As filed with the Securities and Exchange Commission on March 14, 2000
Registration No. 333-
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
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FUTURE MEDIA PRODUCTIONS, INC.
(Exact Name of Registrant as Specified in its Charter)
California 3652 95-4486758
(State or
Other Jurisdiction of (Primary Standard Industrial (I.R.S. Employer
ncorporationIor Organization) Classification Code Number) Identification No.)
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25136 Anza Drive
Valencia, California 91355
(661) 294-5575
(Address, Including Zip Code, and Telephone Number, Including Area Code, of
Registrant's Principal Executive Offices)
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ALEX SANDEL,
President
Future Media Productions, Inc.
25136 Anza Drive
Valencia, California 91355
(661) 294-5575
(Address, Including Zip Code, and Telephone Number, Including Area Code, of
Agent for Service)
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Copies to:
Murray Markiles, Esq. Robert K. Montgomery, Esq.
Scott D. Galer, Esq. Anton W. Leung, Esq.
Phillip Gharabegian, Esq. Gibson, Dunn & Crutcher LLP
Troop Steuber Pasich Reddick & 2029 Century Park East
Tobey, LLP Los Angeles, California 90067
2029 Century Park East (310) 552-8500
Los Angeles, California 90067
(310) 728-3000
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Approximate date of commencement of proposed sale to the public: As soon as
practicable after the effective date of this Registration Statement.
If any of the securities being registered in this form are to be offered on a
delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [_]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following
box and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If the delivery of the prospectus is expected to be made pursuant to Rule
434, please check the following box. [_]
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CALCULATION OF REGISTRATION FEE
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Proposed Maximum
Title of Each Class of Aggregate Amount of
Securities to be Registered Offering Price(1) Registration Fee
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Common Stock, no par value................... $70,000,000 $18,480
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(1) Estimated solely for the purpose of calculating the registration fee,
pursuant to Rule 457(o) under the Securities Act of 1933.
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The Registrant hereby amends this Registration Statement on such date or
dates as may be necessary to delay its effective date until the Registrant
shall file a further amendment which specifically states that this Registration
Statement shall thereafter become effective in accordance with Section 8(a) of
the Securities Act of 1933 or until the Registration Statement shall become
effective on such date as the Commission, acting pursuant to said Section 8(a),
may determine.
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++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+The information in this prospectus is not complete and may be changed. Future +
+Media may not sell these securities until the registration statement filed +
+with the Securities and Exchange Commission is effective. This prospectus is +
+not an offer to sell these securities and it is not soliciting an offer to +
+buy these securities in any state where the offer or sale is not permitted. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
SUBJECT TO COMPLETION-MARCH 14, 2000
PROSPECTUS
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Shares
[LOGO OF FUTURE MEDIA PRODUCTIONS]
Common Stock
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Future Media is offering shares and the selling shareholders are
offering shares of common stock in an initial public offering. Prior to
this offering, there has been no public market for Future Media's common stock.
Future Media will not receive any proceeds from the sale of shares by the
selling shareholders.
Future Media is an independent manufacturer/replicator of Digital Versatile
Discs (DVDs) and Compact Discs (CDs). Future Media targets its sales to
companies in industries including Internet/online, film and entertainment,
edutainment software, publishing and computer hardware.
It is anticipated that the public offering price will be between $ and $
per share. Application has been made to include the common stock for quotation
in the Nasdaq National Market under the symbol "FMPI".
Per
Share Total
Public offering price......................................... $ $
Underwriting discounts and commissions........................ $ $
Proceeds, before expenses, to Future Media.................... $ $
Proceeds to selling shareholders.............................. $ $
See "Risk Factors" on pages 8 to 13 for factors that should be considered
beforeinvesting in the shares of Future Media.
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Neither the Securities and Exchange Commission nor any state securities
commission hasapproved or disapproved of these securities or passed upon the
accuracy or adequacy of thisprospectus. Any representation to the contrary is a
criminal offense.
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The underwriters may purchase up to additional shares from Future Media
and additional shares from the selling shareholders at the public
offering price, less underwriting discounts and commissions. Delivery and
payment for the shares will be on , 2000.
Prudential Volpe Technology
a unit of Prudential
Securities
CIBC World Markets
, 2000
Description of Photographs:
. Photographs of Future Media's headquarters, mastering facility,
replication machines and printing machines.
. Collage of manufactured DVDs and CDs.
TABLE OF CONTENTS
Page
----
Prospectus Summary.................. 4
Risk Factors........................ 8
Forward-Looking Statements.......... 13
Termination Of S Corporation
Status............................. 14
Use Of Proceeds..................... 15
Dividend Policy..................... 15
Dilution............................ 16
Capitalization...................... 17
Selected Financial Data............. 18
Management's Discussion and Analysis
Of Financial Condition and Results
Of Operations...................... 20
Industry Overview................... 26
Business............................ 28
Management.......................... 37
Certain Relationships and Related
Transactions....................... 42
Principal and Selling Shareholders.. 44
Description Of Capital Stock........ 45
Shares Eligible For Future Sale..... 46
Underwriting........................ 47
Legal Matters....................... 49
Experts............................. 49
Where You Can Find More
Information........................ 49
Index To Financial Statements....... F-1
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You should rely only on the information contained in this prospectus. We have
not authorized anyone to provide you with information different from that
contained in this prospectus. We are offering to sell, and seeking offers to
buy, shares of common stock only in jurisdictions where offers and sales are
permitted. The information contained in this prospectus is accurate only as of
the date of this prospectus, regardless of the time of delivery of this
prospectus or of any sale of our common stock.
PROSPECTUS SUMMARY
This summary highlights information contained elsewhere in this prospectus.
This summary is not complete and may not contain all of the information you
should consider before investing in the common stock of Future Media. You
should read the entire prospectus carefully.
Future Media
We are an independent manufacturer/replicator of Digital Versatile Discs
(DVDs) and Compact Discs (CDs). We target our sales to companies in industries
including Internet/online, film and entertainment, edutainment software,
publishing and computer hardware. Our customers include America Online, Inc.,
Modus Media International Holdings, Inc., Havas Interactive, Inc., GT
Interactive Software, Lions Gate Entertainment, infoUSA Inc., Interplay
Entertainment Corp., Juno Online Services, Inc. and a major motion picture
distributor.
We have successfully implemented our business model, which consists of the
following elements:
. High volume customers: Our customer base is comprised of some of the
highest volume customers of DVDs and CDs.
. High replication capacity: Since inception we have continued to add new
equipment and have become one of the largest independent
manufacturers/replicators of DVDs and CDs in the United States.
. Low cost structure: We achieve substantial economies of scale through our
optimally designed facility at a single locale, our dedication to
maximizing machine uptime and our flat organizational structure.
. Superior turnaround service: We are dedicated to providing superior
turnaround service by maintaining high throughput mastering technologies
and high DVD/CD graphic printing capacity and by efficiently managing
operational workflow.
To implement our business model, we have developed a focused operating
approach founded on the following key principles:
. High capacity manufacturing capabilities at a single locale;
. Optimally designed manufacturing facilities;
. Self sufficient repair, maintenance and engineering capabilities;
. Technologically advanced manufacturing equipment; and
. Marketing our services directly to senior management.
We believe that our focused operating approach distinguishes us from our
competitors. We also believe that the effectiveness of our operating approach
has been proven through the growth in our targeted customer base, the retention
of our customers and our demonstrated long-term financial performance.
To foster our continued growth in line with our business model, we plan to
pursue the following opportunities:
. Capitalize on the continuing growth of the DVD market;
. Expand our position as a low cost CD manufacturer within the
Internet/online, film and entertainment, edutainment software, publishing
and computer hardware industries; and
. Actively stimulate new CD replicating business through targeted Internet
related marketing programs.
We are a California corporation. Our executive offices are located at 25136
Anza Drive, Valencia, California 91355, and our telephone number is (661) 294-
5575.
4
The Offering
Shares offered by Future Media................ shares
Shares offered by the selling shareholders.... shares
Total shares outstanding after this offering.. shares
Use of proceeds by Future Media............... To repay all existing debt, to
purchase capital equipment, to
distribute retained earnings
including an amount for the
purpose of paying income taxes
on our 2000 S Corporation
earnings to our existing
shareholders, and for general
corporate purposes, including
potential strategic
investments.
Proposed Nasdaq National Market symbol........ FMPI
Except as otherwise noted, all information in this prospectus regarding the
number of outstanding shares of common stock does not include:
. shares that the underwriters may purchase if they exercise their over-
allotment option;
. 1,200,000 shares of common stock available for issuance pursuant to our
1998 stock incentive plan, of which 828,000 shares were subject to
outstanding options as of the date of this prospectus at a weighted
average exercise price of $11.35 per share; and
. 366,600 shares of common stock issuable upon exercise of warrants issued
to David Moss, our Vice President-Operations, at an exercise price of
$0.0017 per share.
Also, except as otherwise noted, all information in this prospectus has been
adjusted to give effect to the change of the status of Future Media from an S
Corporation to a C Corporation for income tax purposes.
Risk Factors
You should consider the risk factors and the impact of events that could
adversely affect our business before investing in our common stock.
5
Summary Selected Financial and Other Data
(in thousands, except for per share and employee data)
The following table summarizes certain selected financial and operating data
contained in the financial statements and elsewhere in this prospectus.
Year Ended December 31
-------------------------------------------
1995 1996 1997 1998 1999
------- ------- ------- ------- -------
Statement of Income Data:
Net sales........................ $26,972 $25,814 $36,042 $43,311 $53,002
Cost of goods sold............... 14,821 11,972 23,132 27,304 31,938
------- ------- ------- ------- -------
Gross profit..................... 12,151 13,842 12,910 16,007 21,064
Selling, general and
administrative expenses......... 6,093 2,537 4,214 4,232 4,201
Stock related compensation
expense(1)...................... -- -- -- 3,055 720
Abandoned offering costs......... -- -- -- 676 --
------- ------- ------- ------- -------
Income from operations........... 6,058 11,305 8,696 8,044 16,143
Interest income.................. 12 252 42 35 1
Interest expense................. (957) (1,108) (818) (1,264) (1,404)
Change in accounting estimate for
royalties(2).................... -- 3,770 -- -- --
------- ------- ------- ------- -------
Income before state income
taxes........................... 5,113 14,219 7,920 6,815 14,740
Provision for state income
taxes........................... 72 223 120 102 2
------- ------- ------- ------- -------
Net income....................... $ 5,041 $13,996 $ 7,800 $ 6,713 $14,738
======= ======= ======= ======= =======
Pro Forma Statement of Income
Data (unaudited)(3):
Income before provision for
income taxes.................... $14,740
Pro forma income tax provision... 5,896
-------
Pro forma net income............. $ 8,844
=======
Pro forma basic earnings per
share........................... $ 0.98
=======
Pro forma diluted earnings per
share........................... $ 0.86
=======
Weighted average shares
outstanding--basic.............. 9,000
=======
Weighted average shares
outstanding--diluted............ 10,336
=======
Other Data:
Capital expenditures............. $ 6,277 $ 1,585 $ 3,642 $ 6,752 $15,226
Depreciation and amortization.... 1,053 1,389 1,950 2,861 4,368
Number of full-time employees at
period end...................... 44 57 75 92 127
December 31, 1999
---------------------------
Pro
Pro Forma As
Actual Forma(4) Adjusted(5)
------ -------- -----------
Balance Sheet Data:
Current assets...................................... $8,253 $8,553 $
Property and equipment, net......................... 29,837 29,837
Total assets........................................ 41,089 41,389
Current liabilities................................. 16,165 33,272
Long-term debt, less current portion................ 5,327 5,327
Total shareholders' equity.......................... 19,469 2,362
6
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(1) On January 1, 1998, we granted warrants to purchase 366,600 shares of
common stock at an exercise price of $0.0017 per share to David Moss, our
Vice President--Operations. These warrants expire on December 31, 2007. In
connection with the grant of these warrants, we recognized compensation
expense of $3,055,000 in 1998 representing the excess of the estimated fair
value of the shares over the exercise price. In 1999 our existing
shareholders committed to give 30,000 shares of their stock to a director
for services to us. For the year ended December 31, 1999 we recorded stock
related compensation expense of $720,000 for this commitment, based upon
the estimated fair value of the shares to be given.
(2) We executed license agreements with two developers of CD technology
effective June 1, 1996 and October 1, 1996, respectively. The agreements
set forth royalty rates payable to the licensors for the license to
manufacture and sell CDs. We reached settlements totaling $70,000 for CD
sales occurring before the effective dates of the agreements. Because of
the settlement amounts, our prior estimates of royalty liabilities were
overstated by approximately $3,770,000 and the adjustment to the accruals
was made in 1996.
(3) We have been exempt from paying federal income taxes and have paid certain
state income taxes at a reduced rate because of our S Corporation status.
Upon the completion of this offering, our S Corporation status will
terminate. Pro forma statement of income data reflect the income tax
expense recordable had we not been exempt from paying taxes under the S
Corporation election. Because of the termination of our S Corporation
status, we will be required to record a one-time, non-cash charge against
historical earnings for additional deferred taxes based upon the increase
in the effective tax rate from our S Corporation status (1.5%) to C
Corporation status (approximately 40%). This charge will occur in the
quarter during which our S Corporation status is terminated. If this charge
was recorded at December 31, 1999, the amount would have been approximately
$2.7 million.
(4) The pro forma balance sheet reflects (i) an accrual for the distribution of
retained earnings of approximately $14.4 million to our current
shareholders, including an amount for the purpose of paying income taxes on
S Corporation earnings and (ii) the recording of additional deferred taxes
of approximately $2.7 million based on the increase in the effective tax
rate upon our anticipated change from an S Corporation to a C Corporation.
(5) Adjusted for pro forma adjustments discussed above and to give effect to
the receipt and application of the estimated net proceeds of this offering,
including a deduction of $ to be paid to Averil Capital Markets Group,
Inc., a company controlled by one of our directors upon the closing of this
offering and the repayment of existing bank debt.
7
RISK FACTORS
You should carefully consider the following risk factors, in addition to the
other information in this prospectus, before purchasing shares of our common
stock. Each of these risk factors could adversely affect our business,
operating results and financial condition as well as adversely affect the value
of an investment in our common stock.
Risks Related to Our Business
We do not have long-term purchase contracts with our customers and
therefore our customers could stop doing business with us at any time.
Generally, we do not have agreements with our customers that contain purchase
commitments or guarantees for an ongoing business relationship. Accordingly,
our customers could stop doing business with us at any time and we cannot
guarantee an ongoing business relationship with our customers. Since we operate
with virtually no backlog, if a customer stops doing business with us, we may
not be able to replace the lost business with business from another existing
client or a new client. To the extent we are unable to replace the business,
some of our capacity would go unused, our revenues could decline and our
results of operations may be adversely affected.
Our focus on high volume customers results in customer concentration and
increases the likelihood that losing a single customer would have an
adverse impact on our revenues and results of operations.
As part of our business model, we seek to replicate DVDs and CDs for high
volume customers to reduce our marginal production costs. This strategy results
in customer concentration and has inherent risks. For example, our top three
customers, America Online, Inc., Modus Media International Holdings, Inc., and
Havas Interactive, Inc. accounted for approximately 56% of our net sales for
the year ended December 31, 1999. If we lose any of our large customers, our
revenues may be reduced and our operating results may be adversely impacted.
Additionally, the merger between America Online, Inc. and Time Warner may
result in the diversion of some replication business from us to Time Warner's
internal DVD and CD manufacturing operations.
If DVD and/or CD prices decline, our revenues and margins may be reduced
and our operating results may be adversely impacted.
