original shareholders of Sonic entered into a shareholder agreement pursuant to which Continuum was entitled to designate three seats on the Company's Board of Directors and had certain rights of first refusal. On August 31, 1994, the Company repurchased the 600,000 shares of Common Stock held by Continuum for $1,000,000. Harrison Weaver, a director of the Company, is the Chairman of the Board, President and Chief Executive Officer of Continuum. In November 1994, the Company issued to Barry Rubenstein, who the Company has been informed beneficially owns more than 5% of the outstanding Common Stock, options to purchase 125,000 shares of Common Stock pursuant to the Consultant Plan, which are currently exercisable at a price for $3.75 per share and expire on November 10, 2004. In January 1994, in connection with services which were provided to the Company, various persons were granted nonqualified stock options to purchase an aggregate of 252,000 shares of Common Stock at an exercise price of $2.35 per share. Included in such grants were options to purchase 52,000 shares granted to various officers and/or employees of Continuum, including options to purchase 20,000 shares granted to Harrison Weaver, a director of the Company. The balance of such options were granted in connection with consulting or other services performed on behalf of the Company, including options to purchase 100,000 shares of Common Stock granted to Rev-Wood Merchant Partners ("Rev-Wood"), a general partnership of which Mr. Rubenstein is a general partner. The Company has been informed that of the 100,000 options granted to Rev-Wood, options to purchase 50,000 shares of Common Stock were transferred to Mr. Rubenstein in June 1995. All of such options became exercisable commencing in January 1995 and expire in January 2004. In February 1994, Simon T. Brack, Continuum's former president, was granted nonqualified stock options for services performed on behalf of the Company, to purchase 30,000 shares of Common Stock at an exercise price of $3.00 per share. All of such options are exercisable commencing in February 1995 and expire in February 2004. The Company has been advised by Continuum that such options to purchase 30,000 shares as well as options to purchase 20,000 shares at an exercise price of $2.35 per share, described above, were acquired by Continuum. In the May 1994 Bridge Financing, the Company issued the May 1994 Warrants to purchase an aggregate of 800,000 shares of Common Stock at an exercise price of $2.35 per share. The May 1994 Warrants became exercisable on October 20, 1995. One of the investors in this financing transaction was Rev-Wood. Pursuant to the terms of the financing, Rev-Wood loaned $650,000 to the Company and Rev-Wood was issued May 1994 Warrants to purchase 260,000 shares of Common Stock. Upon consummation of the IPO, the May 1994 Warrants were exchanged for IPO Warrants entitling the holder to purchase a like number of shares of Common Stock for $4.00 a share commencing October 20, 1995. Rev-Wood has advised the Company that it sold the IPO Warrants in July 1995. The Company repaid the $650,000 loan with a portion of the net proceeds from the IPO. In August 1994, Rev-Wood purchased 75,000 shares of Common Stock from John Ramo, a director and President of the Company, for $124,500. The Company has been informed that, in December 1994, Rev-Wood transferred to Mr. Rubenstein 37,500 shares of Common Stock. 46 In the January 1996 Bridge Financing, Seneca and the Woodland Fund, entities that the Company has been informed beneficially own more than 5% of the outstanding Common Stock, and a general partner of which is Barry Rubenstein, who the Company has also been informed beneficially owns more than 5% of the outstanding Common Stock, purchased $100,000 and $200,000 principal amount of the Convertible Notes, respectively and 20,000 and 40,000 January 1996 Warrants, respectively. In addition, in the January 1996 Bridge Financing, the Foundation and Applewood purchased $100,000 and $250,000 principal amount of the Convertible Notes, respectively, and 20,000 and 50,000 January 1996 Warrants, respectively. Barry Rubenstein is a trustee of the Foundation and a general partner of Applewood. See "Principal Securityholders." In December 1995, the Company entered into an agreement with John Ramo, Zenon Slawinski, Michael Alford and Jolie Barbiere, each of whom is a director and/or executive officer of the Company, pursuant to which the Company will repurchase, simultaneously with the closing of this Offering, an aggregate of 1,000,000 Contribution Shares. Under the purchase agreement one third of the purchase price is required to be paid at the closing of this Offering and at each of the first two anniversaries of the closing. Interest will accrue interest at the prime rate and is payable quarterly. All of the above transactions resulted from arms-length negotiations and were approved by the independent members of the Company's Board of Directors who did not have an interest in the transaction. The Company believes that the terms of such transaction were on terms that were no less favorable than were available from unaffiliated third parties. Future and ongoing transactions with affiliates of the Company, if any, will be on terms believed by the Company to be no less favorable than are available from unaffiliated third parties and will be approved by a majority of the independent members of the Company's Board of Directors who do not have an interest in the transaction. 47 DESCRIPTION OF SECURITIES The authorized capital stock of the Company is 32,000,000 shares, consisting of 30,000,000 shares of Common Stock, $.01 par value per share and 2,000,000 shares of preferred stock, $.01 par value per share ("Preferred Stock"). As of May 1, 1996, there were 5,500,701 shares of Common Stock outstanding. After the completion of this Offering and after giving effect to repurchase of the Company of 1,000,000 Contribution Shares and the conversion of the Convertible Notes into 740,734 Conversion Shares, there will be 7,341,435 shares of Common Stock outstanding. No shares of Preferred Stock are currently outstanding. COMMON STOCK The holders of shares of Common Stock are entitled to one vote for each share held of record on all matters to be voted on by stockholders. There is no cumulative voting with respect to the election of directors, with the result that the holders of more than 50% of the shares voted can elect all of the directors then being elected. A Stockholders Agreement dated as of August 31, 1994, among Andrew Gyenes, the Company, John Ramo, Jolie Barbiere, Zenon Slawinski, and Michael Alford ("Stockholders Agreement") governs how the current stockholders will vote for directors. The holders of Common Stock are entitled to receive dividends when, as and if declared by the Board of Directors out of funds legally available therefor. In the event of liquidation, dissolution or winding up of the Company, the holders of Common Stock are entitled to share ratably in all assets remaining available for distribution to them after payment of liabilities and after provision has been made for each class of stock, if any, having preference over the Common Stock. Holders of shares of Common Stock, as such, have no redemption, preemptive or other subscription rights, and there are no conversion provisions applicable to the Common Stock. All of the outstanding shares of Common Stock are, and the shares of Common Stock offered hereby, when issued and paid for as set forth in this Prospectus, will be, fully paid and nonassessable. See "-- Stockholders Agreement." PREFERRED STOCK The Company's authorized shares of Preferred Stock may be issued in one or more series, and the Board of Directors is authorized, without further action by the stockholders, to designate the rights, preferences, limitations and restrictions of and upon shares of each series, including dividend, voting, redemption and conversion rights. The Board of Directors also may designate par value, preferences in liquidation and the number of shares constituting any series. The Company believes that the availability of Preferred Stock issuable in series will provide increased flexibility for structuring possible future financings and acquisitions, if any, and in meeting other corporate needs. It is not possible to state the actual effect of the authorization and issuance of any series of Preferred Stock upon the rights of holders of Common Stock until the Board of Directors determines the specific terms, rights and preferences of a series of Preferred Stock. However, such effects might include, among other things, restricting dividends on the Common Stock, diluting the voting power of the Common Stock, or impairing liquidation rights of such shares without further action by holders of the Common Stock. In addition, under various circumstances, the issuance of Preferred Stock may have the effect of facilitating, as well as impeding or discouraging, a merger, tender offer, proxy contest, the assumption of control by a holder of a large block of the Company's securities or the removal of incumbent management. Issuance of Preferred Stock could also adversely effect the market price of the Common Stock. The Company has no present plan to issue any shares of Preferred Stock. IPO WARRANTS AND CONVERSION WARRANTS In connection with the IPO and pursuant to a Warrant Agreement between the Company and Continental Stock Transfer & Trust Company as warrant agent, the Company issued 3,100,000 IPO Warrants, including 800,000 IPO Warrants which were issued in exchange for 800,000 May 1994 Warrants. In January 1996, in connection with the January 1996 Bridge Financing, the Company issued 540,000 January 1996 Warrants which have an exercise price of $4.00 per warrant and are exercisable between July 13, 48 1996 and July 13, 1997. Upon consummation of this Offering, the Company will issue an additional 2,021,468 IPO Warrants which consist of (a) 540,000 January Warrants which will be exchanged for a like number of IPO Warrants and (b) 1,481,468 Conversion Warrants. The terms of such IPO Warrants and the Conversion Warrants are provided below; however, without the Underwriter's consent, such IPO Warrants and Conversion Warrants may not be sold by the holders thereof until twelve months after the date of this Prospectus. Until October 20, 1997, each IPO Warrant will entitle the registered holder to purchase one share of Common Stock at an exercise price of $4.00 per share. The IPO Warrants are not redeemable by the Company. No fractional shares of Common Stock will be issued in connection with the exercise of IPO Warrants. Upon exercise, the Company will pay the holder the value of any such fractional shares in cash, based upon the market value of the Common Stock at such time. Unless extended by the Company at its discretion, the IPO Warrants will expire at 5:00 p.m., New York time, on October 20, 1997. In the event a holder of IPO Warrants fails to exercise the IPO Warrants prior to their expiration, the IPO Warrants will expire and the holder thereof will have no further rights with respect to the IPO Warrants. A holder of IPO Warrants does not have any rights, privileges or liabilities as a stockholder of the Company prior to exercise of the IPO Warrants. The Company is required to keep available a sufficient number of authorized shares of Common Stock to permit exercise of the IPO Warrants. The exercise price of the IPO Warrants and the number of shares issuable upon exercise of the IPO Warrants is subject to adjustment to protect against dilution in the event of stock dividends, stock splits, combinations, subdivisions and reclassifications. No assurance can be given that the market price of the Common Stock will exceed the exercise price of the IPO Warrants at any time during the exercise period. OTHER WARRANTS In January 1994, in connection with the January 1994 Private Placement, the Company issued the January 1994 Warrants to purchase an aggregate of 340,000 shares of Common Stock, at an exercise price of $2.35 per share. The January 1994 Warrants are currently exercisable and expire on January 24, 1999. INDEMNIFICATION OF OFFICERS AND DIRECTORS As permitted by the Delaware General Corporation Law ("DGCL"), the Company's Certificate of Incorporation, as amended, limits the personal liability of a director or officer to the Company for monetary damages for breach of fiduciary duty of care as a director. Liability is not eliminated for (i) any breach of the director's duty of loyalty to the Company or its stockholders, (ii) acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, (iii) unlawful payment of dividends or stock purchases or redemptions pursuant to Section 174 of the DGCL, or (iv) any transaction from which the director derived an improper personal benefit. The Company has also entered into indemnification agreements with each of its directors and executive officers. The indemnification agreements provide that the directors and executive officers will be indemnified to the fullest extent permitted by applicable law against all expenses (including attorneys' fees), judgments, fines and amounts reasonably paid or incurred by them for settlement in any threatened, pending or completed action, suit or proceeding, including any derivative action, on account of their services as a director or officer of the Company or of any subsidiary of the Company or of any other company or enterprise in which they are serving at the request of the Company. No indemnification will be provided under the indemnification agreements, however, to any director or executive officer in certain limited circumstances, including on account of knowingly fraudulent, deliberately dishonest or willful misconduct. To the extent the provisions of the indemnification agreements exceed the indemnification permitted by applicable law, such provisions may be unenforceable or may be limited to the extent they are found by a court of competent jurisdiction to be contrary to public policy. 