Since the introduction of CD media in 1982, there has been a significant
growth in the CD replicating business, which has attracted numerous entrants
and resulted in increased worldwide CD production capacity. As a result of this
increased competition, wholesale CD prices have historically declined. If CD
prices decline further we may not be able to reduce our costs or increase our
volume to offset the decline in price. Additionally, if the acceptance of the
DVD medium continues to grow, the DVD replicating business may attract new
entrants, which may result in an increased worldwide DVD production capacity.
As a result, wholesale DVD prices may decline and we may not be able to reduce
our costs or increase our volume to offset the decline in price. These pricing
pressures in the DVD and CD replication business could reduce our revenues and
margins, which would adversely impact our operating results.
We may not succeed in developing a substantial DVD customer base, which
would adversely impact our growth strategy.
We commenced our DVD production in the fourth quarter of 1999. Our growth
strategy depends in part on our ability to attract additional DVD customers. We
believe motion picture producers and distributors, computer hardware
manufacturers and producers of computer software and games will primarily drive
DVD sales. Although we plan to expand our customer relationships, we will be
competing for DVD business with captive DVD manufacturers of major motion
picture companies and we may not be successful in attracting additional DVD
customers.
8
We may experience operational downtime if we are forced to move production
to another facility.
Since our business model is based on operating replicating facilities at a
single geographic locale to achieve efficiencies associated with high volume,
we will not be able to move production quickly to another facility if we
experience operational downtime or capacity reduction. Earthquakes, power
outages, or other events outside of our control could cause such operational
downtime or capacity reduction. Any operational downtime or capacity reduction
could result in the loss of major orders or customers and have a
disproportionate adverse impact on our business, financial condition and
results of operation.
We substantially depend upon our key personnel and they would be difficult
to replace.
We depend on our executive officers for our success and the loss of any of
these officers or key employees could disrupt our business. We depend on our
key executives, including Alex Sandel, who is our Chief Executive Officer and
David Moss, who is our Vice President--Operations. In addition to his
management duties, Mr. Sandel also plays a key role in our sales and marketing
efforts. We have entered into an employment agreement with Mr. Moss. In
addition, we have purchased $3 million of "key person" life insurance on each
of Messrs. Sandel and Moss, of which we are the sole beneficiary. However, in
the event of the death of either of these executive officers, the proceeds of
such insurance may not be sufficient to offset our loss.
Because our operating results may fluctuate and are unpredictable from
quarter to quarter, our share price may be adversely affected.
Our net sales, net income and results of operations have fluctuated from
quarter to quarter, and we expect these fluctuations to continue in the future
because of many factors, including:
. seasonal pattern of certain of the businesses we serve;
. timing of new product releases by our customers;
. commercial success of products offered by our customers;
. timing of expenses incurred to obtain and support new business; and
. general changes in economic and industry conditions.
The demand for DVDs and CDs is usually highest in the second half of the year
concurrent with the new school year and holiday gift purchases. This
seasonality could result in significant quarterly variations in financial
results, with the third and fourth quarters generally being the strongest.
Additionally, we anticipate that demand for DVDs will be somewhat dependent on
the timing of motion picture releases, with DVDs typically being released six
months following the theatrical release of a motion picture. We may not be able
to adequately reduce our costs on a timely basis if our revenues do not meet
expectations in any given quarter. In addition, historically our product mix
has been more heavily weighted to lower margin customers in the first six
months of each year. If our results of operations for any period fall below the
expectations of securities analysts or investors, the price of our common stock
could decline.
We heavily rely on our customers in the Internet and computer software
industries and our operations could be impaired if demand from such
industries drops.
Currently, a substantial portion of our sales is to Internet service
providers and computer software companies. We are dependent upon the continued
growth and financial stability of the Internet and computer software
industries, which may be affected by changes in any of the following:
. economic conditions;
. consumer trends and preferences;
. sales of personal computers;
. the installed base of CD-ROM and DVD drives in computers; and
. sales of interactive game consoles.
9
Our sales are also dependent upon the ability of software publishers to
create commercially successful content and Internet service providers
continuing to market their services through the mass distribution of CDs.
If we do not respond to technological change, we could lose customers and
our services could become obsolete.
The industries in which we compete are characterized by rapidly changing
technologies. We may not be able to successfully adapt our manufacturing
processes to new technologies. Additionally, we may not have the financial
resources to make the capital expenditures necessary for such adaptations or be
able to generate sufficient sales to recover these capital expenditures. If we
fail to keep pace with rapidly changing industry technology, we will be at a
competitive disadvantage and could lose customers. In addition, competing
technologies, such as broadband data delivery systems, may render our existing
and/or planned products and services obsolete.
Our future performance and profitability could be impaired if we are unable
to manage growth.
Our future performance and profitability will depend on a number of factors,
including our ability to obtain production machinery, and recruit, motivate and
retain qualified personnel. In addition, our performance will depend on whether
we are able to implement enhancements to our operational and financial systems,
including our reporting obligations for being a public company. Moreover, our
management and our administrative and financial resources may face significant
demands resulting from any future expansion, whether internally or through
acquisitions.
If we are unable to compete successfully against current and future
competitors our revenues and operating results could be impaired.
The DVD and CD replication industries are highly competitive. Our primary
competitors include the following DVD and/or CD replication companies:
AmericDisc; Carlton Communications PLC; Cinram International, Inc.; Denon
Electronics, Inc.; Disctronics, Inc.; DOCdata N.V.; JVC Corporation; and Zomax
Optical Media, Inc.
A number of these companies can handle large volume requirements and offer
services not currently offered by us. In addition to the above listed
companies, we compete with foreign manufacturers that can operate at lower
costs. To a limited extent, we compete with large captive manufacturing
divisions of major music and entertainment companies. Many of our existing
competitors and future potential competitors may be larger and more established
and have greater financial and other resources. As a result, such competitors
may respond more quickly than us to market demands or devote greater resources
to the manufacture, promotion and sale of their products.
We heavily depend on licenses for DVD and CD technology and we may not be
successful in obtaining and maintaining such licenses. We could incur
significant loss of revenues if we are unable to obtain and maintain such
licenses.
We cannot guarantee that we will successfully obtain and maintain licenses
for the patented technology we use. We manufacture CDs using patented
technology primarily under nonexclusive licenses from U.S. Philips Corporation
and Discovision Associates. These CD licenses generally provide for the payment
of royalties based upon the number, type and size of CDs sold. Our license from
Discovision Associates continues until the last patent covered by such license
expires and our license from U.S. Philips Corporation continues until the
earlier of October 1, 2006 or the expiration of the last patent covered by such
license.
In order to manufacture/replicate DVDs we must obtain licenses from U.S.
Philips Corporation and Sony Corporation for certain patented DVD technology.
We have entered into nonexclusive DVD licenses with U.S. Philips Corporation,
which continue until October 1, 2009. Additionally, we believe we have
finalized a nonexclusive DVD licensing agreement with Sony Corporation to use
Sony Corporation's patented DVD
10
technology. We are currently awaiting the receipt of the executed copy of this
DVD licensing agreement with Sony Corporation. These DVD licenses generally
provide for the payment of royalties based upon the number and type of DVDs
sold. We cannot assure you neither we nor our licensors will not be sued for
patent infringement and have to stop using the licensed technologies.
Our operating results could be impaired by burdensome environmental
regulation and other legal uncertainties.
Since the DVD and CD manufacturing processes involve the use of hazardous
materials, we are subject to federal, state and local regulations governing the
storage, use and disposal of hazardous materials. Our liability in the event of
an accident or the costs of remediation could exceed our resources or insurance
coverage. Also, we may have to incur substantial expenditures as a result of
having to engage in preventive or remedial action, having to reduce chemical
exposure or dealing with waste treatment or disposal.
Risks Related to this Offering and Our Common Stock
The rights of our shareholders could be adversely affected because our
founders control us.
Upon completion of this offering, two of our founders can elect or remove all
members of the board of directors and thereby control our affairs and
management. Moreover, upon completion of this offering, these two founders,
Alex Sandel and Jason Barzilay, will beneficially own approximately % ( % if
the underwriters' over-allotment option is exercised in full) of our
outstanding shares. As a result of such ownership, these founding shareholders,
acting together, can determine the outcome of elections and other matters
presented to our shareholders for approval. Such concentration of ownership may
cause any of the following:
. delay, defer or prevent a change in our control;
. adversely affect the voting and other rights of our other shareholders;
and
. depress the price of our common stock.
Our existing shareholders will receive substantial benefits from this
offering.
Our existing shareholders will receive substantial benefits from the sale of
our common stock in this offering. Specifically, we expect to use approximately
$27.9 million of the net proceeds from this offering to repay our borrowings
(including approximately $8.3 million which will be distributed to existing
shareholders for 1998 and 1999 S Corporation taxes) that our existing
shareholders personally guaranteed. Our existing shareholders will be released
from such guarantees when we repay our borrowings. Moreover, we expect to
distribute approximately $8.9 million of the net proceeds from this offering to
our existing shareholders as a distribution of retained earnings including an
amount for the purpose of paying income taxes on 2000 S Corporation earnings.
In addition, the selling shareholders will receive net proceeds of $ million
in the aggregate, and may benefit from increased liquidity of their remaining
investment in us resulting from this offering.
Purchasers in this offering will experience immediate and substantial
dilution.
If you purchase our common stock upon completion of this offering, you will
experience an immediate and substantial dilution in the pro forma net tangible
book value of the common stock from the initial public offering price. You will
sustain an immediate and substantial dilution of $ per share, (assuming an
initial public offering price of $ per share), based on the pro forma net
tangible book value at December 31, 1999 of $2.4 million. If outstanding stock
options and warrants are exercised then you will experience additional
dilution.
11
No prior public market exists for our common stock and no active trading
market may develop.
Prior to this offering our common stock has not had a public market.
Additionally, we cannot be certain that as a result of this offering an active
trading market for our common stock will develop, or if it develops whether it
will continue.
Our stock price could fluctuate and we cannot assure you that the shares
offered pursuant to this offering will trade at market prices in the range
of the initial public offering price.
The initial public offering price does not necessarily bear any relationship
to our book value, assets, past operating results, financial condition or any
other established criteria of value. The initial public offering price of the
shares of our common stock is negotiated with the selling shareholders and the
underwriters. The trading price of our common stock could be subject to wide
fluctuations in response to any of the following:
. variations in our operating results;
. announcements relating to our business (including new product
introductions by us or by our competitors);
. technological trends;
. securities analysts changing financial estimates;
. changes in the stock price or operating performance of other companies
investors may deem comparable to us;
. changes in general economic conditions or the financial markets; and
. changes in the manufacturing or retail industries.
Sales of additional shares of our common stock into the public market may
cause our stock price to fall.
Upon completion of this offering, we will have shares of common stock
outstanding ( if the underwriters' over-allotment option is exercised in
full). Of those shares, a total of shares (plus additional shares if
the underwriters exercise their over-allotment option in full) will be freely
tradeable without restriction or further registration under the Securities Act
of 1933, as amended, unless purchased or held by our affiliates as that term is
defined in Rule 144 under the Securities Act. Pursuant to Rule 144, sales of
common stock by our affiliates are subject to the volume limitations, manner of
sale, and notice requirements. All of our executive officers, directors and
shareholders, including the selling shareholders, will execute lock-up
agreements under which they will agree to not sell or otherwise transfer,
directly or indirectly, any shares of common stock or any securities
convertible into, or exercisable or exchangeable for, any shares of common
stock for a period of 180 days after the date of this prospectus without the
prior written consent of Prudential Securities Incorporated, on behalf of the
underwriters. After the expiration of the 180-day period, shares that can be
sold under Rule 144 will be eligible for sale. Prudential Securities
Incorporated may, in its sole discretion, at any time and without notice,
release all or any portion of the shares of our common stock subject to these
lock-up agreements. Sales of substantial amounts of our common stock in the
public market, or the perception sales could occur, could adversely affect the
prevailing market price for the common stock and could impair our ability to
raise capital through a public offering of equity securities.
Number of shares Date of availability for resale into public market
---------------- --------------------------------------------------
9,000,000 180 days after the date of this prospectus due to a lock-up
agreement our two existing shareholders have with
Prudential Securities. However, Prudential Securities can
waive this restriction at any time and without notice.
Since these shares are held by our affiliates, sales of
these shares will also be subject to the volume limitations
of Rule 144.
12
Provisions in our charter documents could deter takeover efforts or depress
our stock price.
Provisions of our Articles of Incorporation, Bylaws and California law could
make it more difficult for a third party to acquire us, even if doing so would
be beneficial to our shareholders. The rights of the holders of common stock
will be subject to, and may be adversely affected by, the rights of the holders
of any preferred stock issued in the future. Our board of directors has the
authority to issue up to 5,000,000 shares of preferred stock and to determine
the price, rights, preferences, privileges and restrictions, including voting
rights, of those shares without any further vote or action by our shareholders.
Following this offering, we will not have any shares of preferred stock
outstanding and we have no present intention to issue any shares of preferred
stock. However, preferred stock could be issued with voting, liquidation,
dividend and other rights superior to those of the common stock. An issuance of
preferred stock could make it more difficult for a third party to acquire a
majority of our outstanding voting stock, which may depress the market value of
our common stock.
Provisions of our Articles of Incorporation make it difficult for minority
shareholders to obtain representation on the board of directors. Our Articles
of Incorporation provide cumulative voting rights of shareholders, which cease
at such time we have 800 or more holders of our common stock as of the record
date of our most recent annual meeting of shareholders. This provision has the
effect of making it more difficult for minority shareholders to obtain
representation on the board of directors once we have 800 or more shareholders.
FORWARD-LOOKING STATEMENTS
This prospectus includes forward-looking statements. We have based these
forward-looking statements largely on our current expectations and projections
about future events and financial trends affecting the financial condition of
our business. These forward-looking statements are subject to a number of
risks, uncertainties and assumptions about us, including, among other things:
. general economic and business conditions, both nationally and in our
markets;
. our expectations and estimates concerning future financial performance,
financing plans and the impact of competition;
. anticipated trends in our business;
. existing and future regulations affecting our business;
. successful implementation of our business strategy;
. our relationship with large customers;
. fluctuations in our operating results;
. increasing adoption of alternative data delivery systems;
. technological trends in the DVD and CD industries; and
. other risk factors described under "Risk Factors" in this prospectus.
In addition, in this prospectus, the words "believe," "may," "will,"
"estimate," "continue," "anticipate," "intend," "expect" and similar
expressions, as they relate to us, our business or our management, are intended
to identify forward-looking statements.
We undertake no obligation to publicly update or revise any forward-looking
statements, whether as a result of new information, future events or otherwise
after the date of this prospectus. Because of these risks and uncertainties,
the forward-looking events and circumstances discussed in this prospectus may
not occur and actual results could differ materially from those anticipated or
implied in the forward-looking statements.
13
TERMINATION OF S CORPORATION STATUS
We have been treated as an S Corporation since our inception. As a result,
our shareholders have been directly taxed on our earnings for federal income
tax purposes instead of us. Other than a tax imposed on S Corporations by the
State of California (currently 1.5% of income), our shareholders have also been
responsible for state income taxes on earnings. Such taxation of our
shareholders will continue through the date immediately preceding the date of
termination of our S Corporation status. The termination date will occur
immediately prior to the closing of this offering. On the termination date, we
will become a C Corporation for tax purposes and be subject to federal and
state corporate income taxes.
From January 1, 2000 through the date of this prospectus we paid an aggregate
of approximately $2.3 million in dividends to our shareholders. From the date
of this prospectus through April 2000 we expect to pay approximately $6.0
million in additional dividends to our shareholders. Out of the proceeds of
this offering, we expect to pay approximately $8.9 million in dividends to our
shareholders, including approximately $1.8 million for the purpose of paying S
Corporation taxes. Pursuant to our current loan agreement with Greyrock, we may
not declare or pay any dividends or make any distribution without the prior
written consent of Greyrock, except for distributions to existing shareholders
for the purpose of paying income taxes on our S Corporation earnings.
We have entered into a tax indemnification agreement with our existing
shareholders relating to their respective income tax liabilities. The tax
indemnification agreement is intended to assure we assume the taxes on the one
hand and our existing shareholders assume certain taxes on the other only to
the extent such parties received the related income giving rise to such taxes.
The tax indemnification agreement generally provides, if an adjustment is made
to our taxable income for a year in which we were treated as an S Corporation,
we will indemnify our existing shareholders and our existing shareholders will
indemnify us against any increase in indemnified party's income tax liability
(including interest and penalties and related costs and expenses), with respect
to any tax year to the extent such increase results in a related decrease in
the income tax liability of the indemnifying party for any year. We will also
indemnify the existing shareholders for all taxes imposed upon them as the
result of their receipt of an indemnification payment under the tax
indemnification agreement. Any payment made by us to the existing shareholders
pursuant to the tax indemnification agreement may be considered by the Internal
Revenue Service or state taxing authorities to be non-deductible by us for
income tax purposes.
14
USE OF PROCEEDS
The net proceeds to us from this offering, at an assumed initial public
offering price of $ per share, are estimated to be approximately $
million, $ million if the underwriters' over-allotment options from us are
exercised in full, after deducting the underwriting discounts and commissions
and estimated offering expenses.
We expect to use a portion of the net proceeds to repay all existing bank
debt to Greyrock Capital, a division of Banc of America Commercial Finance
Corporation, in an amount estimated to be approximately $27.9 million at
closing. The bank debt was used to purchase capital equipment, to pay a
distribution to the existing shareholders and for general corporate purposes.
The existing shareholders have personally guaranteed repayment of the bank debt
and upon repayment of the loan from Greyrock, the shareholder guarantees will
terminate.
We also expect to use approximately $14.1 million to purchase capital
equipment.
We also plan to distribute $ 8.9 million to our existing shareholders as a
distribution of the retained earnings through the closing of this offering,
including an amount for the purpose of paying income taxes on our S Corporation
earnings.
In addition, upon the closing of this offering we plan to pay $ to
Averil Capital Markets Group, Inc., for services rendered in connection with
this offering. Averil Capital Markets Group, Inc., is a financial advisory firm
founded and controlled by Diana Maranon, who is one of our directors.
The balance of the net proceeds will be used for working capital and general
corporate purposes, including potential strategic investments. Pending such
uses, we intend to invest the net proceeds in short-term, interest bearing
securities or guaranteed obligations of the United States government.
We will not receive any proceeds from the sale of shares by the selling
shareholders.
DIVIDEND POLICY
Historically we have paid cash dividends when operating as an S Corporation.
However, other than paying approximately $8.9 million out of the net proceeds
of this offering to our existing shareholders as a distribution of retained
earnings, including an amount for the purpose of paying income taxes on S
Corporation earnings, we have no current intention to declare or pay dividends
on our common stock following our conversion to C Corporation status. Instead,
we intend to follow a policy of retaining earnings to finance the growth of our
business. Our board of directors will have the discretion to determine any
future dividend payments and such discretion may depend on the following: our
results of operations; our financial condition; contractual and legal
restrictions; and other factors our board of directors deems relevant.
Pursuant to our current loan agreement with Greyrock, we may not declare or
pay any dividends or make any distribution without the prior written consent of
Greyrock, except for distributions to existing shareholders for the purpose of
paying income taxes on our S Corporation earnings.
15
DILUTION
Purchasers of our common stock in this offering will experience immediate and
substantial dilution in the pro forma net tangible book value of our common
stock from the initial public offering price. The pro forma net tangible book
value of our common stock as of December 31, 1999 was $2.4 million. Pro forma
net tangible book value per share is equal to our total tangible assets, less
total liabilities, divided by the number of shares of common stock outstanding,
after giving effect to (i) the distribution by us of approximately
$14.4 million to our existing shareholders as a retained earnings distribution,
including an amount for the purpose of paying income taxes on S Corporation
earnings, and (ii) the recording by us of additional deferred taxes as if we
were treated as a C Corporation at December 31, 1999. After giving effect to
the sale of shares of common stock by us and the receipt and application
of the estimated net proceeds, assuming an initial public offering price of
$ per share, after deducting the underwriting discounts and commissions
and estimated offering expenses, including an amount of $ to be paid to
Averil Capital Markets Group, Inc., a company controlled by one of our
directors upon the closing of this offering, our pro forma net tangible book
value as of December 31, 1999 would have been approximately $ or
$ per share. This represents an immediate increase in net tangible book
value of $ per share to our current shareholders and an immediate and
substantial dilution of $ per share to new shareholders purchasing
shares in this offering. The following table illustrates this per share
dilution:
Assumed initial public offering price.......................... $
Pro forma net tangible book value as of December 31, 1999.... $0.26
Increase attributable to new shareholders....................
-----
Pro forma net tangible book value as of December 31, 1999 after
the offering..................................................
-----
Dilution to new shareholders................................... $
=====
The following table summarizes a comparison of the number of shares of common
stock acquired from us, the percentage ownership of such shares, the total
consideration, the percentage of total consideration and the average price per
share paid by the existing shareholders and by the investors purchasing shares
of common stock in this offering, before the deduction of underwriting
discounts and commissions and offering expenses.
Total
Shares Purchased Consideration Average
----------------- --------------- Price Per
Number Percent Amount Percent Share
--------- ------- ------- ------- ---------
Current shareholders............. 9,000,000 % $15,000 % $--
New investors.................... $
--------- ----- ------- ----- ----
100.0% $ 100.0%
========= ===== ======= ===== ====
The foregoing tables and calculations assume no exercise of outstanding
options under our 1998 stock incentive plan and no exercise of the warrants
granted to David Moss. At the date of this prospectus, 828,000 shares of common
stock were subject to outstanding options under our 1998 stock incentive plan
at a weighted average exercise price of $11.35 per share and 366,600 shares of
common stock were issuable upon exercise of the warrants held by David Moss at
an exercise price of $0.0017 per share. To the extent options or warrants are
exercised, there will be further dilution to new investors.
16
CAPITALIZATION
The following table sets forth our capitalization as of December 31, 1999 on
(i) an actual basis; (ii) on a pro forma basis to give effect to the accrual
for the payment of $14.4 million to our current shareholders as a distribution
of retained earnings, including an amount for the purposes of paying income
taxes on S Corporation earnings and the recording of additional deferred taxes
of approximately $2.7 million based on the increase in the effective tax rate
upon our anticipated change from an S Corporation to C Corporation; and
(iii) pro forma as adjusted to reflect the pro forma adjustments and to give
effect to our receipt of approximately $ million in estimated net proceeds
from this offering, including a deduction of $ to be paid to Averil Capital
Markets Group, Inc., a company controlled by one of our directors upon the
closing of this offering and the application of these net proceeds, including
the repayment of existing bank debt of $9.8 million at December 31, 1999, of
which $5.3 million was classified as long-term debt.
At December 31, 1999
-----------------------------
Pro Pro Forma
Actual Forma As Adjusted
------- ------- -----------
(in thousands)
Long-term debt, less current portion............. $ 5,327 $ 5,327 $
------- ------- ----
Shareholders' equity(1):
Preferred Stock, no par value;
5,000,000 shares authorized; no shares issued
or outstanding actual, pro forma or pro
forma as adjusted........................... -- --
Common Stock, no par value;
45,000,000 shares authorized; 9,000,000
shares issued and outstanding actual and pro
forma; shares outstanding pro
forma as adjusted........................... 3,790 3,790
Note receivable from officer................... (1,428) (1,428)
Retained earnings.............................. 17,107 --
------- ------- ----
Total shareholders' equity................. 19,469 2,362
------- ------- ----
Total capitalization....................... $24,796 $ 7,689 $
======= ======= ====
- --------
(1) Does not include: (a) 1,200,000 shares of common stock available for
issuance pursuant to our 1998 stock incentive plan, of which 828,000 shares
were subject to outstanding options as of the date of this prospectus at a
weighted average exercise price of $11.35 per share; and (b) 366,600 shares
of common stock issuable upon exercise of warrants issued to David Moss,
our Vice President--Operations, at an exercise price of $0.0017 per share.
17
SELECTED FINANCIAL DATA
We derived the statement of income data for the years ended December 31,
1997, 1998 and 1999 and the balance sheet data as of December 31, 1998 and 1999
presented below from our financial statements included in another part of this
prospectus. The statement of income data for the years ended December 31, 1995
and 1996 and the balance sheet data as of December 31, 1995, 1996 and 1997 are
derived from our audited financial statements not included in this prospectus.
The financial statements as of and for the years ended December 31, 1997, 1998
and 1999 have been audited by Ernst & Young, LLP, independent auditors. You
should read the selected financial data together with the historical financial
statements and related notes to our audited reports, as well as the section
included in this prospectus entitled "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
Year Ended December 31
-------------------------------------------
1995 1996 1997 1998 1999
------- ------- ------- ------- -------
(in thousands, except per share data)
Statement of Income Data:
Net sales........................ $26,972 $25,814 $36,042 $43,311 $53,002
Cost of goods sold............... 14,821 11,972 23,132 27,304 31,938
------- ------- ------- ------- -------
Gross profit..................... 12,151 13,842 12,910 16,007 21,064
Selling, general and
administrative expenses......... 6,093 2,537 4,214 4,232 4,201
Stock related compensation
expense(1)...................... -- -- -- 3,055 720
Abandoned offering costs......... -- -- -- 676 --
------- ------- ------- ------- -------
Income from operations........... 6,058 11,305 8,696 8,044 16,143
Interest income.................. 12 252 42 35 1
Interest expense................. (957) (1,108) (818) (1,264) (1,404)
Change in accounting estimate for
royalties(2).................... -- 3,770 -- -- --
------- ------- ------- ------- -------
Income before state income
taxes........................... 5,113 14,219 7,920 6,815 14,740
Provision for state income
taxes........................... 72 223 120 102 2
------- ------- ------- ------- -------
Net income....................... $ 5,041 $13,996 $ 7,800 $ 6,713 $14,738
======= ======= ======= ======= =======
Earnings per share:
Basic........................... $ 0.56 $ 1.56 $ 0.87 $ 0.75 $ 1.64
======= ======= ======= ======= =======
Diluted......................... $ 0.56 $ 1.56 $ 0.87 $ 0.71 $ 1.43
======= ======= ======= ======= =======
Shares used in computing earnings
per share:
Basic........................... 9,000 9,000 9,000 9,000 9,000
======= ======= ======= ======= =======
Diluted......................... 9,000 9,000 9,000 9,498 10,336
======= ======= ======= ======= =======
Pro Forma Statement of Income
Data(3)(unaudited):
Pro forma net income data:
Income before provision for
income taxes.................... $14,740
Pro forma income tax provision... 5,896
-------
Pro forma net income............. $ 8,844
=======
Pro forma basic earnings per
share........................... $ 0.98
=======
Pro forma diluted earnings per
share........................... $ 0.86
=======
Weighted average shares
outstanding--basic.............. 9,000
=======
Weighted average shares
outstanding--diluted............ 10,336
=======
December 31, December 31, 1999
------------------------------- -------------------------------------
Pro Forma
1995 1996 1997 1998 Actual Pro Forma (4) As Adjusted (5)
------- ------- ------- ------- ------- ------------- ---------------
(in thousands, except per share data)
Balance Sheet Data:
Current assets.......... $10,846 $11,252 $ 8,036 $ 9,204 $ 8,253 $ 8,553
Property and equipment,
net.................... 11,896 12,097 17,636 21,898 29,837 29,837
Total assets............ 22,909 24,155 25,920 31,438 41,089 41,389
Current liabilities..... 12,839 8,865 14,132 16,246 16,165 33,272
Long term debt, less
current portion........ 4,750 2,129 1,755 9,085 5,327 5,327
Total shareholders'
equity................. 5,305 13,144 9,936 5,999 19,469 2,362
Dividends per share..... -- .68 1.22 1.52 .06 --
18
- --------
(1) On January 1, 1998, we granted warrants to purchase 366,600 shares of
common stock at an exercise price of $0.0017 per share to David Moss, our
Vice President--Operations. These warrants expire on December 31, 2007. In
connection with the grant of these warrants, we recognized compensation
expense of $3,055,000 in 1998 representing the excess of the estimated fair
value of the shares over the exercise price. In 1999 our existing
shareholders committed to give 30,000 shares of their stock to a director
for services to us. For the year ended December 31, 1999 we recorded stock
related compensation expense of $720,000 for this commitment, based upon
the estimated fair value of the shares to be given.
(2) We executed license agreements with two developers of CD technology
effective June 1, 1996 and October 1, 1996, respectively. The agreements
set forth royalty rates payable to the licensors for the license to
manufacture and sell CDs. We reached settlements totaling $70,000 for CD
sales occurring before the effective dates of the agreements. Because of
the settlement amounts, our prior estimates of royalty liabilities were
overstated by approximately $3,770,000 and the adjustment to the accruals
was made in 1996.
(3) We have been exempt from paying federal income taxes and have paid certain
state income taxes at a reduced rate because of our S Corporation status.
Upon the completion of this offering, our S Corporation status will
terminate. Pro forma statement of income data reflect the income tax
expense recordable had we not been exempt from paying taxes under the S
Corporation election. Because of the termination of our S Corporation
status, we will be required to record a one-time, non-cash charge against
historical earnings for additional deferred taxes based upon the increase
in the effective tax rate from our S Corporation status (1.5%) to C
Corporation status (approximately 40%). This charge will occur in the
quarter during which our S Corporation status is terminated. If this charge
was recorded at December 31, 1999, the amount would have been approximately
$2.7 million. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and Notes 1 and 7 to the December 31,
1999 financial statements.
(4) The pro forma balance sheet reflects (i) an accrual for the distribution of
retained earnings of approximately $14.4 million to our current
shareholders, including an amount for the purpose of paying income taxes on
S Corporation earnings and (ii) the recording of additional deferred taxes
of approximately $2.7 million based on the increase in the effective tax
rate upon our anticipated change from an S Corporation to a C Corporation.
(5) Adjusted for pro forma adjustments discussed above and to give effect to
the receipt and application of the net proceeds of this offering, including
a deduction of $ to be paid to Averil Capital Markets Group, Inc., a
company controlled by one of our directors upon the closing of this
offering and the repayment of existing bank debt.
19
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with the
"Selected Financial Data" and the financial statements and related notes, which
are included in this prospectus.
Results of Operations
Sales are generally recorded at the time of shipment. However, in certain
instances, sales are recognized upon completion of an order, prior to shipment,
if the risks of ownership have passed to the customer. In these circumstances,
which have been insignificant at the end of reporting periods, we obtain
written instructions from the customer to hold the product for future shipment.
Cost of goods sold consists primarily of the following:
. raw materials;
. direct labor;
. depreciation of plant equipment;
. repairs and maintenance of plant equipment;
. royalties payable on the sale of DVDs and CDs; and
. rent and utilities related to the plant facility.
In addition to changes in these costs, our cost of goods sold as a percentage
of net sales are affected by various factors, including the following:
. DVD and CD units manufactured and associated number of units sold as a
percentage of our total DVD and CD production capacity in any period,
which directly affects gross margin due to the high component of fixed
costs inherent in our operations;
. average unit prices we are able to charge for our products, which are
subject to market conditions; and
. raw material packaging costs and associated direct labor costs required
to fulfill customer orders during any particular period.
Quarterly Results
The following table sets forth certain unaudited statement of income data for
the last eight quarters and has been prepared on the same basis as the annual
information and in management's opinion includes all adjustments necessary to
present fairly the information for each of the quarters below.