49 DELAWARE LAW The Company is subject to Section 203 of the DGCL, which prevents an "interested stockholder" (defined in Section 203, generally, as a person owning 15% or more of a corporation's outstanding voting stock) from engaging in a "business combination" with a publicly-held Delaware corporation for three years following the date such person became an interested stockholder, unless: (i) before such person became an interested stockholder, the board of directors of the corporation approved the transaction in which the interested stockholder became an interested stockholder or approved the business combination; (ii) upon consummation of the transaction that resulted in the interested stockholder's becoming an interested stockholder, the interested stockholder owns at least 85% of the voting stock of the corporation outstanding at the time the transaction commenced (subject to certain exceptions); or (iii) following the transaction in which such person became an interested stockholder, the business combination is approved by the board of directors of the corporation and authorized at a meeting of stockholders by the affirmative vote of the holders of 66% of the outstanding voting stock of the corporation not owned by the interested stockholder. A "business combination" includes mergers, stock or asset sales and other transactions resulting in a financial benefit to the interested stockholder. The provisions of Section 203 of the DGCL could have the effect of delaying, deferring or preventing a change in control of the Company. STOCKHOLDERS AGREEMENT The Stockholders Agreement terminates in August 1997 with respect to the provisions to elect directors and/or by written agreement of Jolie Barbiere and John Ramo (and Mr. Gyenes with respect to the election of directors). The Stockholders Agreement provides for a seven-member Board of Directors consisting of three nominees designated by Mr. Gyenes and three nominees designated by Mr. Ramo (provided that such nominees are reasonably acceptable to each of Mr. Gyenes and Mr. Ramo), and one person mutually agreed upon by Mr. Ramo and Mr. Gyenes. John Ramo, Jolie Barbiere, Zenon Slawinski and Michael Alford have agreed to vote all of their shares in favor of the election of such seven persons. Upon consummation of this Offering, the stockholders who are parties to the Stockholders Agreement will hold approximately 18.4% of the outstanding shares of Common Stock and, accordingly, the Stockholders Agreement could significantly influence the election of directors. In addition, the Stockholders Agreement provides a right of refusal with respect to the sale of Company securities (as defined in the Stockholders Agreement) by any of Mr. Ramo, Ms. Barbiere, Mr. Slawinski or Mr. Alford except in a public offering or to a controlled affiliate (as defined in the Stockholders Agreement). The Company has also agreed to use its best efforts to elect one designee selected jointly by Randal Hujar and Gary Skiba to be a member of the Board of Directors until the earlier of February 28, 1998 or the termination of the lock-up agreements between the Company and Messrs. Hujar and Skiba. TRANSFER AGENT, WARRANT AGENT AND REGISTRAR The transfer agent, warrant agent and registrar for the Common Stock and the Company's warrants is Continental Stock Transfer & Trust Company, New York, New York. SHARES ELIGIBLE FOR FUTURE SALE Upon completion of this Offering, the conversion of the Convertible Notes into Conversion Shares and the repurchase of Contribution Shares, the Company will have outstanding 7,341,435 shares of Common Stock, not including shares of Common Stock issuable upon exercise of outstanding options, warrants or the Underwriter's UPO and Underwriter's Purchase Option and assuming no exercise of the over-allotment option granted to the Underwriter. Of these outstanding shares, the 2,100,000 shares of Common Stock sold to the public in this Offering may be freely traded without restriction or further registration under the Securities Act, except that any shares that may be held by an "affiliate" of the Company (as that term is defined in the rules and regulations 50 under the Securities Act) may be sold only pursuant to a registration under the Securities Act or pursuant to an exemption from registration under the Securities Act, including the exemption provided by Rule 144 adopted under the Securities Act. In addition, 740,734 Conversion Shares, which have been registered in the Registration Statement of which this Prospectus forms a part, may be sold by the Selling Securityholders if at the time of such sale there is a current prospectus relating the Conversion Shares (subject to the lock-up period described below). 2,200,701 shares of Common Stock are "restricted securities" as that term is defined in Rule 144 under the Securities Act ("Restricted Shares") and may not be sold unless such sale is registered under the Securities Act, or is made pursuant to an exemption from registration under the Securities Act, including the exemption provided by Rule 144. Of such shares, 1,400,489 (of which 1,353,512 shares are subject to the lock-up periods described below) will be available for sale pursuant to Rule 144 commencing May 1996, 75,000 shares will be available for sale pursuant to Rule 144 commencing August 1996, 725,212 shares (614,618 of which shares are subject to the lock-up period described below) will be available for sale pursuant to Rule 144 commencing February 1998. All officers or directors of the Company as of the date of this Prospectus (who hold in the aggregate 1,976,130 of the outstanding shares) have agreed that, until the earlier of two years from the date of this Prospectus or any time after the 20th day after the end of the second consecutive whole fiscal quarter after the date of this Prospectus during which the Company had positive net income on a consolidated basis (each of such quarters being referred to as a "Positive Quarter"), they will not sell any of their shares without the prior consent of the Underwriter, provided, however, that each officer and director who was a stockholder of record as of December 29, 1995 and Randal Hujar and Gary Skiba shall be permitted to sell at the earlier of one year from the date of this Prospectus or any time after the 20th day after the end of the first Positive Quarter, up to 15% of the shares owned by such holder on the date hereof. In addition, prior to February 28, 1997, Mr. Hujar may pledge up to 50% of his Common Stock to cover personal expenses. The Selling Securityholders have agreed that they will not sell their Conversion Shares, the Conversion Warrants and the IPO Warrants they received in exchange for the January 1996 Warrants until twelve months after the date of this Prospectus without the Underwriter's consent. The Company is unable to predict the effect that sales made under Rule 144 or otherwise may have on the market price of the Common Stock prevailing at the time of any such sales. See "Description of Securities" and "Future Sales of Common Stock." In general, under Rule 144 as currently in effect, a stockholder (or stockholders whose shares are aggregated) who has beneficially owned any Restricted Shares for at least two years (including a stockholder who may be deemed to be an affiliate of the Company), will be entitled to sell, within any three-month period, that number of shares that does not exceed the greater of (i) 1% of the then outstanding shares of Common Stock or (ii) the average weekly trading volume of the Common Stock during the four calendar weeks preceding the date on which notice of such sale is given to the Securities and Exchange Commission ("Commission"), provided certain public information, manner of sale and notice requirements are satisfied. A stockholder who is deemed to be an affiliate of the Company, including members of the Board of Directors and senior management of the Company, will still need to comply with the restrictions and requirements of Rule 144, other than the two-year holding period requirement, in order to sell shares of Common Stock that are not Restricted Securities, unless such sale is registered under the Securities Act. A stockholder (or stockholders whose shares are aggregated) who is deemed not to have been an affiliate of the Company at any time during the 90 days preceding a sale by such stockholder, and who has beneficially owned Restricted Shares for at least three years, will be entitled to sell such shares under Rule 144 without regard to the volume limitations described above. The Commission is currently considering a reduction in the required holding periods under Rule 144. No predictions can be made of the effect, if any, that future sales of shares or the availability of shares for sale will have on the market price prevailing from time to time. Nevertheless, sales of substantial amounts of the Common Stock in the public market could adversely affect the then- prevailing market price. REGISTRATION RIGHTS The Company has entered into a registration rights agreement with John Ramo, Jolie Barbiere, Zenon Slawinski, Michael Alford and Ernest B. Kelly III (collectively, "Sonic Group"). Under this registration rights 51 agreement, the Company has provided the Sonic Group (as a group) with (i) "demand" registration rights whereby it can, with certain exceptions, on two occasions require the Company to register under the Securities Act the Company's equity securities it holds and (ii) "piggyback" registration rights whereby it can, with certain exceptions, require the Company to include the Company's equity securities it holds in any registration statement filed by the Company. The Company will pay all registration expenses related to the first demand registration of the Sonic Group. The expenses incurred in connection with the second demand registration for the Sonic Group will be divided pro rata among the Sonic Group based on the number of securities each is registering in such offering. In piggyback registrations, the Company will pay certain of the expenses of such piggyback registration, with the remainder of such expenses to be divided pro rata among the Sonic Group based on the number of securities it is registering in the offering. In connection with this Offering, the Sonic Group has waived its registration rights. In addition, the Company has entered into a registration rights agreement with Randal Hujar and Gary Skiba providing for (i) "demand" registration rights whereby Messrs. Hujar and Skiba can after February 28, 1997, with certain exceptions, require the Company to register under the Securities Act the Company's equity securities they hold and (ii) "piggyback" registration rights whereby Messrs. Hujar and Skiba can after February 28, 1997, with certain exceptions, require the Company to include the Company's equity securities they hold in any registration statement filed by the Company. The Company will pay all registration expenses related to the demand registration. In piggyback registrations, the Company will pay certain of the expenses of such piggyback registration. The Company has also entered into a registration rights agreement with other former shareholders of Lyriq (holding an aggregate of 110,694 shares of Common Stock) providing for "piggyback" registration rights whereby such individuals, with certain exceptions, can require the Company to include the Company's Common Stock they hold in any registration statement filed by the Company pursuant to the "demand" registration rights of Messrs. Hujar and Skiba. The holders of 800,000 IPO Warrants issued in exchange for the May 1994 Warrants had "demand" registration rights whereby they could, with certain exceptions, require the Company to register under the Securities Act, the resale of the IPO Warrants they received in exchange for the May 1994 Warrants and the shares of Common Stock underlying all such IPO Warrants. To date, 560,000 of such IPO Warrants have been resold pursuant to a Registration Statement. The Company has filed a post-effective amendment to such Registration Statement with respect to the resale of the remaining 240,000 of such IPO Warrants and the shares of Common Stock underlying such IPO Warrants. The Company has also registered the 340,000 shares of Common Stock underlying the January 1994 Warrants in a separate Registration Statement. The Company has registered the Conversion Shares, the IPO Warrants issued in exchange for the January 1996 Warrants, the Conversion Warrants and the Common Stock underlying such IPO Warrants in the Registration Statement of which this Prospectus is a part. The Selling Securityholders have agreed not to sell any such warrants or shares of Common Stock until twelve months after the date of this Prospectus without the Underwriter's consent. 52 SELLING SECURITYHOLDERS; PLAN OF DISTRIBUTION Up to 740,734 Conversion Shares and 1,481,468 Conversion Warrants may be offered by 22 Selling Securityholders, who acquired the Conversion Shares and the Conversion Warrants upon the conversion of Convertible Notes at the closing of the Public Offering. The Selling Securityholders received the Convertible Notes in the January 1996 Bridge Financing. Up to 540,000 IPO Warrants may be offered by 28 Selling Securityholders, who acquired the IPO Warrants in exchange for January 1996 Warrants on the closing of the Public Offering. The Company has agreed to bear all expenses (other than underwriting or selling commissions or any fees and disbursements of counsel to such Selling Securityholders) in connection with the registration of the Conversion Shares, the Conversion Warrants and the IPO Warrants. The following table sets forth certain information with respect to holders for whom the Company is registering these IPO Warrants or Conversion Warrants for resale to the public. None of the Selling Securityholders has held any position or office or has had a material relationship with the Company or any of its affiliates within the past three years except that the Woodland Venture Fund and Seneca Ventures were 5% stockholders of the Company prior to the Public Offering. The Company will not receive any of the proceeds from the sale of IPO Warrants or the Conversion Warrants by the Selling Securityholders.
NUMBER/% OF NUMBER/% OF IPO WARRANTS IPO WARRANTS BENEFICIALLY OWNED IPO BENEFICIALLY OWNED PRIOR TO OFFERING WARRANTS AFTER OFFERING -------------------------- TO BE SOLD ----------------------- NAME NUMBER PERCENT IN OFFERING NUMBER PERCENT ---- ---------- --------- ----------- ---------- --------- Applewood Associates, 542,140(1)(2) 10.6% 214,609(3) 10,000(5) * L.P.................... c/o Barry Rubenstein 68 Wheatley Road Brookville, New York 11545 ALSA, INC............... 21,461 * 21,461 -- -- Neil Bellet............. 21,461 * 21,461 -- -- Robert Bender........... 42,922 * 42,922 -- -- Stanley H. Blum......... 21,461 * 21,461 -- -- Dalewood Associates, 40,000 * 40,000 -- -- L.P.................... Craig Effron............ 21,461 * 21,461 -- -- Gordon M. Freeman....... 10,000 * 10,000 -- -- Paula Graff............. 21,461 * 21,461 -- -- James Jannello.......... 5,000 * 5,000 -- -- Frank Lambiase.......... 21,461 * 21,461 -- -- Clifford Lane........... 5,000 * 5,000 -- -- Mariwood Investments.... 21,461 * 21,461 -- -- Alan S. Michalowski..... 21,461 * 21,461 -- -- James J. Pinto.......... 42,922 * 42,922 -- -- The Marilyn and Barry Rubenstein Family 542,142(1)(2) 10.6 20,000(4) 10,000(5) -- Foundation............. c/o Barry Rubenstein 68 Wheatley Road Brookville, New York 11545 Alan J. Rubin........... 21,461 * 21,461 -- --
53
NUMBER/% OF NUMBER/% OF IPO WARRANTS IPO WARRANTS BENEFICIALLY OWNED IPO BENEFICIALLY OWNED PRIOR TO OFFERING WARRANTS AFTER OFFERING ---------------------------TO BE SOLD ----------------------- NAME NUMBER PERCENT IN OFFERING NUMBER PERCENT ---- ----------- -------------------- ---------- --------- Mark Rubin.............. 21,461 * 21,461 -- -- Curtis Schenker......... 21,461 * 21,461 -- -- Seneca Ventures......... 542,140(1)(2) 10.6 85,844(4) 10,000(5) -- c/o Barry Rubenstein 68 Wheatley Road Brookville, New York 11545 Carl E. Siegel.......... 21,461 * 21,461 -- -- David Thalheim.......... 50,000 * 10,000 40,000 * 21st Century Communications Foreign 1,073,046(3) 20.9 85,844(4) -- -- Partners, L.P.......... c/o Fiduciary Trust (Cayman) Limited P.O. Box 1062 Grand Cayman, B.W.I. 21st Century Communications 1,073,046(3) 20.9 729,671(4) -- -- Partners, L.P.......... 767 Fifth Avenue -- 45th Floor New York, New York 10053 21st Century Communications T-E 1,073,046(3) 20.9 257,531(4) -- -- Partners, L.P.......... 767 Fifth Avenue -- 45th Floor New York, New York 10053 Lance Wolfson........... 21,461 * 21,461 -- -- William Wolfson......... 21,461 * 21,461 -- -- Woodland Venture Fund... 542,140(1)(2) 10.6 171,687(4) 10,000(5) * c/o Barry Rubenstein 68 Wheatley Road Brookville, New York 11545 Barry Rubenstein........ 1,615,186(6) 31.5 1,605,186 10,000 * 68 Wheatley Road Brookville, New York 11545
-------- * Less than one percent. The following table sets forth certain information with respect to the holders of the Conversion Shares. None of the Selling Securityholders has held any position or office or has had a material relationship with the Company or any of its affiliates within the past three years except that the Woodland Venture Fund and Seneca Ventures were 5% stockholders of the Company prior to the Public Offering. The Company will not receive any of the proceeds from the sale of such Conversion Shares by the Selling Securityholders.