Three Months Ended
--------------------------------------------------------------------------------------
1998 1999
------------------------------------------- ------------------------------------------
March 31 June 30 September 30 December 31 March 31 June 30 September 30 December 31
-------- ------- ------------ ----------- -------- ------- ------------ -----------
(in thousands)
Net sales............... $ 6,915 $9,794 $12,025 $14,577 $8,675 $11,313 $14,960 $18,054
Cost of goods sold...... 4,634 6,389 7,727 8,554 5,864 6,744 9,283 10,047
------- ------ ------- ------- ------ ------- ------- -------
Gross profit............ 2,281 3,405 4,298 6,023 2,811 4,569 5,677 8,007
Selling, general and
administrative
expenses............... 861 1,146 812 1,413 1,072 1,030 888 1,211
Stock related
compensation expense... 3,055 -- -- -- -- -- -- 720
Abandoned offering
costs.................. -- -- -- 676 -- -- -- --
------- ------ ------- ------- ------ ------- ------- -------
Income (loss) from
operations............. (1,635) 2,259 3,486 3,934 1,739 3,539 4,789 6,076
Interest income......... -- 15 20 -- -- 24 28 (51)
Interest expense........ (131) (317) (416) (400) (351) (330) (372) (351)
------- ------ ------- ------- ------ ------- ------- -------
Income (loss) before
state income taxes..... (1,766) 1,957 3,090 3,534 1,388 3,233 4,445 5,674
Provision (benefit) for
state income taxes..... (16) 19 46 53 -- -- 1 1
------- ------ ------- ------- ------ ------- ------- -------
Net income (loss)....... $(1,750) $1,938 $ 3,044 $ 3,481 $1,388 $ 3,233 $ 4,444 $ 5,673
======= ====== ======= ======= ====== ======= ======= =======
20
We have experienced, and expect to experience in the future, quarterly
variations in revenues and earnings as a result of various factors, many of
which are outside our control, including:
.seasonal patterns of certain of the businesses we serve;
.timing of new product releases by our customers;
.commercial success of products offered by our customers;
.timing of expenses incurred to obtain and support new business; and
.general changes in economic and industry conditions.
Typically, we experience increased demand for our products in our third and
fourth quarters. Such increase is primarily due to the release of new products
by our customers for the new school year and the holiday season.
Yearly Results
The following table provides certain statement of income data expressed as a
percentage of net sales for the specified periods.
Year Ended December 31
-------------------------
1997 1998 1999
------- ------- -------
Net sales............................................ 100.0% 100.0% 100.0%
Cost of goods sold................................... 64.2 63.0 60.3
------- ------- -------
Gross profit......................................... 35.8 37.0 39.7
Selling, general and administrative expenses......... 11.7 9.8 7.9
Stock related compensation expense................... -- 7.1 1.4
Abandoned offering costs............................. -- 1.6 --
------- ------- -------
Income from operations............................... 24.1 18.5 30.4
Interest income...................................... 0.1 0.1 --
Interest expense..................................... (2.2) (2.9) (2.6)
------- ------- -------
Income before state income taxes..................... 22.0 15.7 27.8
Provision for state income taxes..................... 0.3 0.2 --
------- ------- -------
Net income........................................... 21.7% 15.5% 27.8%
======= ======= =======
As shown by the above table, over the last three years, as a percentage of
sales our gross profit margins have increased from 35.8% in 1997 to 39.7% in
1999. In addition our selling, general and administrative expenses have
decreased as a percentage of sales from 11.7% in 1997 to 7.9% in 1999. These
favorable trends are a result of the fact that our business has a high
percentage of fixed costs, both in costs of goods sold, which directly effects
our gross profit, and in selling, general and administrative expenses.
Therefore, by increasing revenues, our costs as a percentage of revenues tend
to decrease resulting in higher income from operations as a percentage of
sales.
Year Ended December 31, 1999 Compared to Year Ended December 31, 1998
Net Sales. Net sales totaled $53,001,871 for the year ended December 31, 1999
as compared to $43,311,180 for the year ended December 31, 1998. This
represents an increase of $9,690,691 or 22.4% for the year ended December 31,
1999, as compared to the year ended December 31, 1998. This increase is a
result of increased CD unit sales of approximately 26.3%, partially offset by
lower packaging revenues. Our pricing is comprised of a price for the unit (CD
or DVD) and a price for packaging, when our customers request this service.
While our unit prices for CDs remained constant during 1999 as compared to
1998, our packaging revenues decreased by approximately $3,048,011. The
additional CD unit sales during 1999 are a result of increased demand for our
products with fulfillment of these orders made possible by production capacity
added subsequent to 1998. In addition, we commenced production and shipment of
DVDs during the fourth quarter of 1999, which added $2,718,333 to revenues for
the year.
21
Cost of Goods Sold. Cost of goods sold was $31,937,704 for the year ended
December 31, 1999 and $27,304,178 for the year ended December 31, 1998. Cost of
goods sold as a percentage of sales was approximately 60.3% for the year ended
December 31, 1999 as compared to 63.0% for the year ended December 31, 1998. As
a percentage of sales in 1999, our raw materials costs decreased 4.8% and
shipping costs decreased 0.7%, partially offset by increases in depreciation
expense of 1.3%, factory overhead of 1.9% and royalties of 0.5%.
Gross Profit. Gross profit for the year ended December 31, 1999 was
$21,064,167 or 39.7% of net sales as compared to $16,007,002 or 37.0% of net
sales for the year ended December 31, 1998. Our gross profit increased because
our volume of CD and DVD units sold increased, in line with our business model,
as a result of the increased production capacity we added during 1999.
Selling, General and Administrative Expenses. As a percentage of net sales,
selling, general and administrative expenses decreased from 9.8% for the year
ended December 31, 1998 to 7.9% for the year ended December 31, 1999. Selling,
general and administrative expenses were $4,200,969 for the year ended December
31, 1999 as compared to $4,232,741 for the year ended December 31, 1998, a
decrease of $31,772 or approximately 0.8%. This decrease is the net result of
reduced amounts paid for consulting fees (approximately $396,000), taxes and
licenses (approximately $107,000) and miscellaneous items (approximately
$147,000), offset by higher amounts paid for salaries and related benefits
(approximately $486,000) and office related expenses (approximately $132,000)
in 1999.
Stock Related Compensation Expense. In 1999 our existing shareholders
committed to give 30,000 shares of their stock to a director for services to
us. For the year ended December 31, 1999 we recorded compensation expense of
$720,000 for this commitment, based upon the estimated fair value of the shares
to be given. On January 1, 1998, we granted warrants to purchase 366,600 shares
of stock at $0.0017 per share to one of our officers, with the warrants
expiring on December 31, 2007. In connection with these warrants, we recognized
compensation expense for $3,055,000 in 1998 representing the excess of the
estimated fair value of the shares over the exercise price.
Income from Operations. Income from operations totaled $16,143,198 for the
year ended December 31, 1999 and $8,043,528 for the year ended December 31,
1998. This represents an increase of $8,099,670 or 100.7% for the year ended
December 31, 1999, as compared to the year ended December 31, 1998. Income from
operations was 30.4% of net sales for the year ended December 31, 1999 and
18.5% of net sales for the year ended December 31, 1998. Excluding the stock
related compensation expense in 1999 and 1998 and abandoned offering costs
recognized in 1998, income from operations would have been 16,863,198 or 31.8%
of net sales in 1999 and $11,774,261 or 27.2% of net sales in 1998. As a
result, income from operations in 1999 as compared to 1998 would have increased
$5,088,937 or 43.2%.
Interest Expense. Interest expense was $1,403,694 for the year ended December
31, 1999 and $1,263,861 for the year ended December 31, 1998. The increase of
11.1% in 1999 as compared to 1998 is the net result of higher average
borrowings during 1999, partially offset by lower average interest rates. Our
weighted average interest rate on our debt was 10.1% for the year ended
December 31, 1999 and 10.4% for the year ended December 31, 1998.
Income Tax Expense. We have operated as an S Corporation for federal and
state income tax purposes, and accordingly we are not subject to federal taxes
and subject to only a minimal percentage of state income taxes. The only
provision for income taxes was the amount required for state income tax
purposes. Our total income tax expense was $2,000 for the year ended December
31, 1999 due to our S Corporation status and credits we receive for state taxes
for purchases of manufacturing equipment.
Net Income. Based on our S Corporation status and the factors discussed
above, net income was $14,738,174 for the year ended December 31, 1999 and
$6,712,633 for the year ended December 31, 1998. This represents an increase of
$8,025,541 or 119.6% for the year ended December 31, 1999 as compared to the
year ended December 31, 1998.
22
Year Ended December 31, 1998 Compared to Year Ended December 31, 1997
Net Sales. Net sales for the year ended December 31, 1998 totaled $43,311,180
compared to net sales for the year ended December 31, 1997, which totaled
$36,042,427. This increase of $7,268,753, or 20.2%, is attributable to an
increase in the number of CDs sold of approximately 55.9%, offset by lower
average CD sales prices for the year ended December 31, 1998 compared to 1997.
Our pricing is comprised of a price for the unit (CD) and a price for
packaging, when our customers request this service. Our average unit price
declined in 1998 as compared to 1997 by approximately 14.8%. In addition, our
packaging revenues decreased by $1,384,468 in 1998 from the amounts in 1997.
The additional unit sales during 1998 are a result of increased demand for our
products with fulfillment of these orders made possible by production capacity
added subsequent to 1997.
Cost of Goods Sold. Cost of goods sold for the year ended December 31, 1998
totaled $27,304,178 or 63.0% of net sales, compared to $23,132,442 or 64.2% of
net sales for the year ended December 31, 1997. As a percentage of net sales,
increases in cost of sales in the year ended December 31, 1998 were related to
increases in royalties of 2.2% and depreciation of production equipment of
1.3%, offset by decreases in factory overhead of 2.3%, raw material costs of
1.0% and obsolescence reserves of 1.4%.
Gross Profit. Because of the foregoing, gross profit for the year ended
December 31, 1998 was $16,007,002, as compared to $12,909,985 for the year
ended December 31, 1997, an increase of $3,097,017 or 24.0%. As a percentage of
net sales, gross profit was 37.0% in 1998 as compared to 35.8% in 1997.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses were $4,232,741 for the year ended December 31, 1998
and $4,214,033 for the year ended December 31, 1997. This represents an
increase of $18,708 or less than 1.0% in 1998 over 1997. As a percentage of net
sales, selling, general and administrative expenses decreased from 11.7% for
the year ended December 31, 1997 to 9.8% for the year ended December 31, 1998.
Income from Operations. Because of the above items, income from operations
was $8,043,528 for the year ended December 31, 1998 and $8,695,952 for the year
ended December 31, 1997, a decrease of $652,424 or 7.5%. As a percentage of net
sales, income from operations was 18.6% in 1998 and 24.1% in 1997. Excluding
the stock warrant compensation expense and abandoned offering costs recognized
in the year ended December 31, 1998, income from operations would have been
$11,774,261 or 27.2% of net sales. This represents an increase of $3,078,309 or
35.4% of the amount in 1997.
Interest Expense. Interest expense totaled $1,263,861 for the year ended
December 31, 1998 and $817,998 for the year ended December 31, 1997. This
increase in 1998 of $445,863, or 54.5%, is a result of higher average
borrowings in 1998 as compared to 1997. The weighted average interest rate on
our debt was 10.4% for the year ended December 31, 1998 and 10.5% for the year
ended December 31, 1997.
Income Tax Expense. We have operated as an S Corporation for federal and
state income tax purposes, and accordingly we were not subject to federal taxes
and we were only subject to a minimal percentage (1.5% of pretax income) of
state income taxes. The only provision for income taxes was the amount required
for state income tax purposes.
Net Income. Because of the items discussed above, net income was
approximately $6,712,633 for the year ended December 31, 1998 and was
approximately $7,800,159 for the year ended December 31, 1997, a decrease of
$1,087,526 or 13.9%.
23
Liquidity and Capital Resources
Historically we have funded our operations and capital expenditures through
cash flow from operations, borrowings under our lines of credit and favorable
terms from our equipment vendors for the purchase of equipment used in our
manufacturing operations. In February 1997, we entered into a credit agreement
with Greyrock Capital, a division of Banc of America Commercial Finance
Corporation ("Greyrock"), which was amended in January 1998 and further amended
in April 1998, July 1998, June 1999 and January 2000. The credit agreement
currently provides (i) receivable loans based on 80% of our eligible
receivables, (ii) equipment loans based on 90% of the net purchase price of new
equipment purchased and delivered subsequent to June 1999 and (iii) additional
revolving loans. Under the credit agreement we are allowed to borrow the lower
of $30,000,000, or an amount equal to 80% of our eligible receivables and up to
$15,000,000 of equipment loans plus the unpaid balance of the revolving loans.
The credit agreement had an original maturity date of February 28, 1998 and
provided for automatic renewals. In January 2000, the maturity date was
extended to June 30, 2001, and continues to provide for automatic renewals. The
credit agreement is secured by accounts receivable, equipment, inventory and
other assets and is personally guaranteed by our existing shareholders. Unlike
a typical revolving loan or line of credit, loans under the Greyrock credit
agreement are advanced at Greyrock's sole discretion. Accordingly, there can be
no guarantee that funds will be available under this credit agreement in the
future. We do not pay any commitment fees for the unused portion of the credit
facility.
Borrowings under receivable loans bear interest at the prime rate (8.5% at
December 31, 1999) plus 2.0% per annum; however, the interest rate will not be
less than 7.0% per annum. At December 31, 1999 there was a total of $1,852,303
borrowed under the receivable loans.
Under the amendment of April 1998, the revolving loans were for up to
$15,000,000, payable in monthly principal installments of $312,500 through (i)
the earlier of the date the credit agreement terminates, or is terminated, or
(ii) April 2002. In addition, this amendment disallowed any distributions to
shareholders except for the purpose of paying income taxes on S corporation
earnings. We obtained permission from Greyrock for the loans and advances to
related parties that are described in Certain Relationships and Related
Transactions. The revolving loans bear interest at the prime rate (8.5% at
December 31, 1999) plus 2.0% per annum; however the interest rate will not be
less than 7.0% per annum. The outstanding balance of the revolving loans was
$9,062,500 at December 31, 1999.
Under the amendment of June 1999, amounts borrowed under the equipment loans
are to be repaid in 48 equal monthly payments of principal through the earlier
of (i) the earlier of the date the credit agreement terminates, or is
terminated or (ii) the date such equipment loans have been repaid in full. The
equipment loans bear interest at the prime rate (8.5% at December 31, 1999)
plus 2.0% per annum; however, the interest rate will not be less than 7.0% per
annum. At December 31, 1999 no amounts had been borrowed under the equipment
loans.
As of December 31, 1999 we had available a total of $8,978,932 under the
credit facility, of which $5,457,420 was available on the equipment loans and
$3,521,512 was available under the receivable loans. We expect to use a portion
of our net proceeds from this offering to repay all amounts outstanding under
the credit agreement. We expect to maintain a $30 million credit facility with
Greyrock or another lender.
Net cash provided by operating activities was $23,046,306 for the year ended
December 31, 1999. We spent a net amount of $5,667,671 in financing activities
for the year ended December 31, 1999. This amount results mainly from repayment
of long-term debt of $3,756,986, loans to an officer of $1,428,000 and
distributions to the existing shareholders of $560,000 for the payment of
taxes.
We spent a total of $17,378,635 in investing activities in 1999. Of this
amount, $15,226,235 was spent for property and equipment utilized in our
operations. In addition, we made cash investments totaling $2,152,400 in two
companies with whom we entered into strategic alliances. On December 21, 1999,
we purchased 648 units of Lions Gate Entertainment totaling $1,652,400 through
a public offering. Each unit consists of one share of 5.25% convertible
redeemable preferred stock and 425 warrants. Through this investment, we were
able to align ourselves with a motion picture company, which distributes DVDs.