NUMBER/% OF SHARES NUMBER/% OF SHARES OF COMMON STOCK SHARES OF OF COMMON STOCK BENEFICIALLY OWNED COMMON BENEFICIALLY OWNED PRIOR TO OFFERING STOCK AFTER OFFERING --------------------------- TO BE SOLD ------------------------ NAME NUMBER PERCENT IN OFFERING NUMBER PERCENT ---- ----------- --------- ----------- ----------- --------- Applewood Associates, 1,065,711(1)(2) 13.2% 82,305(4) 352,500(5) 4.8% L.P. .................. c/o Barry Rubenstein 68 Wheatley Road Brookville, New York 11545 ALSA, INC............... 8,230 * 8,230 -- -- Neil Bellet............. 8,230 * 8,230 -- --
54
NUMBER/% OF SHARES NUMBER/% OF SHARES OF COMMON STOCK SHARES OF OF COMMON STOCK BENEFICIALLY OWNED COMMON BENEFICIALLY OWNED PRIOR TO OFFERING STOCK AFTER OFFERING --------------------------- TO BE SOLD ------------------------ NAME NUMBER PERCENT IN OFFERING NUMBER PERCENT ---- ----------- --------- ----------- ----------- --------- Robert Bender........... 16,461 * 16,461 -- -- Stanley H. Blum......... 8,230 * 8,230 -- -- Craig Effron............ 8,230 * 8,230 -- -- Paula Graff............. 8,230 * 8,230 -- -- Frank Lambiase.......... 10,230 * 8,230 2,000 * Mariwood Investments.... 8,230 * 8,230 -- -- Alan S. Michalowski..... 11,230(7) * 8,230 2,500(6) * James J. Pinto.......... 16,461 * 16,461 -- -- Alan J. Rubin........... 8,230 * 8,230 -- -- Mark Rubin.............. 8,230 * 8,230 -- -- Curtis Schenker......... 8,230 * 8,230 -- -- Seneca Ventures......... 1,065,711(1)(2) 13.2% 32,922(4) 352,500(5) 4.8% 68 Wheatley Road Brookville, New York 11545 Carl E. Siegel.......... 8,230 * 8,230 -- -- 21st Century Communications Foreign 1,484,568(3) 17.6% 32,922(4) -- -- Partners, L.P.......... c/o Fiduciary Trust (Cayman) Limited P.O. Box 1062 Grand Cayman, B.W.I. 21st Century Communications 1,148,568(3) 17.6% 279,835(4) -- -- Partners, L.P.......... 767 Fifth Avenue--45th Floor New York, New York 10053 21st Century Communications T-E 1,484,568(3) 17.6% 98,765(4) -- -- Partners, L.P.......... 767 Fifth Avenue--45th Floor New York, New York 10053 Lance Wolfson........... 8,230 * 8,230 -- -- William Wolfson......... 8,230 * 8,230 -- -- Woodland Venture Fund... 1,065,711(1)(2) 13.2% 65,844(4) 352,500(5) 4.8% 68 Wheatley Road Brookville, New York 11545 Barry Rubenstein........ 2,550,279(6) 27.9% 1,000(4) 352,500(6) 4.8% 68 Wheatley Road Brookville, New York 11545
-------- * Less than one percent. (1) Based upon a Joint Schedule 13D filed on September 21, 1995 by Seneca Ventures ("Seneca"), Woodland Venture Fund ("Woodland Fund"), Woodland Services Corp. ("Woodland Corp.") and Barry Rubenstein with the Commission on September 21, 1995, prior to the Public Offering such entities collectively beneficially held 352,500 shares of Common Stock, of which Seneca and Woodland Fund have sole voting 55 and dispositive power over 50,000 shares and 70,000 shares of Common Stock, respectively. Woodland Corp. and Barry Rubenstein are the general partners of Seneca and the Woodland Fund. Barry Rubenstein is also the President and sole director of Woodland Corp. and based upon the Schedule 13D, has sole power to vote and dispose of 47,500 shares of Common Stock, 10,000 shares of Common Stock issuable upon the exercise of IPO Warrants, which are presently exercisable, and 175,000 shares of Common Stock issuable upon the exercise of presently exercisable options. (2) In the January 1996 Bridge Financing, Applewood Associates, L.P. ("Applewood"), Seneca and the Woodland Fund purchased Convertible Notes which, upon the consummation of the Public Offering, were converted into (a) 82,305; 32,922 and 65,844 Conversion Shares, respectively, and (b) 164,608; 65,844 and 131,688 Conversion Warrants, respectively. In addition, in the January 1996 Bridge Financing, Applewood, The Marilyn and Barry Rubenstein Foundation ("Foundation"), Seneca, the Woodland Fund and Dalewood Associates LP ("Dalewood") purchased 50,000; 20,000; 20,000; 40,000 and 40,000 January 1996 Warrants, respectively, all of which were exchanged into a like number of IPO Warrants. Such IPO Warrants and the Conversion Warrants are presently exercisable and along with the Conversion Shares are being offered for resale for their own accounts; however, the holders of such Securities and the Common Stock underlying such Securities may not sell any of such Securities until one year from the date of the Public Offering without the prior consent of the Underwriter. Barry Rubenstein is a trustee of the Foundation, a general partner of Applewood and is a 50% stockholder and an executive officer of the general partner of Dalewood. The information included herein does not include Common Stock beneficially held by 21st Foreign (as defined herein), 21st Partners (as defined herein) and 21st T-E (as defined herein). If the beneficial ownership of such entities is combined with the beneficial ownership of Seneca, Woodland Fund, Woodland Corp., the Foundation and Dalewood, then all of such entities upon consummation of the Public Offering collectively beneficially held 2,550,279 shares of Common Stock, including presently exercisable options and warrants. (3) In the January 1996 Bridge Financing, 21st Century Communications Foreign Partners, L.P. ("21st Foreign"), 21st Century Communications Partners, L.P. ("21st Partners") and 21st Century Communications T-E Partners, L.P. ("21st T-E") purchased Convertible Notes which, upon the consummation of the Public Offering, were converted into (a) 32,922; 279,835; and 98,765 Conversion Shares, respectively, and (b) 65,844; 559,671 and 197,531 Conversion Warrants, respectively. In addition, in the January 1996 Bridge Financing, 21st Foreign, 21st Partners and 21st T-E purchased 20,000; 170,000 and 60,000 January 1996 Warrants, respectively, all of which were exchanged into a like number of IPO Warrants. Such IPO Warrants and the Conversion Warrants are presently exercisable and along with the Conversion Shares are being offered for resale for their own accounts; however, the holders of such securities, the Common Stock underlying such securities and the Conversion Shares may not sell any of such securities until one year from the date of the Offering without the prior consent of the Underwriter. The general partners of each of 21st Century, 21st Partners and 21st T-E are Sandler Investment Partners Ltd. and InfoMedia Associates, Ltd. Barry Rubenstein is a principal shareholder of InfoMedia Associates Ltd. The information included herein does not include Common Stock beneficially held by Seneca, Woodland Fund, Woodland Corp., Barry Rubenstein, the Foundation and Dalewood. If the beneficial ownership of such entities is combined with 21st Foreign, 21st Partners and 21st T-E, then all of such entities upon the consummation of the Public Offering, collectively beneficially held 2,550,279 shares of Common Stock, including presently exercisable options and warrants. (4) Reflects the number of IPO Warrants (including Conversion Warrants) and Conversion Shares which are being sold individually by such entity. (5) Reflects sales of IPO Warrants (including Conversion Warrants) and Conversion Shares were are being sold by all members of such entity's group. (6) Includes Common Stock, Conversion Shares, Conversion Warrants and IPO Warrants held by Applewood, Seneca, Woodland Fund, the Foundation, Dalewood, 21st Partners, 21st Foreign and 21st T-E. (7) Consists of 300 shares held by Mr. Michalowski's son, 100 shares held by Mr. Michalowski's IRA and 2,100 shares held jointly by Mr. Michalowski and his wife. 56 PLAN OF DISTRIBUTION The Selling Securityholders have advised the Company that sales of the Securities may be effected from time to time in transactions (which may include block transactions) on the Nasdaq SmallCap Market or The Boston Stock Exchange, in negotiated transactions, or a combination of such methods of sale, at fixed prices which may be changed, at market prices prevailing at the time of sale, or at negotiated prices. The Selling Securityholders may effect such transactions by selling the Securities directly to purchasers or to or through broker-dealers, including GKN Securities Corp., which may act as agents or principals. Such broker-dealers may receive compensation in the form of discounts, concessions or commissions from the Selling Securityholders and/or the purchasers of the Securities for whom such broker-dealers may act as agents or to whom they sell as principal, or both (which compensation as to a particular broker-dealer might be in excess of customary commissions). The Selling Securityholders and any broker-dealers that act in connection with the sale of the Securities might be deemed to be "underwriters" within the meaning of Section 2(11) of the Securities Act. Each of the Selling Securityholders is obligated to comply with certain rules promulgated by the Commission designed to prevent manipulative and deceptive practices, including Rules 10b-2, 10b-6 and 10b-7 promulgated under the Exchange Act. The Selling Securityholders may agree to indemnify any agent, dealer or broker-dealer that participates in transactions involving sales of their securities against certain liabilities, including liabilities arising under the Securities Act. All costs, expenses and fees in connection with the registration of securities offered by the Selling Securityholders will be borne by the Company. Brokerage commissions, if any, attributable to the sale of the securities offered by the Selling Securityholders will be borne by the Selling Securityholders. The Company has agreed to indemnify the Selling Securityholders, and the Selling Securityholder shave agreed to indemnify the Company, against certain liabilities, including liabilities under the Securities Act. The Selling Securityholders have agreed that they will not sell any of the Securities registered herein until one year after the consummation of the Public Offering without the prior consent of the Underwriter. 57 LEGAL MATTERS Certain legal matters in connection with the securities offered hereby are being passed upon for the Company by Olshan Grundman Frome & Rosenzweig LLP, New York, New York. Graubard Mollen & Miller, New York, New York, has served as counsel to the Underwriter in connection with this Offering. EXPERTS The financial statements of Enteractive, Inc. as of May 31, 1995 and 1994 and for each of the years in the two-year period ended May 31, 1995 and the financial statements of Lyriq International Corporation as of June 30, 1995 and 1994 and for each of the years in the two-year period ended June 30, 1995 have been included herein and in the Registration Statement of which this Prospectus is a part, in reliance upon the reports of KPMG Peat Marwick LLP, independent certified public accountants, appearing elsewhere herein, and upon the authority of said firm as experts in accounting and auditing. The report of KPMG Peat Marwick LLP covering the May 31, 1995 and 1994 financial statements of Enteractive, Inc. refers to a change in the method of accounting for income taxes. AVAILABLE INFORMATION The Company has filed with the Commission a Registration Statement under the Securities Act with respect to the Common Stock offered hereby. This Prospectus does not contain all of the information set forth in the Registration Statement and the exhibits thereto, certain portions having been omitted from this Prospectus in accordance with the rules and regulations of the Commission. For further information with respect to the Company, the securities offered by this Prospectus and such omitted information, reference is made to the Registration Statement, including any and all exhibits and amendments thereto. Statements contained in this Prospectus concerning the provisions of any document filed as an exhibit are of necessity brief descriptions thereof and are not necessarily complete, and in each instance reference is made to the copy of the document filed as an exhibit to the Registration Statement, each such statement being qualified in its entirety by this reference. The Company is subject to the informational requirements of the Securities Exchange Act of 1934, as amended, and in accordance therewith the Company files reports, proxy statements and other information with the Commission. Such reports, proxy statements and other information may be inspected and copied at public reference facilities of the Commission at 450 Fifth Street, N.W., Washington, D.C. 20549; Northwestern Atrium Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661; and 7 World Trade Center, New York, New York 10048. Copies of such material, including the Registration Statement, can be obtained from the Public Reference Section of the Commission, 450 Fifth Street, N.W., Washington, D.C. 20549, at prescribed rates. The Common Stock is traded on the Nasdaq SmallCap Market and The Boston Stock Exchange. The foregoing material also should be available for inspection at the National Association of Securities Dealers, Inc., 1735 K Street, N.W., Washington, D.C., 20006 and The Boston Stock Exchange, One Boston Place, Boston, Massachusetts 02108. The Company intends to furnish its stockholders with annual reports containing financial statements which will be audited and reported on by its independent public accounting firm, and such other periodic reports as the Company may determine to be appropriate or as may be required by law. 58 INDEX TO FINANCIAL STATEMENTS
PAGE ---- ENTERACTIVE, INC. Independent Auditors' Report............................................. F-3 Balance Sheets at May 31, 1995 and May 31, 1994.......................... F-4 Statements of Operations for the years ended May 31, 1995 and 1994....... F-5 Statements of Stockholders' Equity for the years ended May 31, 1995 and 1994.................................................................... F-6 Statements of Cash Flows for the years ended May 31, 1995 and 1994....... F-7 Notes to Financial Statements............................................ F-8 Consolidated Balance Sheets at February 29, 1996 (unaudited) and May 31, 1995.................................................................... F-16 Consolidated Statements of Operations for the nine months ended February 29, 1996 and February 28, 1995 (unaudited).............................. F-17 Consolidated Statements of Cash Flows for the nine months ended February 29, 1996 and February 28, 1995 (unaudited).............................. F-18 Notes to Condensed Financial Statements.................................. F-19 LYRIQ INTERNATIONAL CORPORATION Independent Auditors' Report............................................. F-22 Balance Sheets at June 30, 1995 and June 30, 1994........................ F-23 Statements of Operations for the years ended June 30, 1995 and 1994...... F-24 Statements of Stockholders' Deficit for the years ended June 30, 1995 and 1994.................................................................... F-25 Statements of Cash Flows for the years ended June 30, 1995 and 1994...... F-26 Notes to Financial Statements............................................ F-27 Statements of Operations for the nine months ended February 29, 1996 and February 28, 1995 (unaudited)........................................... F-31 Statements of Stockholders' Deficit for the nine months ended February 29, 1996 (unaudited).................................................... F-32 Statements of Cash Flows for the nine months ended February 29, 1996 and February 28, 1995 (unaudited)........................................... F-33 Notes to Financial Statements............................................ F-34
F-1 PRO FORMA FINANCIAL INFORMATION ENTERACTIVE, INC. AND LYRIQ INTERNATIONAL CORPORATION* Pro Forma Combined Statement of Operations for the nine months ended February 29, 1996 (unaudited)........................................... F-36 Pro Forma Combined Statement of Operations for the year ended May 31, 1995 (unaudited)........................................................ F-38 Notes to Pro Forma Combined Financial Statements (unaudited)............. F-40
-------- * Lyriq International Corporation was acquired by Enteractive on February 29, 1996. The transaction was accounted for as a purchase and the balances of Lyriq International Corporation are included in Enteractive, Inc.'s consolidated balance sheet at February 29, 1996. F-2 INDEPENDENT AUDITORS' REPORT The Board of Directors and Stockholders Enteractive, Inc.: We have audited the accompanying balance sheets of Enteractive, Inc. as of May 31, 1995 and 1994, and the related statements of operations, stockholders' equity and cash flows for the years then ended. 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 generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Enteractive, Inc. as of May 31, 1995 and 1994, and the results of its operations and its cash flows for the years then ended, in conformity with generally accepted accounting principles. As discussed in Note 3 to the financial statements, the Company adopted a new method of accounting for income taxes in fiscal 1994. KPMG PEAT MARWICK LLP New York, New York July 27, 1995 F-3 ENTERACTIVE, INC. BALANCE SHEETS
MAY 31, ----------------------- 1995 1994 ----------- ---------- ASSETS Current Assets Cash and equivalents................................ $ 2,932,400 $2,343,000 Investments......................................... 1,116,100 449,500 Accounts receivable................................. 126,700 73,900 Income taxes receivable............................. 30,100 39,400 Inventories......................................... 44,000 -- Prepaid expenses and other.......................... 45,900 5,400 Debt issue costs.................................... -- 44,000 ----------- ---------- Total current assets.............................. 4,295,200 2,955,200 Investments........................................... -- 491,800 Property and equipment, net........................... 319,300 215,000 Other................................................. 15,700 21,100 ----------- ---------- $ 4,630,200 $3,683,100 =========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities Accounts payable.................................... $ 439,100 $ 241,500 Accrued expenses.................................... 307,600 122,300 Short-term borrowings............................... -- 75,000 Current maturities of long-term debt................ 15,200 86,500 Current maturities of obligations under capital leases............................................. 4,300 5,400 Convertible notes payable, net of $150,000 discount........................................... -- 1,850,000 ----------- ---------- Total current liabilities......................... 766,200 2,380,700 Long-term debt, excluding current maturities.......... -- 16,200 Obligations under capital leases, excluding current maturities........................................... -- 4,700 ----------- ---------- Total liabilities................................. 766,200 2,401,600 Commitments and contingencies Stockholders' Equity Preferred Stock $.01 par value, 2,000,000 shares authorized and none issued......................... -- -- Common Stock $.01 par value, 15,000,000 shares authorized; 4,775,489 and 3,075,489 shares issued and outstanding for 1995 and 1994, respectively.... 47,800 30,800 Additional paid-in capital.......................... 8,130,300 1,567,400 Accumulated deficit................................. (4,314,100) (316,700) ----------- ---------- Total stockholders' equity........................ 3,864,000 1,281,500 ----------- ---------- $ 4,630,200 $3,683,100 =========== ==========
See notes to financial statements. F-4 ENTERACTIVE, INC. STATEMENTS OF OPERATIONS
YEAR ENDED MAY 31, ----------------------- 1995 1994 ----------- ---------- Product development revenue.......................... $ 365,600 $2,371,500 Royalty revenue...................................... 3,500 10,700 ----------- ---------- Total revenues................................... 369,100 2,382,200 Cost of development revenue.......................... 285,600 1,946,600 Research and development expenses.................... 2,487,600 173,200 Marketing and selling expenses....................... 521,500 -- General and administrative expenses.................. 1,044,200 644,500 ----------- ---------- Total costs and expenses......................... 4,338,900 2,764,300 Operating loss....................................... (3,969,800) (382,100) ----------- ---------- Other income (expense): Interest expense................................... (252,900) (30,600) Interest income.................................... 214,300 15,600 Other.............................................. 11,000 (2,600) ----------- ---------- Loss before income taxes............................. (3,997,400) (399,700) Income tax benefit................................... -- (26,500) ----------- ---------- Net loss............................................. $(3,997,400) $ (373,200) =========== ========== Loss per common and common equivalent share.......... $ (0.93) $ (0.11) =========== ========== Weighted average shares of common stock and common stock equivalents................................... 4,275,908 3,419,409 =========== ==========
See notes to financial statements. F-5 ENTERACTIVE, INC. STATEMENTS OF STOCKHOLDERS' EQUITY YEARS ENDED MAY 31, 1995 AND 1994
PREFERRED STOCK COMMON STOCK ADDITIONAL RETAINED ----------------- ------------------ PAID-IN EARNINGS SHARES AMOUNT SHARES AMOUNT CAPITAL (DEFICIT) TOTAL ------- -------- --------- ------- ---------- ----------- ----------- Balance May 31, 1993.... -- $ -- 1,212 $ 2,400 $ 58,300 $ 56,500 $ 117,200 Conversion of 1,212 shares of Sonic common stock pursuant to business combination... -- -- 2,474,277 22,400 (22,400) -- -- Issuance of common stock at incorporation....... -- -- 600,000 6,000 1,525,100 -- 1,531,100 Issuance of common stock warrant................ -- -- -- -- 150,000 -- 150,000 Adjustment for business combination............ -- -- -- -- (143,600) -- (143,600) Net loss................ -- -- -- -- -- (373,200) (373,200) ------- -------- --------- ------- ---------- ----------- ----------- Balance May 31, 1994.... -- -- 3,075,489 30,800 1,567,400 (316,700) 1,281,500 Repurchase and retirement of common stock.................. -- -- (600,000) (6,000) (994,000) -- (1,000,000) Sale of common stock, net.................... -- -- 2,300,000 23,000 7,556,900 -- 7,579,900 Net loss................ -- -- -- -- -- (3,997,400) (3,997,400) ------- -------- --------- ------- ---------- ----------- ----------- Balance May 31, 1995.... -- $ -- 4,775,489 $47,800 $8,130,300 $(4,314,100) $ 3,864,000 ======= ======== ========= ======= ========== =========== ===========
See notes to financial statements. F-6 ENTERACTIVE, INC. STATEMENTS OF CASH FLOWS
YEAR ENDED MAY 31, ----------------------- 1995 1994 ----------- ---------- Cash flows from operating activities Net loss............................................ $(3,997,400) $ (373,200) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization..................... 314,000 100,600 Gain on sale of investments....................... (8,800) -- (Gain) loss on disposal of assets................. (1,100) 1,200 Changes in assets and liabilities: Accounts receivable............................... (52,800) (22,000) Income taxes receivable........................... 9,300 (39,500) Inventories....................................... (44,000) -- Prepaid expenses and other........................ (40,500) (2,700) Other assets...................................... 5,400 900 Accounts payable.................................. 197,600 202,700 Accrued expenses.................................. 185,300 89,000 Deferred revenues................................. -- (287,600) ----------- ---------- Net cash used in operating activities........... (3,433,000) (330,600) ----------- ---------- Cash flows from investing activities Purchases of investments............................ (1,831,700) -- Proceeds from sale of investments................... 1,665,700 -- Cash acquired in merger............................. -- 2,325,800 Purchases of property and equipment................. (223,200) (80,000) ----------- ---------- Net cash (used in) provided by investing activities..................................... (389,200) 2,245,800 ----------- ---------- Cash flows from financing activities Proceeds from sale of common stock, net............. 7,579,900 -- Proceeds from short-term borrowings................. -- 75,000 Proceeds from borrowings under long-term debt....... -- 35,000 Repurchase and retirement of common stock........... (1,000,000) -- Repayment of short-term borrowings.................. (75,000) -- Repayment of convertible notes payable.............. (2,000,000) -- Principal payments under long-term debt............. (87,500) (166,000) Principal payments under capital lease obligations.. (5,800) (10,900) ----------- ---------- Net cash provided by (used in) financing activities..................................... 4,411,600 (66,900) Net increase in cash and equivalents.................. 589,400 1,848,300 Cash and equivalents Beginning of year................................... 2,343,000 494,700 ----------- ---------- End of year......................................... $ 2,932,400 $2,343,000 =========== ==========
See notes to financial statements. F-7 ENTERACTIVE, INC. NOTES TO FINANCIAL STATEMENTS MAY 31, 1995 (1) BASIS OF PRESENTATION AND BUSINESS COMBINATION Enteractive, Inc. (Enteractive) was formed in December 1993 as a wholly owned subsidiary of The Continuum Group through an initial cash investment of $1,531,097, net of associated costs of $18,903, in return for 600,000 shares of Enteractive's common stock. In May 1994, as a condition to the merger agreement described below, Enteractive raised an additional $2,000,000 through the sale of convertible notes and the issuance of warrants to purchase 800,000 shares of the Company's common stock (see note 8). On May 10, 1994, Enteractive consummated a merger with Sonic Images Productions, Inc. (Sonic) whereby 2,475,489 shares of Enteractive's common stock was exchanged for 100% of the outstanding common stock of Sonic. The merger was accounted for under the purchase method of accounting with Sonic as the acquiring entity, as its former shareholders received 80% of the voting common stock of the surviving entity (the Company). Sonic was a privately-held multimedia software development company without a readily determinable market value. Accordingly, the consideration for the purchase was determined to be the fair value of the net assets acquired from Enteractive. The accompanying financial statements include the historical results of Sonic and reflect the results of operations of the Company from the date of the merger. The capital stock accounts of the former Sonic have been adjusted to reflect the capital stock of the surviving entity, Enteractive. Prior to the Merger, Enteractive had no operations and had only expenses related to administrative costs associated with formation, raising equity and debt financing, and certain other merger activities. Total costs incurred for these activities from Enteractive's inception date until the effective date of the merger amounted to $143,600. This amount has been reflected as a reduction of additional paid- in capital in the accompanying financial statements. (2) INITIAL PUBLIC OFFERING On October 20, 1994, 2,300,000 units of interest in the Company were sold in an initial public offering filed with the Securities and Exchange Commission ("SEC") on Form SB-2. Each unit, which was sold for $4.00, consisted of one share of the Company's common stock and one common stock purchase warrant, which entitles the warrant holder to purchase one share of the Company's common stock for $4.00 at any time during the period from October 20, 1995 to October 20, 1997. Proceeds of approximately $7,600,000, net of related expenses of approximately $1.6 million, were received in exchange for the units issued. In connection with this sale of units, the Company sold to the underwriter, for an aggregate of $50, the right to purchase 200,000 units with identical terms to those sold in the initial public offering, except that the exercise price of the warrants is $5.20. Such units are exercisable at $6.60 per unit from October 20, 1995 through October 20, 1999, and have certain "piggy back" and demand registration rights. (3) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (a) Cash and Equivalents All highly liquid debt instruments with maturities of three months or less at the time of purchase are considered to be cash equivalents. Cash equivalents of $2,662,600 and $2,307,300 at May 31, 1995 and 1994, respectively, consist of cash held in interest-bearing money market accounts. (b) Investments Investments at May 31, 1995, consist of certificates of deposit and are carried at cost, which approximates market. Investments at May 31, 1994, consists of certain debt securities of the U.S. Government and, in accordance with provisions of Statement of Financial Accounting Standards No. 115, Accounting for Certain F-8 ENTERACTIVE, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED) Investments in Debt and Equity Securities, have been classified as "available for sale" and are carried at fair value. (c) Revenue Recognition Revenues under fixed price product development contracts are recognized using the percentage of completion method based on progress to date, which is measured by comparing costs to date to total estimated costs. Losses on contracts, if any, are recognized in the period they become estimable. Royalty revenue is recognized when earned. (d) Inventories Inventories of multimedia software are recorded at the lower of cost (on a first-in, first-out basis) or market. (e) Property and Equipment Property and equipment are stated at cost and are depreciated over their estimated useful lives using the straight-line depreciation method, except for the leasehold improvements which are amortized over the lesser of the lease term or the life of the related asset. (f) Income Taxes Effective as of June 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes. The cumulative effect of the change in the method of accounting for income taxes was not material. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be realized or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. (g) Software Development Costs Capitalization of costs associated with internally developed software begins upon the determination by the Company of a product's technological feasibility, as evidenced by a working model. Capitalized software development costs are amortized over related sales on a per-unit basis based on estimated total sales, with a minimum amortization based on a straight-line method over three years. There were no capitalized software development costs at May 31, 1995 or 1994 due to the short period of time and insignificance of costs incurred from the time the Company's products were determined to be technologically feasible and the time they were available for general release to the public. F-9 ENTERACTIVE, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED) (h) Earnings Per Share Pursuant to SEC Staff Accounting Bulletin Topic 4:D, stock issued and stock options and warrants granted during the twelve month period preceding the date of the Company's initial public offering (the "IPO") have been included in the calculation of weighted average shares of common stock outstanding weighted average shares of common stock and common equivalents outstanding for the years ended May 31, 1995 and 1994 is as follows:
1995 1994 --------- --------- Weighted average shares of common stock outstanding, exclusive of issuance's within twelve months prior to the IPO............................................... 4,031,928 2,475,489 Shares issued within twelve months prior to the IPO assumed to be outstanding for the entire period....... -- 600,000 Incremental shares assumed to be outstanding related to common stock options and warrants granted within twelve months prior to the IPO........................ 243,980 343,920 --------- --------- 4,275,908 3,419,409 ========= =========