As an additional element to
24
our investment in Lions Gate Entertainment we received the right to replicate
all of its DVDs at market prices for a period of three years. On December 23,
1999 we invested cash of $500,000 in Synthonics Technologies, Inc. in return
for a note receivable convertible into 11,518,096 shares of Synthonics
Technologies, Inc. common stock. As part of our investment, we agreed to
replicate up to 2 million CDs without charge to Synthonics Technologies, Inc.
and establish a catalog entity to develop and produce 3D interactive catalogs
on behalf of Synthonics Technologies, Inc. and its customers.
Out of the net proceeds of this offering, we anticipate investing
approximately $14,100,000 in capital equipment. This new equipment will expand
our capacity for replication of DVDs and CDs. It should be noted, however, the
purchase of equipment is subject to many factors, including but not limited to
future demand for our product. Therefore, no assurance can be given we will
purchase equipment as described above, and actual equipment purchased may vary
significantly from our projections.
We believe cash flows from operations, net proceeds from this offering,
together with available funds under the credit agreement, will be sufficient to
support our operating and capital expenditures for the next twelve months.
However, long-term capital requirements depend on many factors, including, but
not limited to, the rate at which we expand our business, whether internally or
through acquisitions and strategic alliances. To the extent the funds generated
from the sources described above are insufficient to fund our activities in the
short or long term, we will be required to raise additional funds through
public or private financings. No assurance can be given additional funds will
be available on terms acceptable to us.
Seasonality
The demand for DVDs and CDs is usually highest in the second half of the
year, concurrent with the new school year and holiday gift purchases. This
seasonality could result in significant quarterly variations in financial
results, with the third and fourth quarters generally being the strongest.
Inflation
Prices for raw materials used in the production of DVDs and CDs have not
changed substantially as a percentage of sales since 1996, and in certain
instances decreased during the year 1999. However, some of our other
manufacturing and selling, general and administrative costs have continued to
increase (primarily in the aggregate and sometimes as a percentage of net
sales) since the beginning of 1996. As our general CD selling price has been
relatively unchanged over the last two years, we have been unable to pass these
costs on to our customers. Despite this trend we have remained profitable by
increasing net sales.
Impact of Year 2000
In 1999, we completed our remediation and testing of systems. Because of
those planning and implementation efforts, we experienced no significant
disruptions in mission critical information technology and non-information
technology systems and those systems have successfully responded to the Year
2000 date change. We did not incur any significant expenses during 1999 in
connection with remediating our systems. We are not aware of any material
problems resulting from Year 2000 issues, either with our products, internal
systems, or the products and services of third parties. We will continue to
monitor our mission critical computer applications and those of our suppliers
and vendors throughout the year 2000 to ensure any latent Year 2000 matters
arising are addressed promptly.
Qualitative and Quantitative Disclosures About Market Risk
We are exposed to market risk related to changes in interest rates. There are
currently no risks related to foreign currency exchange rates and we do not use
derivative financial instruments, swaps, commodity investments or hedging. Our
interest expense is sensitive to changes in the prime rate. Due to the nature
of our debt, we have concluded that there is no material market risk exposure.
25
INDUSTRY OVERVIEW
The Digital Versatile Disc (DVD) and Compact Disc (CD) are among the most
popular optical media for content delivery and are widely used in the
distribution of movies, music, application and edutainment software, publishing
content and Internet/online promotional materials. The wide acceptance of DVD
and CD as a content delivery media has fueled the growth of the replication
industry.
The first commercial application of CD technology was storage and playback of
pre-recorded music, or CD-Audio, which was adopted as an international standard
in 1982, and introduced to the consumer market in 1983. The CD-ROM entered the
market in 1991, providing cost-effective storage and retrieval of any
combination of data, text, graphics, audio and video. The DVD entered
commercial distribution in December 1996. DVDs are currently capable of storing
up to 13 times as much data as CDs and are suitable for high quality playback
of film and video, multi-channel surround sound audio and interactive media.
An important advantage of DVD players and DVD-ROM drives, which should speed
their market penetration, is their compatibility with CD-Audio and CD-ROMs.
This compatibility feature of DVD players and DVD-ROM drives is expected to
increase consumer acceptance of DVD technology. Unlike the introduction of CDs,
when consumers were reluctant to purchase CD players because they would be
required to spend substantial amounts on new music collections, consumers will
be able to acquire the DVD players and DVD-ROM drives without making their CDs
obsolete.
During the past decade, CDs have become the dominant format in audio and
portable data storage and retrieval markets. Since its introduction, the
popularity of DVDs has grown rapidly and the DVD is increasingly becoming a
standard format for video. DVDs and CDs can be replicated faster than
traditional tape storage mediums at a comparable cost. In addition, consumer
acceptance of the DVD and CD formats is due in part to the following
combination of advantages over other mass storage formats:
. Higher storage capacity / longer play time;
. Greater portability and ease of storage;
. Higher quality presentation including crisper sounds and sharper video;
. Longer life as a result of lack of degradation; and
. Random accessibility of data.
CD-ROM. According to Infotech, CD-ROM disc units sold in the United States by
CD-ROM replicators have grown at a compound annual growth rate of 34.0% from
approximately 443 million units in 1996 to approximately 1.066 billion units in
1999. The consumer market has emerged within the past several years and its
substantial growth is expected to help sustain CD-ROM unit sales in the next
few years. Infotech estimates that total worldwide CD-ROM disc units sold will
continue to increase through the year 2001.
CD-ROM is well suited to applications involving the storage of large amounts
of information in a form that can be distributed to a diverse user population.
CD-ROM was developed in the late 1980s and was initially limited to business
and professional applications such as library references and parts catalogs. In
the 1990s, the increasingly widespread presence of personal computers (PCs) and
CD-ROM drives has created a thriving consumer market for CD-ROM applications.
Infotech estimates that in the United States, the installed base of CD-ROM
drives will grow from approximately 60.4 million in 1996 to approximately 338.8
million by 2004 representing a compounded annual growth rate of 24.1%. In
addition, CD-ROM discs can be played on DVD-ROM drives. This rapidly growing
installed base of CD-ROM drives, as well as the growth in the installed base of
DVD-ROM drives, expands the potential consumer market for publishers of CD-ROM
software, data and entertainment products.
26
DVD. DVD is becoming the accepted new medium for home video distribution.
Unlike videocassettes, DVD-Video experiences no image or sound degradation with
normal use and offers greater storage capacity, indexing, random access and
lower manufacturing costs. DVD is capable of holding a full length motion
picture with up to three spoken languages, three foreign language subtitles and
multi-channel, digital surround sound. Added features such as multilingual
voice tracks, soundtrack albums, director's notes, out takes, story-based games
and other CD applications may be available with the higher storage capacity
afforded with DVDs.
The home video market, both rental and purchased videos, has been served
primarily by pre-recorded videotape (VHS). We believe the DVD-Video format will
surpass the VHS format in the pre-recorded video market over time. Infotech
estimates the following:
. The installed base of DVD-Video players in the United States will
increase from approximately 300,000 in 1997 to 39.6 million in 2004,
representing a compounded annual growth rate of approximately 100.9%.
Infotech estimates the worldwide installed base of DVD-Video players
will reach 96.7 million players by 2004.
. DVD-Video disc units sold in the United States by replicators will
increase from 3.4 million units in 1997 to approximately 991.0 million
units in 2004, representing a compounded annual growth rate of 124.9%.
. In the United States, more than 5,000 DVD-Video titles are currently
available and the number of titles will approach 42,500 by the end of
2004.
In addition to the growth in home video, Infotech projects that DVD-ROM drive
shipments in the United States will increase from approximately 125,000 in 1997
to 134.2 million in 2004, representing a compounded growth rate of 171.0%.
Also, the next generation of game consoles being manufactured by Sega,
Nintendo, Sony and Microsoft will be DVD-based. Consequently, there will be
pressure on some software game manufacturers to produce higher-capacity
software games in the DVD format. We believe that certain of our software game
customers will supplement their CD business in this area. Infotech estimates
that DVD-ROM disc units sold by replicators in the United States will increase
from approximately 520,000 in 1997 to 589.0 million in 2004, representing a
compounded growth rate of 173.1%.
Growth of Internet Usage and E-Commerce
As the number of Internet users has increased the functionality of the
Internet has expanded to a medium that enables complex business-to-business
communications and commerce. The Internet and related online technologies are
revolutionizing the way businesses and consumers communicate, share information
and conduct business.
We believe CDs and DVDs will play an important role in the expansion of the
Internet and online commerce. Specifically, we believe CDs, and potentially
DVDs, will function as an important marketing medium for integrating Internet
or online strategies with traditional commerce, distribution and communication
channels, such as "bricks and mortar" stores, mail order catalogs, television
sales and retail-based kiosks. DVDs and CDs have special features, in addition
to those discussed above, which particularly enhance their use in connection
with the Internet and e-commerce programs. These include the following:
. The ability of a DVD or CD to direct or link consumers to a website; and
. The increased ability to include special promotional or customer brand
information in the form of graphics, audio, video and other data.
In fact, certain of our Internet and e-commerce customers, most notably
America Online, have already adopted a technique of mass-mailing CDs for
marketing purposes as a cost effective alternative to other methods of
advertising.
27
BUSINESS
We are an independent manufacturer/replicator of Digital Versatile Discs
(DVD) and Compact Discs (CD). We target our sales to companies in industries
including Internet/online, film and entertainment, edutainment software,
publishing and computer hardware. We have successfully implemented our business
model, which consists of the following elements:
. High volume customers: Our customer base is comprised of some of the
highest volume customers of DVDs and CDs.
. High replication capacity: Since inception we have continued to add new
equipment and have become one of the largest independent
manufacturers/replicators of DVDs and CDs in the United States.
. Low cost structure: We achieve substantial economies of scale through
our optimally designed facility at a single locale, our dedication to
maximizing machine uptime and our flat organizational structure.
. Superior turnaround service: We are dedicated to providing superior
turnaround service by maintaining high throughput mastering technologies
and high DVD/CD graphic printing capacity and by efficiently managing
operational workflow.
Our customers include America Online, Inc., Modus Media International
Holdings, Inc., Havas Interactive, Inc., GT Interactive Software, Lions Gate
Entertainment, infoUSA Inc., Interplay Entertainment Corp., Juno Online
Services, Inc. and a major motion picture distributor. In order to achieve
significant cost efficiencies we focus on customers requiring high volume
production runs and have designed our business processes to support them. We
are thereby able to achieve lower overall unit costs and therefore we believe
we are less vulnerable to competitive pricing pressures and have greater
flexibility in the pricing of our products and services.
Due to our technologically advanced equipment, plant design, in-house
engineering capabilities and workflow techniques, we believe we are one of the
most efficient high volume, low cost DVD and CD manufacturers in the industry.
As a result of these factors, as well as our self-sufficient engineering,
repair and maintenance capabilities, we believe we are able to provide superior
turnaround service. This is not only a fundamental selling advantage but also
helps foster long-term relationships with our high volume customers.
Based upon our strong business model, we believe we are well positioned to
capitalize on the anticipated growth in the DVD market, the continuing growth
in the CD-ROM market, as well as the growing use of CDs in connection with
marketing of Internet, e-commerce and other distribution channels.
Operating Approach
We believe that our operating approach distinguishes us from our competitors
and that the effectiveness of our operating approach has been proven through
the growth in our targeted customer base, the retention of our customers and
our demonstrated long-term financial performance. Our focused operating
approach is based on the following principles.
High Capacity Manufacturing Capabilities at a Single Locale. We maintain all
of our production and mastering facilities within two buildings, aggregating
approximately 73,000 square feet, in Valencia, California. In April 2000 we
plan to move our production facilities into an 83,000 square foot building in
the same area, at which time we will have approximately 112,000 square feet for
our operations. With our current equipment configuration, we have current
production capacity of approximately 220 million CDs per year or, as a result
of having replicating machines convertible between DVD and CD, we have
production capacity of 30 million DVDs and 140 million CDs per year. Following
our move to the larger production facility, we will have sufficient square
footage to more than double our current production capacity. By aggregating our
production capacity in a single locale, we can maintain high product yield
rates, manage costs and facilitate overall profitability. In addition, we
believe we can more closely administer our daily production schedule and
quickly respond to unanticipated time sensitive customer requests. Because of
our fast turnaround times, we are able to fulfill the replication needs of a
national customer base from our Valencia, California facility. We believe we
have one of the most efficient facilities in the industry. As compared to
others in the industry, our manufacturing facilities are relatively new and
were designed to facilitate high volume production. We believe our sales per
employee, operating income per employee, operating margins and yield rates
historically have been among the highest in the industry.
28
Optimally Designed Manufacturing Facilities. Our manufacturing facilities
have been engineered to provide optimal efficiency. The layout of our
facilities, coupled with redundant operating systems, has allowed us to
efficiently manage operational workflow and to maximize factory throughput. We
are able to complete and control all mastering, replication, printing and
packaging functions internally without dependence on outside subcontractors. As
a result, we believe we have established faster turnaround times for customer
orders than most others in the industry.
Self-Sufficient Repair, Maintenance and Engineering Capabilities. We operate
24 hours a day, seven days a week, and have staff engineers on the production
floor at all times to monitor and maintain a smooth production flow. In order
to maximize our machine uptime, we maintain a full machine shop with
substantial spare parts inventory for our manufacturing equipment. Our
engineering talent, coupled with our investment in spare parts inventory, has
allowed us to develop a high degree of self-sufficiency, resulting in higher
productivity. We also maintain a close technical working relationship with each
of our equipment vendors.
Technologically Advanced Manufacturing Equipment. To implement our business
model, we have always invested in the most advanced, high volume equipment
available. As of December 31, 1999, we have invested approximately $39.1
million in our mastering, replication, printing and packaging equipment. We
expect to invest approximately $18.0 million toward the purchase of new
equipment during 2000, including $14.1 million of the net proceeds of this
offering.
Marketing Our Services Directly to Senior Management. Since our business
model requires us to attract customers with large annual replication
requirements, the selection of the replication vendor by our customers usually
has higher visibility and importance at the executive levels. Consequently, we
are able to more precisely target our prospective customers and minimize the
use of field sales personnel. Alex Sandel, who has extensive relationships in
the computer hardware and software industries, spearheads our sales and
marketing effort. As a result, we are able to actively target and market our
services at the executive level. A strong sales team with substantial
experience in the CD replicating business and extensive industry knowledge and
contacts supports Mr. Sandel. In addition to our sales team, we plan to utilize
the relationships of the members of our board of directors to increase our
visibility and penetration with both DVD and CD customers.
Growth Strategy
In order to foster our continued growth in line with our business model, we
plan to pursue the following opportunities.
Capitalize on the Continuing Growth of DVD. We commenced our DVD production
in the fourth quarter of 1999. In order to continue our participation in this
growing market, we have purchased and plan to purchase additional machines that
will significantly increase our DVD manufacturing capacity. Through a direct
sales effort targeting motion picture production companies, post production and
authoring houses and existing edutainment customers, we intend to pursue a
marketing strategy targeted at senior executives similar to the one we have
successfully implemented in the CD-ROM market. We believe that our location in
Southern California, as well as our independence from large entertainment
companies, will provide an advantage in obtaining business from independent
motion picture production companies as well as overflow work from the major
motion picture production companies having captive replicating facilities. We
have made and intend to continue to make strategic investments, where
appropriate, in selected companies that either currently or in the future may
have high volume DVD replication requirements. By making this type of strategic
investment, we have the ability to negotiate a long-term exclusive DVD
replication agreement.
Expand our Position as a Low Cost CD-ROM Manufacturer. Our penetration of the
marketplace for CDs is focused on the CD-ROM market with a significant presence
among computer software developers and Internet/online providers. Because of
our success as a low cost, high volume replicator, we believe we are well
positioned to address the growth in the market for CD-ROM. We believe we can
offer our customers cost effective CD manufacturing services with turnaround
times among the shortest in the industry. In addition to maintaining our
existing customer base, we intend to use the contacts of our board of directors
and our senior executives' direct selling efforts to expand our customer base
to other companies with high volume replicating needs.