(4) INVESTMENTS Investments at May 31, 1995, consist of certificates of deposit maturing at various dates through November 1995. Investments at May 31, 1994, consisted of U.S. Treasury Notes and Federal agency securities having a fair value of $941,300, which approximated the amortized cost. (5) PROPERTY AND EQUIPMENT Property and equipment, at May 31, 1995 and 1994, consists of the following:
1995 1994 ---------- --------- Computer and production equipment..................... $ 791,100 $ 585,500 Furniture and other equipment......................... 54,100 41,000 Leasehold improvements................................ 200,300 193,700 ---------- --------- 1,045,500 820,200 Accumulated depreciation and amortization............. (726,200) (605,200) ---------- --------- Property and equipment, net........................... $ 319,300 $ 215,000 ========== =========
(6) ACCRUED EXPENSES At May 31, 1995, accrued expenses totaled $307,600 and included $163,100 of accrued compensation. (7) SHORT-TERM BORROWINGS At May 31, 1994, the Company had an outstanding line of credit agreement which provided for borrowings up to $75,000. The line of credit agreement expired in June 1994 at which time the Company repaid all outstanding amounts. (8) CONVERTIBLE NOTES PAYABLE On May 9, 1994, the Company entered into a series of debt financing agreements. Under the terms of these agreements, the Company received $2,000,000 in cash in exchange for the issuance of $2,000,000 in 10% F-10 ENTERACTIVE, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED) convertible notes payable and common stock purchase warrants (note 10) for the purchase of 800,000 shares of the Company's common stock. The estimated value of the warrants at the time of issuance was $150,000, which was reflected as a component of equity and unamortized discount on the convertible notes payable. In accordance with its planned use of the proceeds received from the initial public offering, the Company, in November 1994, repaid all principal and interest amounts outstanding under its convertible notes payable. (9) LONG-TERM DEBT Long-term debt at May 31, 1995 and 1994, consists of the following:
1995 1994 ------- ------- Note payable in monthly installments of $1,173, including interest at the lending institution's prime rate (7.5% at May 31, 1995) plus 2%, (note is collateralized by certain property and equipment).................................. $12,600 $24,200 Various notes payable with interest approximating prime, repaid in fiscal 1995.................................... -- 68,400 Other notes payable....................................... 2,600 10,100 ------- ------- Total long term debt.................................. 15,200 102,700 Less current maturities................................. 15,200 86,500 ------- ------- Long term debt, excluding current maturities.......... $ -- $16,200 ======= =======
Interest costs of approximately $102,900 (principally relating to a bridge loan repaid in October 1994) and $19,100 were paid in fiscal 1995 and 1994, respectively. F-11 ENTERACTIVE, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED) (10) STOCK OPTIONS AND WARRANTS The Company has reserved 750,000 shares of unissued common stock under its 1994 Incentive and Non-qualified Stock Option Plan (the "1994 Plan") for employees. At May 31, 1995, 469,770 options have been granted under the 1994 Plan, of which 427,217 represent non-qualified stock options and 42,553 represent incentive stock options. Additionally, the Company periodically grants stock options outside the 1994 Plan to other parties. All stock options, which have been granted by the Company, with the exception of those options granted to persons holding more than ten percent of the voting common stock in the Company on the date of grant, expire ten years after grant and are issued at exercise prices which are not less than the fair value of the stock on the date of grant. Options granted to persons holding more than ten percent of the voting common stock of the Company on the date of grant expire five years after grant and are issued at exercise prices which are not less than 110 percent of the fair value of the stock on the date of grant. Stock options generally vest one-third in each of the first three years after the date of grant. Payment for the exercise price of an option may be made with previously acquired common stock of the Company with certain limitations. A summary of all stock option transactions of the Company is as follows:
NUMBER OF OPTIONS PRICE PER SHARE ----------------- --------------- Outstanding May 31, 1993 Granted.................................. 531,510 $1.71-3.00 Exercised................................ -- -- Canceled................................. -- -- --------- ---------- Outstanding May 31, 1994................... 531,510 $1.71-3.00 Granted.................................. 470,260 $1.71-4.00 Exercised................................ -- -- Canceled................................. -- -- --------- ---------- Outstanding May 31, 1995................... 1,001,770 $1.71-4.00 ========= ========== Exercisable at May 31, 1995................ 523,340 $1.71-3.00 ========= ==========
On August 12, 1994, the Company's Board of Directors increased the number of shares reserved under the 1994 Plan from 500,000 to 750,000 shares. In addition, the Board approved a new stock option plan for consultants under which 250,000 shares of common stock have been reserved for issuance. In November 1994, a total of 250,000 options were granted to two consultants (one of which was a former director of the Company) under the stock option plan for consultants for advisory services. The options are exercisable for 10 years from date of grant at an exercise price of $3.75. The expense related to the services will be recognized over the period the services are provided Under a separate Stock Option Plan for Outside Directors, each person who is an outside director on January 1 of each calendar year, commencing January 1, 1996, shall be granted 5,000 options to purchase shares of common stock of the Company. Approval of this option plan is subject to approval by the Company's shareholders. In December 1994, the Company registered with the SEC 800,000 common stock warrants which were issued in May 1994 in connection with the issuance of convertible notes payable, which were repaid in October 1994. The warrants entitle the holder to purchase one share of common stock for $4.00 during the two-year period commencing October 20, 1995. In connection with the initial capitalization of the Company, the Company issued warrants to purchase 340,000 shares of common stock at $2.35 per share. The warrants are currently exercisable and expire in January 1999. No value was ascribed to these warrants. F-12 ENTERACTIVE, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED) All of the warrants issued by the Company carry certain limited "piggyback" registration rights which provide the warrant holders with the right to have the shares into which the warrants have been or will be converted included in any registration statement filed by the Company with the Securities and Exchange Commission, other than a registration statement filed in connection with an IPO or on Forms S-4 or S-8. Additionally, certain stockholders have entered into demand registration rights agreements with the Company whereby they can require the Company, with certain exceptions, to register shares under the Securities Act of 1933. (11) PREFERRED STOCK On August 12, 1994, the Company's Board of Directors authorized the Company to issue up to 2,000,000 shares of preferred stock, with a par value of $.01, none of which has been issued. (12) INCOME TAXES Income tax benefit consists of the following for the years ended May 31, 1995 and 1994:
1995 1994 -------- -------- Current: Federal................................................. $ -- $(13,700) State................................................... -- (12,800) -------- -------- -- (26,500) ======== ======== Deferred: Federal................................................. -- -- State................................................... -- -- -------- -------- $ -- $(26,500) ======== ========
Income tax benefit amounted to $26,500 for 1994, an effective rate of 7 percent. The actual benefit differs from the "expected" tax benefit for 1995 and 1994, computed by applying the U.S. Federal corporate tax rate of 34 percent to loss before income taxes, as follows:
1994 1994 ----------- --------- Computed "expected" tax benefit.................... $(1,359,100) $(135,900) Increase (reduction) in income taxes resulting from: State income taxes, net of Federal benefit....... (185,700) (8,400) Increase in valuation allowance, primarily due to Federal net operating loss carry forwards....... 1,537,800 105,300 Other............................................ 7,000 12,500 ----------- --------- $ -- $ (26,500) =========== =========
F-13 ENTERACTIVE, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED) The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at May 31, 1995 and 1994, are as follows:
1995 1994 ----------- --------- Deferred tax assets: Net operating loss carry forwards................. $ 1,582,600 $ 108,900 Accrued expenses.................................. 64,000 -- Valuation allowance............................... (1,643,100) (105,400) ----------- --------- Net deferred tax asset.......................... 3,500 3,500 ----------- --------- Deferred tax liability--property and equipment, principally due to differences in depreciation methods............................................ 3,500 3,500 ----------- --------- Net deferred tax asset/liability................ $ -- $ -- =========== =========
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax asset will be realized. The ultimate realization of the deferred tax asset is dependent upon the generation of future taxable income during the periods in which temporary differences become deductible. Management considers scheduled reversals of deferred tax liabilities, projected future taxable income, and tax planning strategies which can be implemented by the Company in making this assessment. The Company believes that it is more likely than not that it will not be able to realize its deferred tax asset and has established a valuation allowance of $1,643,000 at May 31,1995, based upon the provisions of Statement of Financial Accounting Standard No. 109, the Company's historical taxable losses and the lack of offsetting objective evidence, the Company's projected taxable loss through May 31, 1997 and the fact that the Company cannot produce reasonably reliable projections during the remainder of the net operating loss carry forward period. Approximately $ 30,100 was paid in income taxes for the year ended May 31, 1994 and for which a refund is expected in fiscal 1996. At May 31, 1995, the Company had available approximately $4,100,000 of tax loss carry forwards which expire in years 2009 through 2010. (13) EMPLOYEE BENEFIT PLAN The Company sponsors an employee savings plan under Section 401(k) of the Internal Revenue Code (IRC) that covers substantially all employees of the Company who elect to participate on a voluntary basis. Participants may authorize salary deferral amounts under the plan up to 15 percent of their compensation limited to a maximum amount stipulated in the IRC. The plan also provides for a discretionary Company contribution which is determined by the Board of Directors. No discretionary Company contributions were made during the years ended May 31, 1995 and 1994. (14) COMMITMENTS (a) Leases The Company leases its office facilities under several non-cancelable operating leases which expire at various times through May 31, 1997. The following is a schedule by years of future minimum lease commitments required under the Company's non-cancelable operating leases:
YEAR ENDED MAY 31 ----------------- 1996.............................................................. $175,700 1997.............................................................. 182,400 -------- $358,100 ========
F-14 ENTERACTIVE, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED) Rent expense for operating leases for 1995 and 1994 approximated $129,700 and $136,500, respectively. (b) Employment Agreements The Company has entered into employment agreements with certain key executives and employees. Minimum salary commitments under these agreements are approximately $585,000, $485,000, and $185,400 for the years ending May 31, 1996, 1997, and 1998, respectively. (15) BUSINESS AND CREDIT CONCENTRATIONS During 1994 approximately $1,450,000 of the Company's total revenues were received under a grant from the National Science Foundation (NSF). The grant was used for the development of a specific educational multimedia product. Under the terms of the grant, the Company owns all rights to the completed product; however, the Company must provide the NSF with a royalty-free license to use the material for government purposes and a percentage of the Company's royalties earned on sales of the initial version of the product to the American Academy for the Advancement of Sciences. The product was substantially completed as of May 31, 1994, and no additional funds were received under this grant in fiscal 1995. In addition there was one customer that comprised 25% of total revenue in 1995 and 1994 and two other customers that comprised 51% and 20% of total revenue in 1995. (16) REPURCHASE AND RETIREMENT OF COMMON STOCK On August 31, 1994, the Company repurchased and retired 600,000 shares of its outstanding common stock from a stockholder at a price of $1,000,000. F-15 ENTERACTIVE, INC. CONSOLIDATED BALANCE SHEETS
FEBRUARY 29, MAY 31, 1996 1995 ------------ ----------- (UNAUDITED) ASSETS Current Assets Cash and equivalents.......................... $ 1,842,000 $ 2,932,400 Investments................................... 30,400 1,116,100 Accounts receivable, net...................... 649,200 126,700 Income taxes receivable....................... 16,400 30,100 Inventories................................... 303,700 44,000 Debt issuance costs........................... 226,700 -- Prepaid expenses and other.................... 25,900 45,900 ------------ ----------- Total current assets........................ 3,094,300 4,295,200 Property and equipment, net..................... 261,900 319,300 Capitalized software, net....................... 1,177,800 -- Other........................................... 24,200 15,700 ------------ ----------- $ 4,558,200 $ 4,630,200 ============ =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities Accounts payable.............................. $ 962,400 $ 439,100 Accrued expenses.............................. 354,800 307,600 Notes payable................................. 123,600 15,200 Convertible promissory notes.................. 2,190,000 -- Obligations under capital leases.............. 1,400 4,300 ------------ ----------- Total current liabilities................... 3,632,200 766,200 Commitments and contingencies Stockholders' Equity Preferred Stock $.01 par value, 2,000,000 shares authorized, none issued............... -- -- Common Stock $.01 par value, 15,000,000 shares authorized; 5,500,701 and 4,775,489 shares issued and outstanding February 29, 1996 and May 31, 1995, respectively................... 55,000 47,800 Additional paid-in capital...................... 11,563,900 8,130,300 Accumulated deficit............................. (10,692,900) (4,314,100) ------------ ----------- Total stockholders' equity.................. 926,000 3,864,000 ------------ ----------- $ 4,558,200 $ 4,630,200 ============ ===========
See notes to financial statements. F-16 ENTERACTIVE, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
NINE MONTHS ENDED -------------------------- FEBRUARY 29, FEBRUARY 28, 1996 1995 ------------ ------------ Product sales...................................... $ 324,800 $ -- Product development revenue........................ 257,700 292,600 Royalty revenue.................................... 103,300 2,400 ----------- ----------- Total revenues................................. 685,800 295,000 Cost of product sales.............................. 77,600 -- Cost of development revenue........................ 225,500 237,600 Research and development expenses.................. 2,301,500 1,592,900 Marketing and selling expenses..................... 1,354,700 117,600 General and administrative expenses................ 1,246,900 756,200 Acquired in-process research and development....... 1,915,100 -- ----------- ----------- Total costs and expenses....................... 7,121,300 2,704,300 Operating loss..................................... (6,435,500) (2,409,300) Other income (expense): Interest expense................................. (58,200) (252,000) Interest income.................................. 110,000 138,400 Other............................................ 4,900 10,300 ----------- ----------- Net loss........................................... $(6,378,800) $(2,512,600) =========== =========== Loss per common and common equivalent share........ $ (1.34) $ (0.62) =========== =========== Weighted average shares of common stock and common stock equivalent.................................. 4,775,489 4,057,812 =========== ===========
See notes to financial statements. F-17 ENTERACTIVE, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED ------------------------ FEBRUARY FEBRUARY 29, 28, 1996 1995 ----------- ----------- (UNAUDITED) CASH FLOWS FROM OPERATING ACTIVITIES Net loss........................................... $(6,378,800) $(2,512,600) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization..................... 287,400 268,900 Acquired in-process research and development...... 1,915,100 -- Gain on sale of investments....................... -- (8,800) Gain on disposal of assets........................ (9,000) -- Changes in assets and liabilities net of acquisi- tion of Lyriq: Accounts receivable............................... (101,000) (87,200) Income taxes receivable........................... 13,700 9,300 Inventories....................................... (140,200) -- Prepaid expenses and other........................ 30,400 (53,100) Other assets...................................... (2,800) (1,800) Accounts payable.................................. 271,400 22,800 Accrued expenses.................................. (194,000) 125,500 ----------- ----------- Net cash used in operating activities............ (4,307,800) (2,237,000) ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from sale of investments................. 1,085,700 950,100 Notes receivable.................................. (285,800) -- Cash acquired from Lyriq acquisition.............. 11,300 -- Purchases of property and equipment............... (35,700) (165,800) ----------- ----------- Net cash provided by investing activities........ 775,500 784,300 ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES Principal payments under capital lease obliga- tions............................................ (2,900) (4,400) Repayment of short-term borrowings................ (15,200) (75,000) Principal payments under long-term debt........... -- (82,400) Principal payments under convertible notes pay- able............................................. -- (2,000,000) Repurchase and retirement of common stock......... -- (1,000,000) Proceeds from issuance of convertible notes, net.. 2,460,000 -- Proceeds from sale of common stock, net........... -- 7,579,800 ----------- ----------- Net cash provided by financing activities........ 2,441,900 4,418,000 NET (DECREASE) INCREASE IN CASH AND EQUIVALENTS.. (1,090,400) 2,965,300 CASH AND EQUIVALENTS Beginning of period................................ 2,932,400 2,343,000 ----------- ----------- End of period...................................... $ 1,842,000 $ 5,308,300 =========== ===========
See notes to financial statements. F-18 ENTERACTIVE, INC. NOTES TO CONDENSED FINANCIAL STATEMENTS (UNAUDITED) 1. GENERAL The accompanying unaudited financial statements have been prepared in accordance with the instructions to Form 10-QSB and in the opinion of management contain all adjustments (consisting of only normal recurring entries) necessary to present fairly the Company's interim financial statements. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. The interim financial statements should be read in conjunction with the Company's financial statements and related notes in the May 31, 1995 Annual Report on Form 10-KSB. The results for the three and nine month period ended February 29, 1996 are not necessarily indicative of the results to be obtained for the full year. 2. BUSINESS The Company's primary business is the development and publication of proprietary entertainment and educational interactive multimedia software for distribution on personal computers utilizing the CD-ROM platform. Initial shipment of these products commenced in June 1995 and represent the first sales of titles published by the Company. To a limited extent, the Company continues to develop interactive titles for others. 3. REVENUE RECOGNITION Revenue from product sales is recognized upon shipment, provided no significant vendor obligations remain and collection of the resulting receivable is deemed probable. Revenue under fixed price product development contracts is recognized using the percentage of completion method based on progress to date, which is measured by comparing costs to date to total estimated costs. Royalty revenue is recognized when earned. The Company's agreements with certain product distributors and retailers permit them to exchange or return products for which the Company provides an allowance. 4. CONVERTIBLE PROMISSORY NOTES On January 23, 1996, the Company consummated a $2,700,000 bridge financing through the issuance of 54 units, each consisting of a $50,000 unsecured convertible promissory note and 10,000 warrants. Each warrant will enable the holder to purchase one share of common stock at $4.00 per share. The promissory notes are convertible into a number of common shares equal to the principal of the notes divided by 90% of the per share offering price of the Company's common stock in its proposed public offering (Note 7) plus twice that number of warrants to purchase common stock at $4.00 per share. Debt acquisition costs totaled $240,000. The fair market value of the warrants was $540,000 at time of issuance. Such amount was reflected as an increase in additional paid in capital and as a discount on the convertible promissory notes to be amortized over the term of the notes. The convertible notes bear interest at 10% per annum through June 30, 1996, and thereafter until paid at 15% per annum, with principal and interest due the earlier of July 23, 1997 or the closing of a public offering of shares of the Company's common stock. Investors holding an aggregate of $2,250,000 of convertible promissory notes have elected to convert their convertible promissory notes into shares of the Company's stock at the closing of the planned public offering (Note 7). 5. MERGER On February 29, 1996, the Company completed its merger with Lyriq International Corporation, a developer and publisher of interactive multimedia software, pursuant to an Agreement and Plan of Merger, whereby Lyriq F-19 ENTERACTIVE, INC. NOTES TO CONDENSED FINANCIAL STATEMENTS--(CONTINUED) (UNAUDITED) was merged into a wholly-owned subsidiary of the Company. The merger was accounted for under the purchase method of accounting and, accordingly, the net assets and operations of Lyriq are included in the Company's consolidated financial statements beginning on February 29, 1996. The purchase price was determined as follows: 725,212 shares of Enteractive common stock at $4.00 per share........................................................ $2,900,848 Excess of fair value of liabilities assumed over assets ac- quired of Lyriq.............................................. 247,050 Acquisition costs............................................. 52,102 ---------- Total....................................................... $3,200,000 ========== The acquisition price was allocated as follows: In-process research and development expense................... $1,915,156 Capitalized software.......................................... 1,284,844 ---------- Total....................................................... $3,200,000 ==========
The Company recorded an expense of $1,915,100 on February 29, 1996 for the acquired in-process research and development, including certain core technology, that will be used in the development of additional titles in the future. The statement of operations charge equaled the estimated current fair value of the future related cash flows to be derived from specifically identified technologies (discounted at a risk-adjusted rate of 30%) for which technological feasibility had not yet been established pursuant to SFAS No. 86 (consistent with management's definition of internally developed software) and the technologies have no alternative future use. Capitalized software will be amortized over a three year period. 6. UNAUDITED PRO FORMA INFORMATION The following unaudited combined pro forma information shows the results of the Company's operations for the nine month periods presented had the merger with Lyriq occurred at the beginning of each period.
NINE MONTHS ENDING ------------------------ FEBRUARY FEBRUARY 29, 28, 1996 1995 ----------- ----------- Total revenues.................................... $ 1,548,200 $ 1,331,300 Net loss.......................................... $(5,060,600) $(2,787,000) Net loss per share................................ $ (.92) $ (0.58)
The information does not necessarily indicate what would have occurred had the acquisition been consummated at the beginning of the respective periods, or of the results that may occur in the future. Pro-forma adjustments included amortization of acquired capitalized software over three years. F-20 ENTERACTIVE, INC. NOTES TO CONDENSED FINANCIAL STATEMENTS--(CONTINUED) (UNAUDITED) 7. SUBSEQUENT EVENTS On March 29, 1996 the Company amended its charter to increase the number of authorized common shares from 15,000,000 to 30,000,000. In addition the Company increased the number of shares authorized for issuance under its stock option plans as follows:
PLAN FROM TO ---- ------- --------- 1994 Incentive and Non-qualified Stock Option Plan...... 750,000 1,500,000 1994 Stock option plan for consultants.................. 350,000 1,000,000 1995 Stock Option Plan for Outside Directors............ 75,000 150,000
The Company anticipates filing the amendment to its charter on or about April 25, 1996. The amendments to the above plans will not become effective until the charter amendment is filed. On March 12, 1996, the Company filed a registration statement on Form SB-2 with the Securities and Exchange Commission regarding a proposed sale by the Company of 2,000,000 shares of the Company's common stock to the public. In the quarter in which the Offering occurs, the Company will incur one-time charges for the write-off of debt acquisition costs and the discount on the Convertible Notes totalling $736,700, based on the balances at February 29, 1996. In December 1995, the Company entered into an agreement with certain of its officers pursuant to which the Company will repurchase, simultaneously with the closing of the proposed public offering of common stock, an aggregate of 1,000,000 shares of common stock at $1.00 per share. Under the purchase agreement one third of the purchase price is required to be paid at the closing of the proposed public offering and at each of the first two anniversaries of the closing. The outstanding balance will accrue interest at the prime rate and is payable quarterly. F-21 INDEPENDENT AUDITORS' REPORT The Board of Directors and Stockholders Lyriq International Corporation: We have audited the accompanying balance sheets of Lyriq International Corporation as of June 30, 1995 and 1994, and the related statements of operations, stockholders' deficit and cash flows for the years then ended. 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 generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Lyriq International Corporation as of June 30, 1995 and 1994, and the results of its operations and its cash flows for the years then ended, in conformity with generally accepted accounting principles. KPMG PEAT MARWICK LLP New York, New York March 1, 1996 F-22 LYRIQ INTERNATIONAL CORPORATION BALANCE SHEETS
YEARS ENDED JUNE 30, ------------------- 1995 1994 --------- -------- ASSETS Current Assets Cash................................................... $ 8,638 $ 24,200 Accounts receivable, net............................... 233,030 115,346 Inventories............................................ 103,418 34,125 Prepaid expenses and other............................. 19,807 1,646 --------- -------- Total current assets................................. 364,893 175,317 Property and equipment, net.............................. 18,595 38,888 Other.................................................... 5,795 5,795 --------- -------- $ 389,283 $220,000 ========= ======== LIABILITIES AND STOCKHOLDERS' DEFICIT Current Liabilities Accounts payable....................................... $ 285,459 $ 57,865 Accrued expenses....................................... 163,983 12,700 Notes payable.......................................... 54,590 0 Convertible debt....................................... 0 100,000 16,743 49,470 --------- -------- Total current liabilities............................ 520,775 220,035 Commitments and contingencies Stockholders' Deficit Common Stock, no par value, 1,250,000 shares authorized, 895,525 and 845,500 shares issued and outstanding at June 30, 1995 and 1994, respectively.................... 101,000 1,000 Accumulated deficit...................................... (232,492) (1,035) --------- -------- Total stockholders' deficit.......................... (131,492) (35) --------- -------- $ 389,283 $220,000 ========= ========
See accompanying notes to financial statements. F-23 LYRIQ INTERNATIONAL CORPORATION STATEMENTS OF OPERATIONS
YEARS ENDED JUNE 30, -------------------- 1995 1994 ---------- -------- Product revenues......................................... $ 617,536 $206,339 Product development revenue.............................. 162,132 171,262 Royalty and other revenue................................ 464,906 47,031 ---------- -------- Total revenues....................................... 1,244,574 424,632 Cost of product revenues................................. 250,932 51,098 Cost of product development revenue...................... 185,225 65,806 Research and development expenses........................ 342,444 175,103 Marketing and selling expenses........................... 431,077 52,858 General and administrative expenses...................... 254,894 88,428 ---------- -------- Total operating expenses............................. 1,464,572 433,293 Operating loss........................................... (219,998) (8,661) Other income (expense): Interest expense....................................... (10,023) (1,963) Other.................................................. (821) (2,558) ---------- -------- Loss before income taxes................................. (230,842) (13,182) Provision for income taxes............................... 615 1,831 ---------- -------- Net loss................................................. $ (231,457) $(15,013) ========== ========
See accompanying notes to financial statements. F-24 LYRIQ INTERNATIONAL CORPORATION STATEMENTS OF STOCKHOLDER'S DEFICIT YEARS ENDED JUNE 30, 1995 AND 1994