29
Stimulate CD Demand through Targeted Internet-Related Marketing Programs. The
rise of the Internet and related services has caused various industries to re-
examine traditional distribution methods, such as "bricks and mortar" retail
stores, direct mail catalogs, television sales and retail-based kiosks, and
their connection to online users. This has caused both business-to-business and
business-to-consumer companies to alter their marketing and distribution
programs in order to address changing market trends caused by growing Internet
commerce. In Europe, the CD has been a significant marketing tool, often
distributed as inserts to magazines or other publications. In our market, some
of our largest customers, such as America Online and Juno, are using CDs as
marketing tools. We believe CDs, and potentially DVDs, will play an
increasingly important role in the marketing strategy of many e-commerce and
catalog companies.
CDs are relatively inexpensive to both manufacture and mail. As compared to
paper based catalogs, creating an updated or subsequent version of catalogs on
CDs and DVDs is generally easier and less expensive. CDs and DVDs also provide
interactive functionality and an entertaining means of advertising. Certain of
our Internet and e-commerce customers, most notably America Online, have
already adopted a technique of mass-mailing CDs for marketing purposes as a
cost effective alternative to other methods of advertising.
In order to capitalize on this market need, our objective is to assist
companies in establishing and producing marketing programs enhancing, promoting
and integrating their e-commerce businesses utilizing CDs and DVDs. We will
focus on promoting our business through three principal avenues:
. the digital production and distribution of product catalogs through CDs
and, in the future, DVDs;
. e-commerce programs capitalizing on the convergence of traditional
retail, catalog, kiosk and online formats through various CD-based
applications; and
. marketing programs utilizing the CD as an advertising medium used to
drive customers to a targeted online destination by either new or
existing retailers and e-tailers.
30
Customers
We service a broad range of high volume DVD and CD customers. The following
table summarizes the principal market segments within DVD and CD-ROM and our
market orientation, our current customer base and our estimate of the growth
potential of the DVD and CD markets.
Estimated Estimated
Selected CD-ROM DVD
Market Segment Customers Potential Potential
-------------- ------------------------- ---------- ---------
(All CD customers except
where DVD is indicated)
Online Providers
These customers are large users America Online High Low
due to the continued and Juno
growing prevalence of Internet
and online services. These
customers are attractive to us
due to their less seasonal and
higher volume requirements.
Internet Marketing
These customers include "bricks Synthonics Technologies High High
and mortar," direct mail
catalog, kiosk and online
companies. They are looking to
promote their e-commerce
presence and integrate it with
other distribution channels.
The DVD and CD formats can
stimulate new customer growth
and also connect to the current
customer base.
Film/Entertainment
One of the largest users of DVD A major motion picture Not High
products. We are positioned to distributor/DVD applicable
penetrate this market segment Lions Gate Entertainment/
based upon our capacity and DVD
rapid turnaround capabilities.
Edutainment Software
This segment is one of the Havas Interactive High High
mass-market segments most GT Interactive
appropriately suited to our Interplay
speed and quality capabilities. Encore
These companies are expected to
be large volume users driven by
edutainment, games and
application software.
Microsoft Authorized
Replicators and Turnkey
Manufacturers
These replicators are Modus Media High High
authorized by Microsoft to Zomax
assemble and distribute Banta
operating systems, applications
and manuals to OEM computer
manufacturers. These companies
outsource a significant portion
of their CD requirements.
Publishing
Publishing companies are a infoUSA/CD and DVD High Medium
large and increasing user of Ziff/Davis
the DVD and CD formats given
the continued transition from
print to electronic media. This
segment is expected to continue
to grow because of the low cost
of storing a high volume of
printed product on DVD or CD.
OEM Computer Hardware &
Peripherals
This is a substantial market 3dfx High Medium
sector in which we have a Toshiba
demonstrated track record; we Fountain Technology
intend to continue to
aggressively pursue PC and
peripheral manufacturers.
31
Currently, approximately 40 customers account for substantially all of our
net sales. Our top three customers, America Online, Modus Media and Havas
Interactive, accounted for approximately 32%, 14% and 10%, respectively, of our
net sales for the year ended December 31, 1999. We have expanded our customer
base aggressively since our founding in July 1994 primarily due to the focused
efforts of our senior management and sales team. We plan to continue expanding
and diversifying our customer base in order to reduce our dependence on any one
customer and to optimize our production capacity. Specifically, we plan to
further expand and diversify our customer base beyond our current presence by
further penetrating the Internet, film/entertainment, and publishing
industries.
Our current customer base is characterized primarily by: (i) customers
requiring production runs that are annual and ongoing, less cyclical in nature
and less time-sensitive, such as America Online and (ii) customers with
substantial annual production requirements tied to seasonal consumer purchasing
trends and product announcement cycles such as Havas Interactive and GT
Interactive. To the extent we are successful in our efforts to promote DVD and
CD business within the film/entertainment industry or through Internet related
marketing programs, we will attract and acquire customers with substantial
production requirements revolving around film releases, retail cycles and other
planned marketing events. Our large capacity allows us to manage the competing
demands of our customers on a daily basis. We work closely with customers to
monitor the actual production schedule and the product quality and service
delivered.
Our business is based primarily on purchase orders. Due to our fast
turnaround time, high capacity and strong customer service support, we believe
that we have been able to develop excellent relationships with our customers.
However, we do not have any significant backlog and we do not typically enter
into supply contracts with our customers.
As part of our effort to secure certain DVD business, we recently invested
$1.7 million in Lions Gate Entertainment, a Canadian production and
distribution film and entertainment studio, in order to become affiliated with
and establish relationships within the entertainment industry. In addition,
assuming price and quality are in line with industry standards, we have
obtained the exclusive right to all of the DVD replication needs of Lions Gate
for the next three years. We also have a five year agreement with Synthonics
Technologies, Inc., which grants us exclusive rights to all DVD and CD
replication needs of Synthonics, assuming price and quality are in line with
industry standards.
Sales and Marketing
Our sales and marketing effort is tailored to a customer base consistent with
our business model. We have targeted customers who require and depend upon high
volume DVD and CD manufacturing capacity. We maintain a focused sales and
marketing effort led by Alex Sandel and supported by a strong sales staff who
have significant experience in the replication industry. Our sales and
marketing efforts are focused on expanding our reach across the United States,
across a broader industrial base, to customers in the Internet/online area and
to the future users of DVDs and CDs. These efforts are supported by
relationships and contacts of our board of directors and sales and marketing
team.
Develop DVD Customer Base. We believe DVD technology is positioned to become
the new medium for home video and the high-capacity medium for software
distribution and high-capacity computer games.
Home Video: We anticipate DVD demand will continue to grow in the motion
picture industry, the primary area utilizing the DVD format today. We
intend to broaden our sales and marketing efforts in this industry through
relationships certain of our directors have with leading motion picture
producers and distributors. In order to further stimulate our growth and
broaden our relationships within the entertainment industry, and where
appropriate, we intend to continue making strategic investments in selected
companies that can direct their DVD replication requirements exclusively to
us. As an example, we recently invested $1.7 million in Lions Gate
Entertainment, a Canadian production and distribution film and
entertainment studio. As part of the investment, we received exclusive
rights to all DVD replication needs of Lions Gate for the next three years,
assuming price and quality are in line with
32
acceptable industry standards. Additionally, we are marketing to
independent post-production companies that provide DVD authoring services
to the motion picture industry because of the long-term relationships they
have with the movie studios and, in certain cases, the autonomy to
independently select the services of DVD replicators.
Software Distribution and Computer Games: DVD-ROM drives are becoming
increasingly popular. Furthermore, home video game companies, such as Sony,
Nintendo and Sega, are introducing home video game consoles that are
compatible with the DVD format. Microsoft has also announced its plans to
introduce a DVD compatible game console. With this large installed base,
which is projected to continue to grow, we believe there will be a growing
demand for high-capacity computer games playable on the DVD format. In
addition, some of our current customers in the software publishing industry
are moving selected product titles to the DVD format. We will be well-
positioned to attract future DVD business from our current computer
hardware and software customers as a result of our strong relationships and
demonstrated performance with these customers.
Stimulate CD Demand through Targeted Internet-Related Marketing Programs. As
a result of the increasing popularity of the Internet, many companies now have
to integrate an Internet strategy with their traditional retail and direct mail
marketing strategies. We believe CDs, and potentially DVDs, will play an
increasingly important role as part of the marketing strategy of many e-
commerce and catalog companies. When a CD or DVD is used as a catalog or
promotional tool in the Internet e-commerce space, we believe it will generate
high-volume demand. In order to capitalize on this market, our objective is to
assist companies to establish and produce marketing programs enhancing,
promoting and integrating their e-commerce businesses utilizing CDs and DVDs.
We will focus on three principal areas:
Targeted Internet Marketing Programs: We believe the CD format is well
suited for driving customer traffic to designated online sites because it
is less expensive than other advertising media, it can be targeted to an
intended audience, it can deliver a dynamic, interactive advertising
message and it can deliver to the customer software that currently cannot
be delivered via the Internet due to file size concerns. The most notable
example of this use, which involves our leading customer, is that of
America Online. We are identifying and marketing to our current customers
as well as potential customers this technique in stimulating growth in CDs.
E-Commerce Programs: The introduction of online and digital capabilities
has also introduced new and more engaging ways in which retailers and e-
tailers can interact with their customers. There will be application
programs that interactively promote commerce. These types of interactive
programs may require CDs and DVDs as a program medium. We recently invested
in Synthonics Technologies, Inc., a 3D technology firm, which utilizes its
technology in the digital catalog, kiosk and e-commerce areas. As a result,
we believe there will be opportunities for future CD replication.
Digital Catalog Business: In order to respond to an increasingly
"digital" consumer as well as the increasing popularity of online e-
commerce, many direct mail catalog companies are considering various
changes to their traditional distribution programs. One possible
alternative is the partial or total substitution of the traditional paper-
based catalog with a CD or DVD catalog. By following this approach, a
company can appeal to the new and growing base of online consumers, "link"
and drive traffic to its website, interact with customers in a more
entertaining way, and more effectively integrate a customer with its online
capabilities.
Many customers and potential customers interested in CD or DVD marketing
programs lack the knowledge and resources to internally develop and execute
these programs. We will oversee the coordination of the overall production
process of these programs. We intend to outsource the creative, graphic and
production services necessary to implement the above programs. Where the
customer handles creative programming, we will carry out our replicating and
packaging functions upon delivery of a master from the customer. By following
this model, we can stimulate growth in our main business, the replication of
DVDs and CDs, while maintaining our core high volume business model.
Broader Industry Coverage for CDs. Our marketing efforts have been
historically targeted toward companies in the computer hardware and software
industries, and we intend to further penetrate these areas. As
33
a result of the rise of the Internet, we will also continue to focus on online
service providers and other related companies. Because of our efficiency, high
capacity, fast turnaround time and independence within the replicating
industry, we have obtained overflow work from other CD replicators that do not
have sufficient internal capacity. We only accept orders from replicators who
provide such work on a year-round basis. Our main marketing thrust is to
attract new customers whose usage patterns are driven by fundamentals that
counterbalance the seasonal usage patterns of the computer hardware and
software market segments. We believe this strategy helps to balance capacity
demands and thereby moderate seasonal fluctuations.
Suppliers
We seek to reduce costs and enhance quality by purchasing from a limited
number of suppliers. However, all raw materials needed to manufacture our
products are readily available from multiple suppliers at competitive prices.
The principal raw materials used to manufacture DVDs are optical grade
polycarbonate, aluminum, nickel, ultraviolet-curable lacquers and ink. Also,
certain types of DVDs require a minimal amount of gold. The principal raw
materials used to manufacture CDs are the same as those used for manufacturing
DVDs, except for gold.
Warehousing and Distribution
We primarily use common carriers to ship products to customers throughout the
United States. We also deliver products by truck directly to a small number of
customers who demand direct shipping. To meet the needs of customers distant
from our facility, we ship unpackaged or "spindled" DVDs and CDs directly to
the customer or its distribution facility. If required, we have relationships
with packaging companies in other parts of the United States that would be able
to handle individual customer fulfillment needs. We currently believe that this
strategy is superior to building multiple manufacturing facilities. The cost to
ship unpackaged DVDs or CDs to a packaging company is lower than the investment
required to construct, operate and maintain multiple manufacturing facilities.
Also, by aggregating our production capacity in a single locale, we believe we
can optimize our production capacity, maintain high product yield rates, manage
costs and facilitate overall profitability. In addition, we believe we can more
closely administer our daily production schedule and quickly respond to large
volume, unanticipated time sensitive customer requests. Because of our low-cost
structure and fast turnaround times, we are able to fulfill the replication
needs of a national customer base from our Valencia, California facility.
Seasonality and Backlog
Our peak sales activity normally occurs in the four-month period from August
through November, as hardware manufacturers and software developers introduce
new products before the back-to-school and holiday season. Typically, DVDs and
CDs are produced and shipped as orders are received and we operate with
virtually no backlog during most of the year. As a result, net sales in any
quarter generally are dependent on orders shipped in that quarter. However, we
believe focusing our marketing efforts on a more diversified customer base will
help reduce the effects of seasonal cycles of our business. For example, to the
extent we are successful in our efforts to promote DVD and CD business within
the film/entertainment industry or through Internet related marketing programs,
we will attract and acquire customers with substantial production requirements
revolving around film releases, retail cycles and other planned marketing
events, which are not as seasonal as our computer hardware and software
customers.
Competition
The DVD and CD replication industries are highly competitive. We believe that
the principal competitive factors in the DVD replicating industry are price,
quality, turnaround time, capacity and service and relationships with studios,
with price and quality being the most important. We believe the factors listed
above are also critical in the CD replicating industry, with price and
turnaround time typically being the most important. We believe that we compete
favorably with respect to each of these factors in both DVD and CD replicating
and that the quality of our products and services, our low cost manufacturing
operations, our ability to accommodate tight delivery schedules, and our
flexibility in production create significant competitive advantages.
34
The replication industry can be divided into two categories: (i) companies
that are affiliated with and are captives of large entertainment companies
(music and motion pictures), and (ii) independent companies, such as us, that
have no affiliation. We compete more directly with the independent replicators,
which include: AmericDisc, Carlton Communications PLC, Cinram International,
Inc., Denon Electronics, Inc., Disctronics, Inc., DOCdata N.V., JVC
Corporation, and Zomax Optical Media, Inc. In addition to the above listed
companies, we also compete with foreign manufacturers that can operate at lower
costs than us. We do not typically compete directly with captive manufacturers.
In some instances, we provide replication services to them to cover their
overflow work caused by their own capacity constraints. These captive
replicators include the following: Sony Music Entertainment, Inc., Polygram
Holdings, Inc., Warner Advanced Media Operations and Warner Music Group (both
divisions of Time Warner, Inc.), Bertelsmann Music Group and Capitol-EMI Music.
Many of the independent replicators are manufacturers of DVDs and CDs but
also other pre-recorded multimedia products including video cassettes, audio
cassettes and audio CDs. In addition, certain of these independent replicators
consider themselves full outsource service providers offering such services as
call center operations, customer support, warehousing inventory management,
distribution and fulfillment.
We concentrate on providing high volume, low cost DVD and CD replication
along with mastering, packaging and fulfillment services which are essential to
our customers needs. We believe we distinguish ourselves from our competitors
through our strict focus on those replication and affiliated services necessary
to meet our customers' requirements for high capacity manufacturing and quick
turnaround of DVDs and CDs.
We may also face indirect competition from broadband online service
providers, such as telephone, cable and wireless service providers. However, we
believe online delivery of data will not, for the foreseeable future, be a
practical alternative for consumers due to significant time and hardware
storage requirements to download the capacity of a DVD or CD.