RETAINED COMMON STOCK EARNINGS ---------------- (ACCUMULATED SHARES AMOUNT DEFICIT) TOTAL ------- -------- ------------ --------- Balance, June 30, 1993............... 845,500 $ 1,000 $ 13,978 $ 14,978 Net Loss............................. -- -- (15,013) (15,013) ------- -------- --------- --------- Balance, June 30, 1994............... 845,500 1,000 (1,035) (35) Shares issued upon conversion of debt................................ 50,025 100,000 -- 100,000 Net loss............................. -- -- (231,457) (231,457) ------- -------- --------- --------- Balance, June 30, 1995............... 895,525 $101,000 $(232,492) $(131,492) ======= ======== ========= =========
See accompanying notes to financial statements. F-25 LYRIQ INTERNATIONAL CORPORATION STATEMENTS OF CASH FLOWS
YEARS ENDED JUNE 30, -------------------- 1995 1994 --------- --------- Cash flows from operating activities Net loss............................................... $(231,457) $(15,013) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization.......................... 19,177 17,345 Loss on disposal of assets............................. 1,802 -- Changes in assets and liabilities: Accounts receivable.................................. (117,684) (111,739) Inventories.......................................... (69,293) (15,188) Prepaid expenses and other........................... (18,161) 354 Other assets......................................... -- 1,255 Accounts payable..................................... 227,594 34,073 Accrued expenses..................................... 151,283 11,250 --------- --------- Net cash used in operating activities.............. (36,739) (77,663) --------- --------- Cash flows from investing activities Purchases of property and equipment.................... (686) (9,758) --------- --------- Net cash used in investing activities.............. (686) (9,758) --------- --------- Cash flows from financing activities Short-term borrowings.................................. 54,590 -- Proceeds from issuance of convertible debt............. -- 100,000 (Repayment of) proceeds from shareholder loans......... (32,727) 8,206 --------- --------- Net cash provided by financing activities.......... 21,863 108,206 Net (decrease) increase in cash and equivalents.... (15,562) 20,785 Cash Beginning of period.................................... 24,200 3,415 --------- --------- End of period.......................................... $ 8,638 $ 24,200 ========= ========= Supplemental disclosure of cash flow information: Cash paid during the year for interest................. $ 11,266 $ 4,877 Cash paid during the year for income taxes............. $ 615 $ 1,831
See accompanying notes to financial statements. F-26 LYRIQ INTERNATIONAL CORPORATION NOTES TO FINANCIAL STATEMENTS JUNE 30, 1995 AND 1994 (1) BUSINESS Lyriq International Corporation (the Company) was founded in December 1991 and is primarily engaged in the development of interactive multimedia titles for the home education and recreation markets. The Company is currently developing software for the CD-ROM platform as well as the Internet and commercial on-line services. (2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (a) Cash Cash of $8,638 and $24,200 at June 30, 1995 and 1994, respectively, consists of cash held in interest-bearing commercial bank accounts. (b) Revenue Recognition Sales and related costs are recorded by the Company upon shipment of products provided no significant vendor obligations remain and collection of the resulting receivable is deemed probable. The Companys agreements with certain product distributors and retailers permit them to exchange or return products for which the Company provides an allowance. Royalty revenue is recognized when earned. Product development revenue is recognized as the services are provided. (c) Inventories Inventories of multimedia software and related components are recorded at the lower of cost (on a first-in, first-out basis) or market. (d) Property and Equipment Property and equipment are stated at cost and are depreciated over their estimated useful lives of 3 to 5 years using the straight-line depreciation method, except for the leasehold improvements which are amortized over the lesser of the lease term or the life of the related asset. (e) Income Taxes Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be realized or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. (f) Software Development Costs Capitalization of costs associated with internally developed software begins upon the determination by the Company of a product's technological feasibility as evidenced by a working model. Capitalized software development costs are amortized over related sales on a per-unit basis based on estimated total sales, with a minimum amortization based on a straight-line method over three years. There were no capitalized software development costs at June 30, 1995 or 1994 due to the short period of time and insignificance of costs incurred from the time the Company's products were determined to be technologically feasible and the time they were available for general release to the public. F-27 LYRIQ INTERNATIONAL CORPORATION NOTES TO FINANCIAL STATEMENTS--(CONTINUED) JUNE 30, 1995 AND 1994 (g) Use of Estimates Management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare these financial statements in conformity with generally accepted accounting principles. Actual results could differ from those estimates. (3) ACCOUNTS RECEIVABLE At June 30, 1995 and 1994 accounts receivable totaled $233,030 and $115,346 net of allowance for doubtful accounts and product returns of $154,049 and $20,500 in 1995 and 1994, respectively. (4) PROPERTY AND EQUIPMENT Property and equipment, at June 30, 1995 and 1994, consists of the following:
1995 1994 -------- -------- Property and equipment................................... $ 68,922 $ 72,740 Accumulated depreciation and amortization................ (50,327) (33,852) -------- -------- Property and equipment, net.............................. $ 18,595 $ 38,888 ======== ========
(5) ACCRUED EXPENSES Accrued expenses at June 30, 1995 consists of accrued payroll and related payroll costs totaling $86,643, and $77,340 for amounts owed a vendor for marketing and sales services. The amount owed to the vendor was paid by the issuance of 50,000 shares of the Company's common stock in September 1995 (Note 13). (6) NOTES PAYABLE The notes payable at June 30, 1995 consists of the following: $9,152 charged to a company credit card bearing interest at 14%; a $10,000 loan payable to an individual bearing interest at a rate of 10% which was subsequently satisfied by the issuance of 5,000 shares of the Company's common stock in September 1995 (Note 13); and, $35,438 advanced from a factoring company. The factoring agreement, dated November 1994, allows the Company to borrow against eligible accounts receivable at an interest rate of 3% of the outstanding amount per month with the amounts outstanding secured by the assets of the Company. (7) CONVERTIBLE DEBT On April 27, 1994, the Company borrowed $100,000 from an individual which, at the culmination of certain events per the loan and stock purchase agreement, would be converted into shares of the Company's common stock. The terms of the loan provided for interest at a rate of 10% per annum. On September 30, 1994, the debt was converted into 50,025 shares of common stock (after giving effect to the stock split--Note 13). Total interest paid on the loan until conversion was $6,722. (8) DUE TO STOCKHOLDERS At June 30, 1995 and 1994, the Company owed the stockholders of the Company a total of $16,743 and $49,470, respectively. These amounts advanced to the Company are payable upon demand and bear interest at 20% per year after outstanding for 30 days. F-28 LYRIQ INTERNATIONAL CORPORATION NOTES TO FINANCIAL STATEMENTS--(CONTINUED) JUNE 30, 1995 AND 1994 (9) INCOME TAXES The provision for income taxes in fiscal 1995 and 1994 were comprised of state minimum taxes. The actual income tax benefit differs from the "expected" tax benefit for 1995 and 1994, computed by applying the U.S. Federal corporate tax rate of 34 percent to loss before income taxes, as follows:
1995 1994 --------- -------- Computed "expected" Federal income tax benefit........ $ (78,700) $ (5,100) Increase in income taxes resulting from: State income taxes, net of Federal benefit.......... 615 1,831 Increase in valuation allowance, primarily due to reserves........................................... 78,700 5,100 --------- -------- $ 615 $ 1,831 ========= ========
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at June 30, 1995 and 1994, are as follows:
1995 1994 -------- ------- Deferred tax assets: Accounts receivable reserve........................... $ 64,700 $ -- Net operating loss carryforward....................... 20,100 -- Accrued vacation...................................... 4,100 4,100 -------- ------- 88,900 4,100 Valuation allowance..................................... (82,800) (4,100) -------- ------- Deferred tax asset.................................... 6,100 -- -------- ------- Deferred tax liability--property and equipment, principally due to differences in depreciation methods................................................ 6,100 -- -------- ------- Net deferred income taxes............................... $ -- $ -- ======== =======
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax asset will be realized. The ultimate realization of the deferred tax asset is dependent upon the generation of future taxable income during the periods in which temporary differences become deductible. Management considers scheduled reversals of deferred tax liabilities, projected future taxable income, and tax planning strategies which can be implemented by the Company in making this assessment. Based upon the Company's historical taxable losses and scheduled reversal of deferred tax liabilities, the Company has established a valuation allowance of $82,800 and $4,100 at June 30, 1995 and 1994, respectively. (10) COMMITMENTS The Company leases approximately 4,875 square feet of office space under a non-cancelable operating lease which expired September 30, 1994. Since the expiration of the current lease the Company has been paying the landlord $2,250 per month. Rent expense for the operating lease for fiscal 1995 and 1994 approximated $27,000 per year. F-29 LYRIQ INTERNATIONAL CORPORATION NOTES TO FINANCIAL STATEMENTS--(CONTINUED) JUNE 30, 1995 AND 1994 (11) SIGNIFICANT CUSTOMER The Company received 21% and 49% of its total revenues from one customer in 1995 and 1994, respectively. These revenues represent royalty payments earned from sales of educational titles developed by the Company and product development fees (12) STOCK OPTIONS In October 1994 and September 1995, the Company granted options to purchase 8,455 and 5,000 shares of the Company's common stock at an exercise price of $.01 and $2.50 per share, respectively. Such options were converted to options of Enteractive on February 29, 1996 (Note 13). (13) SUBSEQUENT EVENTS In September 1995, the Companys Board of Directors authorized an increase in the number of authorized shares of common stock, without par value, from 3,000 to 1,250,000. On September 1, 1995, the Board of Directors authorized a 422.75 to 1 stock split, which resulted in the issuance of 893,407 shares of common stock of the Company. All references to the number of shares of common stock of the Company and to stock option data reflect the stock split. Additionally, in September 1995 the following transactions occurred: The Company satisfied $10,000 of notes payable to an individual by issuing 5,000 shares of the Company's common stock. The Companys Board of Directors authorized the issuance of 50,000 shares of common stock to a vendor of the Company as payment for sales and marketing services. The Company recorded an expense of $77,340 in fiscal 1995 for the portion of the services provided in that year. The Companys Board of Directors authorized the issuance of 2,000 shares of common stock to a consultant of the Company as payment for marketing services. The Companys Board of Directors authorized the issuance of a total of 36,375 shares of common stock of the Company to employees of the Company. On September 28, 1995, the Company entered into an agreement with Enteractive, Inc., an interactive multimedia software publisher, to merge the Company into a wholly owned subsidiary of Enteractive. Per the agreement to merge the companies, the Company borrowed $250,000 from Enteractive at an interest rate of prime plus 2% to be used for working capital. On February 29, 1996, the merger was consummated with the Companys shareholders receiving 725,212 shares of common stock of Enteractive representing 13% of the combined companys outstanding shares. Of the shares received, 10%, or 72,521 shares will be held in escrow to be released subject to certain conditions. Upon consummation of the merger, the $250,000 loan became an inter-company payable. F-30 LYRIQ INTERNATIONAL CORPORATION STATEMENTS OF OPERATIONS
NINE MONTHS ENDED ------------------------- FEBRUARY 29, FEBRUARY 28, 1996 1995 ------------ ------------ (UNAUDITED) Product revenues.................................. $ 517,444 $ 607,760 Product development revenue....................... 121,000 125,487 Royalty and other revenue......................... 223,961 303,053 ---------- --------- Total revenues.................................. 862,405 1,036,300 Cost of product revenues.......................... 182,104 232,488 Cost of product development revenue............... 131,020 119,571 Research and development expenses................. 386,887 234,260 Marketing and selling expenses.................... 360,114 285,775 General and administrative expenses............... 154,291 114,667 ---------- --------- Total costs and expenses........................ 1,214,416 986,761 Operating (loss) income........................... (352,011) 49,539 ---------- --------- Other income (expense): Interest expense................................ (32,632) (1,950) Other........................................... 1,741 (997) ---------- --------- Net (loss) income................................. $ (382,902) $ 46,592 ========== =========
See accompanying notes to financial statements. F-31 LYRIQ INTERNATIONAL CORPORATION STATEMENTS OF STOCKHOLDERS' DEFICIT NINE MONTHS ENDED FEBRUARY 29, 1996 (UNAUDITED)
COMMON STOCK ----------------- SHARES AMOUNT ACCUMULATED DEFICIT TOTAL ------- --------- ------------------- --------- Balance, June 30, 1995....... 895,525 $ 101,000 $ (232,492) $(131,492) Shares issued upon conversion of debt..................... 5,000 10,000 -- 10,000 Stock issued as payment for services.................... 52,000 105,000 -- 105,000 Stock issued to employees.... 36,375 72,750 -- 72,750 Net loss..................... -- -- (382,902) (382,902) ------- --------- ---------- --------- Balance, February 29, 1996... 988,900 $ 288,750 $ (615,394) $(326,644) ======= ========= ========== =========
See accompanying notes to financial statements. F-32 LYRIQ INTERNATIONAL CORPORATION STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED ------------------------- FEBRUARY 29, FEBRUARY 28, 1996 1995 ------------ ------------ (UNAUDITED) Cash flows from operating activities Net (loss) income.................................. $(382,902) $ 46,592 Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization.................... 10,223 14,656 Loss on disposal of assets....................... -- 1,802 Common stock issued for services................. 105,000 -- Stock compensation expense....................... 72,750 -- Changes in assets and liabilities: Accounts receivable.............................. (188,398) (171,007) Inventories...................................... (16,110) (70,903) Prepaid expenses and other....................... 9,323 (17,737) Accounts payable................................. (6,026) 129,689 Accrued expenses................................. (12,472) 45,048 --------- --------- Net cash used in operating activities.......... (408,612) (21,860) --------- --------- Cash flows from investing activities Purchases of property and equipment.............. (16,301) -- --------- --------- Net cash used in investing activities.......... (16,301) -- --------- --------- Cash flows from financing activities Short-term borrowings.............................. 422,025 56,193 Proceeds from (repayment of) shareholder loans..... 5,757 (27,726) --------- --------- Net cash provided by financing activities...... 427,782 28,467 Net increase (decrease) in cash and equivalents................................... 2,869 6,607 Cash Beginning of period................................ 8,638 24,200 --------- --------- End of period...................................... $ 11,507 $ 30,807 ========= =========