DVD and CD Manufacturing Process
The DVD and CD manufacturing process consists of three stages.
Pre-production. Pre-production of DVDs and CDs consists of three distinct
processes: pre-mastering, mastering and electroplating. Through these
processes, metal stampers are created which contain tracks with pits and lands
holding data in a digital format. The metal stampers are then mounted in the
proper injection molding equipment to produce either DVDs or CDs. Pre-
production begins with receipt of the customer's data, which is supplied in any
number of approved input media.
The mastering process forms the master image of the DVD or CD from which the
polycarbonate replicas are molded. Mastering begins with the preparation of a
glass substrate, which is coated with a thin photo resist layer and placed on a
computer-controlled laser beam recorder. The laser exposes a series of areas in
the photo-resist layer on the glass plate as the data is transferred from a
playback device. Chemicals etch the exposed areas of photo resist layer,
producing a series of microscopic "pits" and "lands," or physical
representations of the digital information. The glass substrate is then
developed and then initialized to produce the glass master.
An electroplating unit is then used to electroplate the glass master with
nickel vanadium to create the metal master (commonly referred to as the metal
"father"). The metal father is then separated from the glass master and
electroplated a second time to create an inverted impression on a metal
"mother." A further electroplating process is used to produce several stampers
from the metal mother. The nickel-plated stampers are punched, polished and
mounted in the proper injection molding machine to replicate DVDs or CDs.
Replication and Printing. CD replication uses a fully integrated in-line
process, which incorporates injection molding machines, metallizing equipment,
protective coating machinery and inspection equipment. To begin, optical grade
polycarbonate plastic is heated and injected under high pressure into the mold
cavity of the machine against the metal stamper. The molding process creates a
clear polycarbonate disc with pits on one side containing all of the digitized
data. In order to make the disc readable by reflected laser light, a thin layer
35
of reflective aluminum is deposited onto the disc surface by a metallizing
machine. A clear protective coating is then applied to the disc by a spin
coating device in order to protect the disc from scratches and oxidation and to
serve as a base for printing on the disc. An in-line inspection device is used
to scan each disc for physical flaws. Thereafter, the disc is ready for label
printing, the final step of production.
The DVD production process is essentially the same as the CD production
process, except that DVD replication entails the use of a special substrate-
bonding machine, which is integrated into the replication line itself. In
addition, the replication process is slightly different from the production of
other CD formats in that each replication line has two presses, which produce
two polycarbonate substrates, each one-half the thickness of a standard CD.
Information is molded onto a layer or multiple layers of a substrate depending
on the specific data requirements. The two substrates are bonded together to
form a DVD. A DVD-5 contains 4.7 gigabytes of data molded onto one layer of the
polycarbonate substrate. A DVD-10 contains 9.4 gigabytes of data molded into
both polycarbonate substrates. A DVD-9 contains approximately 8.5 gigabytes of
data molded onto both polycarbonate substrates, one of which is semi-
transparent. The semi-transparent layer contains a thin layer of reflective
material, usually gold.
Post-Production Services. Post-production services primarily involve
printing, packaging, fulfillment and distribution, including confectionering,
stickering, cellophaning, shrink-wrapping, spine printing, bundling and other
services. We maintain equipment to provide for most customer-requested
packaging configurations and use temporary labor to manage labor intensive
packaging requests. Currently the standard packaging configuration is the jewel
box with customer supplied print material on the bottom and top of the box. The
jewel box is typically shrink-wrapped for protection.
Employees
At December 31, 1999, we had 127 full-time employees, including 3 engaged in
sales and marketing, 13 engaged in general administration and finance and 111
engaged in DVD and CD replicating/manufacturing. In addition, we use temporary
employees in varying numbers throughout the year, who are primarily engaged in
packaging. We rely on our ability to vary the number of part-time and temporary
employees in order to respond to fluctuating market demand for our packaging
services. None of our employees are covered by a collective bargaining
agreement. We believe we have a good relationship with our employees.
Properties
Our executive offices and manufacturing, sales and marketing operations are
located at 25136 Anza Drive, Valencia, California, where we lease approximately
44,500 square feet of space. This lease expires on February 28, 2002. Our
mastering facilities are located near our executive offices at 24833 Anza
Drive, Valencia, California, in leased facilities occupying an aggregate of
approximately 28,500 square feet of space. This lease expires on May 31, 2007.
We expect to enter into a multi-year lease for approximately 83,000 square feet
of space located at 24811 Avenue Rockefeller, Valencia, California at
commercially standard terms. We currently plan to move our executive offices,
manufacturing, sales and marketing operations to this location during April
2000. We are currently negotiating the release from our lease for the property
located 25136 Anza Drive in Valencia, and we do not believe that this will
result in any material out-of-pocket costs to us. We believe that our new
facilities will be adequate to meet our projected needs for the foreseeable
future. We do not believe that the relocation of certain of our operations to
these new facilities will cause any material disruption in our business. See
"Certain Relationships and Related Transactions."
Legal Proceedings
We are not involved in any pending, nor are we aware of any threatened, legal
proceedings which we believe could reasonably be expected to have a material
adverse effect on our business, operating results or financial condition.
36
MANAGEMENT
Directors and Executive Officers
The following table sets forth certain information with respect to our
directors and executive officers as of February 15, 2000:
Name Age Position
- ---- --- --------
Alex Sandel.................. 57 Chairman of the Board, Chief Executive
Officer and President
David Moss................... 39 Vice President--Operations
Louis L. Weiss............... 49 Chief Financial Officer, Principal Accounting
Officer and Secretary
Sanford R. Climan(1)(2)...... 44 Director
Mark Dyne(1)(2).............. 39 Director
Diana Maranon................ 41 Director
- --------
(1) Member of the Audit Committee.
(2) Member of the Compensation Committee.
Directors are elected at each annual meeting of shareholders and hold office
until the following annual meeting and their successors are duly elected and
qualified. Our Bylaws presently provide the number of directors shall not be
less than five nor more than nine, with the exact number to be fixed from time
to time by resolution of our board of directors. The current number of
directors is fixed at five. The remaining directors may fill any vacancy on the
board of directors, including a vacancy resulting from an increase in the size
of the board of directors. The board of directors cannot decrease the number of
directors or shorten the term of any incumbent director.
The board of directors appoints the executive officers and subject to
employment contracts, such officers serve at the discretion of the board of
directors.
Alex Sandel is one of our co-founders and he has served as our Chairman of
the Board, Chief Executive Officer and President since we were founded in June
1994. Mr. Sandel was one of the original founders of Packard Bell Electronics
(1986), an innovative PC manufacturer that was first to market PCs via
traditional consumer electronics retail outlets. Mr. Sandel served as a
director of Packard Bell Electronics since its inception until 1999. Mr. Sandel
is a principal shareholder in Argoguest, Inc., an incubator focused on
investing in early stage Israeli-based Internet and Internet enabling
technology companies. Mr. Sandel has founded, managed and held engineering
positions with several companies over the past thirty years. He was educated at
the Israeli Institute of Technology, Haifa, Israel. While continuing his
education in the United States, he received his BSEE from California State
College, Pomona, California (1969) and MSOR from the University of Southern
California (1974).
David Moss has served as our Vice President--Operations since our founding in
June 1994. From May 1993 through May 1994, Mr. Moss served as Vice President
and General Manager of ASR Recording, a manufacturer of CDs. From April 1991
through April 1993, Mr. Moss served as director of manufacturing at Denon
Digital, also a manufacturer of CDs. Mr. Moss has worked in the CD and other
media replication business for 15 years. He has a B.A. degree in Production and
Operation Management and a B.A. degree in Computer Science, both from
California State University at Northridge.
Louis L. Weiss joined us in May 1998 as Chief Financial Officer and Principal
Accounting Officer. From December 1996 through April 1998, Mr. Weiss served as
Chief Financial Officer of P.D.I. Industries, Inc., a pharmaceuticals
distributor. From January 1996 through September 1996, Mr. Weiss served as
Chief Financial Officer of Cardkey Industries, a manufacturer of keycards for
building security systems. From June 1992 through December 1995, Mr. Weiss
served as President of LLW Associates, a financial consulting firm founded by
Mr. Weiss. Mr. Weiss is a Certified Public Accountant (inactive status) and he
has a B.B.A. and M.B.A. from the University of Wisconsin.
37
Sanford R. Climan has served as a Director since August 1998. Mr. Climan is
Managing Director of Entertainment Media Ventures (EMV), a Los Angeles-based
venture capital fund focused on investment in the areas of technology, media,
and the Internet. From October 1995 through May 1997, Mr. Climan was Executive
Vice President and President of Worldwide Business Development for Universal
Studios, Inc., where he oversaw corporate international strategy and the
following Universal Studios operating units: Consumer Products; Home Video; Pay
Television; New Media; Spencer Gifts and Strategic Marketing. From June 1997
through February 1999 and from June 1986 to September 1995, Mr. Climan was a
member of the senior management team at Creative Artists Agency, a leading
talent and literary representation firm, working with both talent and corporate
clients. Prior to joining CAA, Mr. Climan held executive positions at various
entertainment companies, working in general management capacities, as well as
overseeing areas of motion picture and television production and distribution.
Mr. Climan serves as a director of a number of public and private companies.
Mr. Climan received his B.A. from Harvard College, a M.S. in Health Policy and
Management from the Harvard School of Public Health and his M.B.A. from Harvard
Business School.
Mark Dyne has served as a Director since August 1998. Since October 1996, Mr.
Dyne has served as Chairman of the Board of Directors and as Chief Executive
Officer of Brilliant Digital Entertainment, Inc., a production and development
studio producing digital entertainment. Currently, Mr. Dyne is a Director of
Ozisoft Pty. Limited, a company he founded in 1982. From November 1998 through
January 2000, Mr. Dyne was Chief Executive Officer of Virgin Interactive
Entertainment. From June 1995 through May 1997, Mr. Dyne served as an executive
officer of Sega Enterprises (Australia) Pty., Ltd., a theme park developer,
which operated the $70 million interactive indoor theme park in Darling Harbor
in Sydney, Australia. Moreover, currently, Mr. Dyne is Chairman of the Board of
Directors of Tag-It Pacific, Inc., a manufacturer of buttons, tags and other
apparel trim products, and a director of Talent Connection.com, an
entertainment portal.
Diana Maranon has served as a Director since August 1998. Ms. Maranon is the
President and Managing Director of Averil Capital Markets Group, Inc., a
financial advisory firm, and a member of the National Association of Securities
Dealers. Ms. Maranon serves as a director of Brilliant Digital Entertainment,
Inc. Before founding Averil Capital Markets Group, Inc., in 1994, Ms. Maranon
was a Vice President with Wasserstein Perella & Co., Inc., an investment
banking firm, with whom she started in 1988. From 1985 to 1988, Ms. Maranon
practiced securities law with Skadden Arps Slate Meagher & Flom, LLP. Ms.
Maranon received J.D. and M.B.A. degrees from the University of California at
Los Angeles and is a member of the California Bar.
Board Committees
The board of directors will maintain an audit committee and a compensation
committee. The audit committee will review the scope of our audits, the
engagement of our independent auditors and their audit reports. The members of
the audit committee are Sanford Climan and Mark Dyne. The compensation
committee will evaluate our compensation policies and administer our stock
option plan. The members of the compensation committee are Sanford Climan and
Mark Dyne.
Director Compensation
We intend to pay non-employee directors fees of $1,500 for each meeting
personally attended. We intend to pay non-employee directors fees of $500 for
each telephonic meeting attended. Our directors are also reimbursed for their
reasonable travel expenses incurred in attending board or committee meetings.
38
Compensation Committee Interlocks and Insider Participation
We did not have a compensation committee for the fiscal year ended December
31, 1999. Our board of directors made all decisions regarding executive
compensation for the fiscal year ended December 31, 1999. No interlocking
relationship exists between any member of our compensation committee and any
member of any other company's board of directors or compensation committee.
Executive Compensation
The following table presents both cash and noncash compensation paid or to be
paid by us to each of our executive officers who received compensation for the
year ended December 31, 1999 in excess of $100,000:
Summary Compensation Table
Annual
Compensation
Year Ended ----------------
Name and Principal Position December 31 Salary Bonus
- --------------------------- ----------- -------- -------
Alex Sandel, Chief Executive Officer and
President....................................... 1999 $540,000 --
David Moss, Vice President--Operations........... 1999 $461,561 $52,000
Louis Weiss, Chief Financial Officer............. 1999 $228,894 --
Employment Agreements with Executive Officers
David Moss has an employment agreement with us. According to his agreement,
he is entitled to a salary of $395,000 per year subject to automatic annual
increases of six percent. The compensation committee can make further salary
increase adjustments to Mr. Moss' agreement if they choose to do so. In
addition, the compensation committee can grant bonus compensation to Mr. Moss.
If Mr. Moss' employment is terminated without cause, he will be entitled to
severance pay at his then-current annual salary through the expiration of his
employment agreement plus a lump sum payment of $1,000,000. Mr. Moss'
employment agreement is effective August 26, 1998 through August 26, 2003,
subject to extension through August 26, 2006 upon our written consent and Mr.
Moss' written consent.
Fiscal Year-End Option Values
Number of Securities Value of Unexercised
Underlying Unexercised In-The-Money Options at
Options at Fiscal Year-End Fiscal Year-End
Name Exercisable/Unexercisable Exercisable/Unexercisable
- ---- -------------------------- -------------------------
Alex Sandel, Chief
Executive Officer and
President............... 72,500/217,500
David Moss, Vice
President--Operations... 36,250/108,750
Louis Weiss, Chief
Financial Officer....... 21,250/63,750
Stock Plan
We adopted a stock incentive plan in May 1998. Each of our executive
officers, other employees, non-employee directors or consultants is eligible to
be considered for the grant of awards under our stock incentive plan. A maximum
of 1,200,000 shares of common stock may be issued under our stock incentive
plan. If any award expires or terminates for any reason, then the common stock
subject to that award will again be available for issuance under our stock
incentive plan.
Our board of directors or a committee of two or more non-employee directors
appointed by the board of directors will administer our stock incentive plan.
The administrator will have full and final authority to select the executives
and other employees to whom awards will be granted. Additionally, the
administrator will have the full and final authority to grant the awards and to
determine the terms and conditions of the awards and the number of shares to be
issued.
39
Awards. Our stock incentive plan authorizes the administrator to enter into
both incentive and non-statutory options. An award under the stock incentive
plan may permit the recipient to pay the entire purchase price of the shares by
delivering previously-owned shares of our capital stock.
Plan Duration. Our board of directors adopted our stock incentive plan on May
7, 1998 and on the same day our shareholders approved the plan. Our stock
incentive plan was subsequently amended on August 25, 1998. Our shareholders
approved the amendment on the same day. As a result of the amendment the number
of shares of our common stock subject to our stock incentive plan was increased
to 1,200,000. As of the date of this prospectus, our board of directors has
granted options covering an aggregate of 828,000 shares of our common stock to
our directors, officers and employees, with a weighted average exercise price
of $11.35 per share. The options will typically vest in four equal annual
installments commencing on the first anniversary of the date of grant. Any
award duly granted on or prior to May 7, 2008 may be exercised or settled in
accordance with its terms. No award may be granted on or after May 7, 2008.
Amendments. The administrator may amend or terminate our stock incentive plan
at any time and in any manner. However, no recipient of any option may be
deprived of any of his or her rights under the option as a result of any
amendment or termination without his or her consent. Shareholder approval is
required to increase the number of shares available for issuance under our
stock incentive plan.
Form S-8 Registration. We intend to file a registration statement under the
Securities Act to register the 1,200,000 shares of our common stock reserved
for issuance under our stock incentive plan and the 366,600 shares issuable
upon David Moss' exercise of his warrants. The registration statement is
expected to be filed shortly following the date of this prospectus and will
become effective immediately upon filing with the Securities and Exchange
Commission. Shares issued under our stock incentive plan after the effective
date of this registration statement generally will be available for sale to the
public without restriction, except for the 180-day lock-up provisions and
except for shares issued to our affiliates, which will remain subject to the
volume and manner of sale limitations of Rule 144. See "Shares Eligible for
Future Sale."