See accompanying notes to financial statements. F-33 LYRIQ INTERNATIONAL CORPORATION NOTES TO FINANCIAL STATEMENTS FEBRUARY 29, 1996 AND FEBRUARY 28, 1995 (UNAUDITED) 1. GENERAL In the opinion of management the accompanying unaudited financial statements contain all adjustments (consisting of only normal recurring entries) necessary to present fairly the Company's financial position as of February 29, 1996 and the results of its operations and its cash flows for the nine months ended February 29, 1996 and February 28, 1995. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. The interim financial statements should be read in conjunction with the Company's June 30, 1995 audited financial statements and related notes. The results for the nine month period ended February 29, 1996 are not necessarily indicative of the results to be obtained for the full year. 2. BUSINESS Lyriq International Corporation (the Company) was founded in December 1991 and is primarily engaged in the development of interactive multimedia titles for the home education and recreation markets. The Company is currently developing software for the CD-ROM platform as well as the Internet and commercial on-line services. 3. REVENUE RECOGNITION Revenue from product sales is recognized upon shipment, provided no significant vendor obligations remain and collection of the resulting receivable is deemed probable. Royalty revenue is recognized when earned. The Company's agreements with certain product distributors and retailers permit them to exchange or return products for which the Company provides an allowance. 4. STOCKHOLDERS DEFICIT In September 1995, the Company's Board of Directors authorized an increase in the number of authorized shares of common stock, without par value, from 3,000 to 1,250,000. On September 1, 1995, the Board of Directors authorized a 422.75 to 1 stock split which resulted in the issuance of 893,407 shares of common stock of the Company. All references to the number of shares of common stock of the Company and to stock option data reflect the stock split. Additionally, in September 1995 the following transactions occurred: The Company satisfied $10,000 of notes payable to an individual by issuing 5,000 shares of the Company's common stock. The Company's Board of Directors authorized the issuance of 50,000 shares of common stock to a vendor of the Company as payment for sales and marketing services. The Company recorded an expense of $77,340 in fiscal 1995 for the portion of the services provided in that year. The Company's Board of Directors authorized the issuance of 2,000 shares of common stock to a consultant of the Company as payment for marketing services. The Company's Board of Directors authorized the issuance of a total of 36,375 shares of common stock of the Company to employees of the Company. F-34 LYRIQ INTERNATIONAL CORPORATION NOTES TO FINANCIAL STATEMENTS--(CONTINUED) 5. MERGER On February 29, 1996, the Company completed its merger with Enteractive, Inc., a developer and publisher of interactive multimedia software, pursuant to an Agreement and Plan of Merger, whereby the Company was merged into a wholly-owned subsidiary of Enteractive. The merger was accounted for under the purchase method of accounting and, accordingly, the net assets and operations of the Company are included in Enteractive's consolidated financial statements beginning on February 29, 1996. As consideration for this transaction, the shareholders of the Company were issued a total of 725,212 shares of common stock of Enteractive. F-35 PRO FORMA FINANCIAL INFORMATION ENTERACTIVE, INC. AND LYRIQ INTERNATIONAL CORPORATION PRO FORMA COMBINED STATEMENT OF OPERATIONS (UNAUDITED) The following pro forma combined statement of operations (unaudited) combines, on a purchase basis of accounting, the statement of operations of Enteractive for the nine months ended February 29, 1996 (unaudited) with the statement of operations of Lyriq for the nine months ended February 29, 1996 (unaudited). The pro forma combined statement of operations gives effect to the acquisition of Lyriq as if it had occurred on June 1, 1995. The pro forma combined statement of operations is not necessarily indicative of future operating results and should not be used as a forecast of future operations of Enteractive and Lyriq as an Enteractive subsidiary. This pro forma statement should be read in conjunction with the notes to the pro forma combined financial statements and the historical financial statements of both companies included elsewhere herein. F-36 ENTERACTIVE, INC. AND LYRIQ INTERNATIONAL CORPORATION PRO FORMA STATEMENT OF OPERATIONS (UNAUDITED)
NINE MONTHS ENDED FEBRUARY 29, 1996 PRO FORMA NINE MONTHS ENDED LYRIQ ADJUSTMENTS FEBRUARY 29, 1996 INTERNATIONAL ---------------------- PRO FORMA ENTERACTIVE, INC. CORPORATION DEBIT CREDIT COMBINED ----------------- ----------------- -------- ---------- ----------- Product sales........... $ 324,800 $ 517,400 $ $ $ 842,200 Product development revenue................ 257,700 121,000 378,700 Royalty and other revenue................ 103,300 224,000 327,300 ----------- ---------- ----------- Total revenues........ 685,800 862,400 1,548,200 Cost of product revenues............... 77,600 182,100 214,000(b) 473,700 Cost of development revenue................ 225,500 131,000 356,500 Research and development expenses............... 2,301,500 386,900 2,688,400 Marketing and selling expenses............... 1,354,700 360,100 1,714,800 General and administrative expenses............... 1,246,900 154,300 1,401,200 Acquired in-process technology............. 1,915,100 -- 1,915,100(a) -- ----------- ---------- -------- ---------- ----------- Total costs and expenses............. 7,121,300 1,214,400 214,000 1,915,100 6,634,600 Operating loss.......... (6,435,500) (352,000) 214,000 1,915,100 (5,086,400) ----------- ---------- -------- ---------- ----------- Other income (expense): Interest expense...... (58,200) (32,600) (90,800) Interest income....... 110,000 -- 110,000 Other................. 4,900 1,700 6,600 ----------- ---------- ----------- Loss before income taxes.................. (6,378,800) (382,900) 214,000 1,915,100 (5,060,600) ----------- ---------- -------- ---------- ----------- Net loss................ $(6,378,800) $ (382,900) $214,000 $1,915,100 $(5,060,600) =========== ========== ======== ========== =========== Loss per common share... $ (0.92) =========== Weighted average shares of common stock........ (c) 5,500,701 ===========
See notes to pro forma combined financial statements. F-37 PRO FORMA FINANCIAL INFORMATION ENTERACTIVE, INC. AND LYRIQ INTERNATIONAL CORPORATION PRO FORMA COMBINED STATEMENT OF OPERATIONS (UNAUDITED) The following pro forma combined statement of operations (unaudited) combines, on a purchase basis of accounting, the statement of operations of Enteractive for the year ended May 31, 1995 with the statement of operations of Lyriq for the year ended June 30, 1995. The pro forma combined statement of operations gives effect to the acquisition of Lyriq as if it had occurred at the beginning of the year. The pro forma combined statement of operations is not necessarily indicative of future operating results and should not be used as a forecast of future operations of Enteractive and Lyriq as an Enteractive subsidiary. This pro forma statement should be read in conjunction with the notes to the pro forma combined financial statements and the historical financial statements of both companies included elsewhere herein. F-38 ENTERACTIVE, INC. AND LYRIQ INTERNATIONAL CORPORATION PROFORMA STATEMENT OF OPERATIONS (UNAUDITED)
YEAR ENDED JUNE 30, 1995 PRO FORMA YEAR ENDED LYRIQ ADJUSTMENTS MAY 31, 1995 INTERNATIONAL ------------------ PRO FORMA ENTERACTIVE, INC. CORPORATION DEBIT CREDIT COMBINED ----------------- ------------- -------- ------ ----------- Product sales........... $ -- $ 617,500 $ $ $ 617,500 Product development revenue................ 365,600 162,100 527,700 Royalty and other revenue................ 3,500 464,900 468,400 ----------- ---------- -------- ---- ----------- Total revenues........ 369,100 1,244,500 1,613,600 Cost of product revenues............... -- 250,900 428,000(b) 678,900 Cost of development revenue................ 285,600 185,200 470,800 Research and development expenses............... 2,487,600 342,500 2,830,100 Marketing and selling expenses............... 521,500 431,100 952,600 General and administrative expenses............... 1,044,200 254,900 1,299,100 ----------- ---------- -------- ---- ----------- Total costs and expenses............. 4,338,900 1,464,600 428,000 6,231,500 Operating loss.......... (3,969,800) (220,100) 428,000 (4,617,900) ----------- ---------- -------- ---- ----------- Other income (expense): Interest expense...... (252,900) (10,000) (262,900) Interest income....... 214,300 -- 214,300 Other................. 11,000 (800) 10,200 ----------- ---------- -------- ---- ----------- Loss before income taxes.................. (3,997,400) (230,900) 428,000 (4,656,300) ----------- ---------- -------- ---- ----------- Provision for income taxes.................. -- 600 600 Net loss................ $(3,997,400) $ (231,500) $428,000 $ $(4,656,900) =========== ========== ======== ==== =========== Loss per common share... $ (0.93) =========== Weighted average shares of common stock........ (c) 5,001,120 ===========
See notes to pro forma combined financial statements. F-39 ENTERACTIVE, INC. AND LYRIQ INTERNATIONAL CORPORATION NOTES TO PRO FORMA COMBINED FINANCIAL STATEMENTS (UNAUDITED) 1. BASIS OF PRESENTATION The acquisition of Lyriq is accounted for as a purchase and, in accordance with generally accepted accounting principles, Enteractive's purchase price is allocated to the assets and liabilities of Lyriq based on their fair values at the date of the acquisition. 2. PRO FORMA ADJUSTMENTS AND ASSUMPTIONS The pro forma combined financial statements of Enteractive and Lyriq give effect to the following pro forma adjustments and assumptions: a. This adjustment records the acquisition of Lyriq as described elsewhere herein with the purchase price determined as follows: 725,212 shares of Enteractive common stock @ $4.00 per share.. $2,900,848 Excess of fair value of liabilities assumed over assets acquired of Lyriq............................................ 247,050 Acquisition costs............................................. 52,102 ---------- Total..................................................... $3,200,000 ========== The acquisition price was allocated as follows: In-process research and development expense................. $1,915,156 Capitalized software........................................ 1,284,844 ---------- Total..................................................... $3,200,000 ==========
The Company recorded an expense of $1,915,100 on February 29, 1996 for the acquired in-process research and development that will be used in the development of additional titles in the future. As this charge will not have a continuing impact, it has been eliminated from the pro forma statements of operations. The statement of operations charge equaled the estimated current fair value of the future related cash flows to be derived from specifically identified technologies (discounted at a risk-adjusted rate of 30%) for which technological feasibility had not yet been established pursuant to SFAS No. 86 (consistent with management's definition of internally developed software) and the technologies have no alternative future use. b. Records amortization of acquired capitalized software over three years, as if the acquisition had taken place at the beginning of the period. c. Reflects weighted average shares of Enteractive for the period (4,775,489 for the nine months ended February 29, 1996 and 4,275,908 for the year ended May 31, 1995, plus 725,212 shares of Enteractive common stock issued to Lyriq.) F-40 ------------------------------------------------------------------------------- ------------------------------------------------------------------------------- NO DEALER, SALESPERSON OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATIONS IN CONNECTION WITH THIS OFFERING OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR MADE, SUCH IN- FORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR BY THE UNDERWRITER. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR SOLICITATION OF AN OFFER TO BUY ANY SECURITY OTHER THAN THE SECURITIES OFFERED BY THIS PROSPECTUS, OR AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY SECURITIES BY ANY PERSON IN ANY JURISDICTION IN WHICH SUCH OFFER OR SOLICITATION IS NOT AUTHORIZED OR IS UNLAWFUL. THE DELIVERY OF THIS PROSPECTUS SHALL NOT, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THE INFORMATION HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO THE DATE OF THIS PROSPECTUS. --------------- TABLE OF CONTENTS
PAGE ---- Prospectus Summary....................................................... 3 The Company.............................................................. 8 Risk Factors............................................................. 8 Use of Proceeds.......................................................... 16 Dilution................................................................. 17 Capitalization........................................................... 18 Dividend Policy.......................................................... 18 Price Range of the Common Stock.......................................... 19 Management's Discussion and Analysis of Financial Condition and Results of Operations........................................................... 20 LYRIQ.................................................................... 24 Business................................................................. 27 Management............................................................... 38 Principal Securityholders................................................ 43 Certain Transactions..................................................... 46 Description of Securities................................................ 48 Shares Eligible For Future Sale.......................................... 50 Selling Securityholders, Plan of Distribution............................ 53 Plan of Distribution..................................................... 57 Legal Matters............................................................ 58 Experts.................................................................. 58 Available Information.................................................... 58 Index to Financial Statements............................................ F-1
------------------------------------------------------------------------------- ------------------------------------------------------------------------------- ------------------------------------------------------------------------------- ------------------------------------------------------------------------------- 740,734 SHARES 2,021,468 COMMON STOCK PURCHASE WARRANTS LOGO ENTERACTIVE, INC. ---------- PROSPECTUS ---------- MAY 15, 1996 ------------------------------------------------------------------------------- ------------------------------------------------------------------------------- This Prospectus is printed on recycled paper using soy-based inks. LOGO