Limitation of Liability and Indemnification Matters
Our Articles of Incorporation include a provision eliminating the personal
liability of our directors to us and to our shareholders for monetary damages
for breach of the director's fiduciary duties in certain circumstances. This
limitation has no effect on a director's liability for any of the following:
. for acts or omissions involving intentional misconduct or a knowing and
culpable violation of law;
. for acts or omissions a director believes to be contrary to our best
interest or to the best interest of our shareholders;
. for acts or omissions involving the absence of good faith on the part of
the director;
. for any transaction from which a director derived an improper personal
benefit;
. for acts or omissions showing a reckless disregard for the director's
duty to us or to our shareholders in circumstances in which the director
was aware, or should have been aware, in the ordinary course of
performing a director's duties, of a risk of serious injury to us or to
our shareholders;
. for acts or omissions constituting an unexcused pattern of inattention
amounting to abdication of the director's duty to us or to our
shareholders;
. under Section 310 of the California Corporations Code (concerning
contracts or transactions between a director and us); or
. under Section 316 of the California Corporations Code (concerning
director's liability for improper dividends, loan and guarantees).
This limitation of liability does not apply to a director acting in his
capacity as an officer. Further, this limitation of liability provision does
not affect the availability of injunctions and other equitable remedies
available including injunctive relief or recession.
40
Our Articles of Incorporation and Bylaws provide indemnification of our
directors and executive officers and discretionary indemnification of our other
officers and employees and other agents to the fullest extent permitted by law.
Pursuant to this provision, our Bylaws provide for indemnification of our
directors, officers and employees. In addition, we may provide indemnification
to persons whom we are not obligated to indemnify. The Bylaws also allow us to
enter into indemnity agreements with individual directors, officers, employees
and other agents. We have entered into indemnification agreements designed to
provide the maximum indemnification permitted by law with all our directors and
executive officers. These agreements, together with our Bylaws and Articles of
Incorporation, may require us, among other things, to indemnify these directors
against certain liabilities that arise by reason of their status or service as
directors (other than liabilities resulting from willful misconduct of a
culpable nature), to advance expenses to them as they are incurred, provided
they undertake to repay the amount advanced if it is ultimately determined by a
court that are not entitled to indemnification, and to obtain directors' and
officers' insurance if available on reasonable terms. We maintain director and
officer liability insurance.
Section 317 of the California Code, our Bylaws and our indemnification
agreements with our directors and executive officers make provision for the
indemnification of officers, directors and other corporate agents in terms
sufficiently broad to indemnify such persons, under certain circumstances, for
liabilities (including reimbursement of expenses incurred) arising under the
Securities Act. Insofar as indemnification for liabilities arising under the
Securities Act may be permitted to our directors, officers, and controlling
persons pursuant to the foregoing provisions, or otherwise, we have been
advised in the opinion of the Securities and Exchange Commission such
indemnification is against public policy as expressed in the Securities Act and
is, therefore, unenforceable.
41
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
We have been treated as an S Corporation since our inception. We paid an
aggregate of approximately $23.3 million in cash dividends to our shareholders
from January 1, 1997 through March 1, 2000. These dividends were paid to our
shareholders to pay their income taxes, and as a return of their investment. We
intend to pay dividends aggregating approximately $8.9 million to our
shareholders prior to the closing of this offering as a distribution of
retained earnings and for the purpose of funding income taxes on 2000
S Corporation earnings.
Our current shareholders have personally guaranteed repayment of the Greyrock
bank debt. Upon completion of this offering and the application of the net
proceeds to repay the loan from Greyrock, the shareholder guarantees will
terminate. See "Use of Proceeds."
Our current shareholders have entered into a tax indemnification agreement
with us relating to their respective income tax liabilities. See "Termination
of S Corporation Status."
In January 2000, we loaned $2,630,000 to Alex Sandel with interest at our
borrowing rate from Greyrock. We expect such amount to be repaid prior to or
concurrently with the closing of this offering.
In 1999, we made rental payments on a new facility totaling $86,000 to a
company owned by Alex Sandel, our president and majority shareholder. We intend
to enter into a multiyear lease agreement with this company. This lease,
including the amount of the lease payments, is expected to be on terms similar
with those currently prevailing in the market.
During 1999, we made non-interest bearing loans to Alex Sandel totaling
$1,472,000 and interest bearing loans totaling $1,075,000 (interest accrued at
our borrowing rate from our major lender). These loans were repaid in their
entirety during 1999 except for interest accrued, totaling approximately
$72,000, which was subsequently forgiven by our board of directors.
In December 1999, we invested $500,000 in Synthonics Technologies, Inc. in
return for a note convertible into 11,518,096 shares of Synthonics common
stock, which at the time represented approximately 38% of Synthonics
outstanding shares. In addition, we agreed to replicate and package up to 2
million CDs without charge to Synthonics and establish a catalog entity to
develop and produce 3D interactive digital catalogs on behalf of Synthonics for
its customers. At the time of the investment, Diana Maranon, one of our
directors, was a member of the board of directors of Synthonics.
In December 1999, we made advances totaling $2,500,000 to Jason Barzilay, one
of our shareholders. This amount was repaid before the end of 1999. During
1999, we also made a loan of $1,000,000 to a company owned by Alex Sandel and
Jason Barzilay, which was repaid before the end of the year. Interest on these
amounts accrued at our borrowing rate from Greyrock.
In connection with the warrants issued to David Moss, our Vice President--
Operations, we loaned him a total of $1,428,000 in 1999 under promissory notes
bearing compound interest at the rate of 4.6% per annum, in order to allow him
to pay the federal and state taxes due as a result of the receipt of the
warrants. The unpaid principal balance and any accrued but unpaid interest
shall be due and payable on the earlier of: (1) January 1, 2006; or (2) the
fifteenth day following the date of delivery of written demand for payment made
at any time after the later of (a) the closing of a liquidity event (which
includes this offering), or (b) if applicable, the expiration of any lock-up
period imposed in connection with such liquidity event on our common stock held
by David Moss.
Since September 1997, Averil Capital Markets Group, Inc., a financial
advisory firm founded and controlled by Diana Maranon, has performed various
services for us including investigation of strategic and financing
alternatives. As consideration for these services rendered, we have paid Averil
Capital Markets Group, Inc. approximately $186,184, including expenses. As
consideration for services rendered in connection
42
with this offering, we have agreed to pay Averil Capital Markets Group, Inc. a
cash payment of 0.75% of the gross proceeds raised upon consummation of this
offering and warrants to purchase shares of our common stock equivalent to
0.25% of the gross proceeds raised at an exercise price equal to 110% of the
initial public offering price. The warrants given to Averil Capital Markets
Group, Inc. will become exercisable on the first anniversary of this offering.
We have entered into an indemnification agreement with Averil Capital Markets
Group, Inc. pursuant to which we will indemnify Averil Capital Markets Group,
Inc. and Ms. Maranon against any amounts these parties may become obligated to
pay in connection with Ms. Maranon's service as one of our directors and her
consulting services to us.
We lease one of our two facilities in Valencia, California, from Bascal
Properties II, a partnership owned by our existing shareholders. This lease
expires in May 2007 and currently provides for a monthly base rent of $20,000,
with periodic adjustments based on the consumer price index. We believe this
lease is at prevailing market rates for similar properties. Rental payments to
Bascal Properties II were $240,000 for the year ended December 31, 1999,
$240,000 for the year ended December 31, 1998 and $140,000 for the year ended
December 31, 1997. In June 1997, we loaned approximately $1.9 million to Bascal
Properties II. This loan bore interest at prime plus two percent and was repaid
in full in September 1997.
On November 1, 1997, we entered into a Purchase and Sale Agreement with
Packard Bell NEC. The Packard Bell NEC Agreement governed our relationship with
Packard Bell NEC with respect to the procedures for ordering, pricing and
delivering products, as well as product warranties. Pursuant to the Packard
Bell NEC Agreement, Packard Bell NEC agreed to purchase from us substantially
all of its United States requirements for CDs, so long as the pricing, terms,
conditions and quality of the CDs being sold by us were at least as favorable
as those available from any other third party supplier. The Packard Bell NEC
Agreement expired in November 1999. At the time this agreement was entered
into, our current shareholders owned a significant minority interest in Packard
Bell NEC and Alex Sandel was a director of Packard Bell NEC.
Historically, significant portions of our net sales have been to Packard Bell
NEC. Our net sales to Packard Bell NEC were approximately $554,000 for the year
ended December 31, 1999, $5.3 million for the year ended December 31, 1998,
$12.1 million for the year ended December 31, 1997, $14.2 million for the year
ended December 31, 1996 and $20.9 million for the year ended December 31, 1995.
Such sales represented approximately 1.0% of our net sales for the year ended
December 31, 1999, 12.4% of our net sales for the year ended December 31, 1998,
33.5% of our net sales for the year ended December 31, 1997, 55.3% of our net
sales for the year ended December 31, 1996 and 65.8% of our net sales for the
year ended December 31, 1995. At December 31, 1999, accounts receivable from
Packard Bell NEC were approximately $23,000, or 0.3% of total trade receivables
as of such date.
We had net sales to Reveal Computer Products (formerly named Cal Circuit
Abco, Inc. prior to December 1994), a re-packager of computer peripherals
managed by Jason Barzilay and controlled by our current and former
shareholders, amounting to $35,000 for the year ended December 31, 1996 and
$4,212,000 for the year ended December 31, 1995. During the second quarter of
1996, we wrote off accounts receivable balances of $1,559,000 due from Reveal
Computer Products. Moreover, from June 1995 to November 1995, we loaned an
aggregate of approximately $3.3 million to Reveal Computer Products bearing
interest at prime plus three percent. We determined this amount was
uncollectible and reserved for it at December 31, 1995. We ultimately wrote off
such amount in 1996, the same year Reveal Computer Products entered bankruptcy
and ceased operations.
43
PRINCIPAL AND SELLING SHAREHOLDERS
The following table presents information regarding the beneficial ownership
of our common stock as of March 1, 2000, and as adjusted to reflect our sale of
shares of our common stock and the selling shareholders sale of our common
stock offered by this prospectus, for:
. each person who is known to us to be the beneficial owner of more than
5% of our outstanding common stock;
. each of our directors; and
. the named executive officers as a group.
The address of each person listed is in care of us, at 25136 Anza Drive,
Valencia, California 91355, unless otherwise provided below such person's name.
Shares Beneficially Shares Beneficially
Owned Prior to Owned After the
Offering(1) Offering
-------------------- Number of ----------------------
Number of Percent of Shares Number of Percent of
Name of Beneficial Owner Shares Class Offered Shares Class
- ------------------------ --------- ---------- --------- --------- ----------
Alex Sandel(2)............ 6,145,000 67.2%
Jason Barzilay............ 3,000,000 33.3%
David Moss(3)............. 439,100 4.7%
Louis Weiss(4)............ 42,500 * 42,500
Sanford R. Climan(4)(5)... 30,000 * 30,000
Mark Dyne(4)(6)........... 7,500 * 37,500(9)
Diana Maranon(4)(7)....... 7,500 * 7,500
All of the directors and
executive officers as a
group (six persons)(8)... 6,671,600 69.0%
- --------
* Less than one percent.
(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission that deem shares to be beneficially
owned by any person who has or shares voting or investment power with
respect to such shares. Shares of common stock under warrants or options
currently exercisable or exercisable within 60 days of the date of this
offering are deemed outstanding for purposes of computing the percentage
ownership of the person holding such warrants or options but are not
deemed outstanding for computing the percentage ownership of any other
person. Unless otherwise indicated, the persons named in this table have
sole voting and sole investment power with respect to all shares shown as
beneficially owned, subject to community property laws where applicable.
(2) Includes 145,000 shares of common stock, which may be purchased upon
exercise of options that are currently exercisable.
(3) Includes 366,600 shares of common stock, which may be purchased upon
exercise of warrants that are currently exercisable and 72,500 shares of
common stock, which may be purchased upon exercise of options that are
currently exercisable.
(4) Represents shares of common stock, which may be purchased upon exercise of
options that are currently exercisable.
(5) Mr. Climan's address is c/o Entertainment Media Ventures, LLC, 828 Moraga
Drive Second Floor, Los Angeles, California 90049.
(6) Mr. Dyne's address is c/o Brilliant Digital Entertainment, Inc., 6355
Topanga Canyon Boulevard, Suite 513, Woodland Hills, California 91367.
(7) Ms. Maranon's address is c/o Averil Capital Markets Group, Inc., 2029
Century Park East, Suite 1900, Century City, California 90067.
(8) Includes 671,600 shares of common stock, which may be purchased upon
exercise of warrants and options that are currently exercisable.
(9) Includes 30,000 shares to be given by the existing shareholders to Mr.
Dyne.
44
DESCRIPTION OF CAPITAL STOCK
We are authorized to issue 45,000,000 shares of our common stock, no par
value and 5,000,000 shares of preferred stock, no par value. As of March 1,
2000, there were 9,000,000 shares of our common stock outstanding and there
were two holders of record of the common stock. Currently, there are no shares
of preferred stock outstanding. The following statements are brief summaries of
our capital stock.
Common Stock
The holders of common stock are entitled to one vote for each share held of
record on all matters on which the holders of common stock are entitled to vote
and have cumulative voting rights with respect to the election of directors.
The right to cumulate votes will automatically cease as of the first record
date of our annual meeting of shareholders where we have at least 800 holders
of our equity securities. The holders of our common stock are entitled to
receive dividends in proportion to their ownership when, as and if declared by
our board of directors out of legally available funds. In the event of our
liquidation, dissolution or winding up, the holders of common stock are
entitled subject to the rights of holders of preferred stock issued by us, if
any, to share proportionally in all assets remaining available for distribution
to them after payment of liabilities and after provision is made for each class
of stock, if any, having preference over the common stock.
The holders of common stock have no preemptive or conversion rights and they
are not subject to further calls or assessments by us. Our common stock does
not have any redemption or sinking fund provisions. The outstanding shares of
our common stock are, and the common stock issuable pursuant to this offering
will be, when issued, fully paid and nonassessable.
Preferred Stock
Our board of directors has the authority to issue the authorized and unissued
preferred stock in one or more series and our board of directors may determine
the designations, rights and preferences of the preferred stock. Accordingly,
and without the need for shareholder approval, our board of directors has the
power to issue preferred stock with dividend, liquidation, conversion, voting
or other rights, which adversely affect the voting power or other rights of the
holders of our common stock. In the event of issuance, and under certain
circumstances, we could use our preferred stock as a way of discouraging,
delaying or preventing an acquisition or a change in our control. We do not
currently intend to issue any shares of our preferred stock.
Warrants
We have granted to David Moss warrants to purchase 366,600 shares of our
common stock. The warrants granted to David Moss expire on December 31, 2007
and are exercisable for $0.0017 per share. None of the warrants granted to
David Moss will have any voting rights, dividend rights or preferences until
such time as they are exercised for shares of our common stock.
Effective upon the closing of this offering, we will grant to Averil Capital
Markets Group, Inc. warrants to purchase shares of our common stock equivalent
to 0.25% of the gross proceeds raised in this offering with an exercise price
equal to 110% of the initial public offering price. The warrants granted to
Averil Capital Markets Group, Inc. expire five years after they are granted.
See "Certain Relationships and Related Transactions."
Transfer Agent
Our transfer agent and registrar for our common stock is U.S. Stock Transfer
Corporation.
45
SHARES ELIGIBLE FOR FUTURE SALE
Prior to this offering, there has been no public market for our common stock.
We cannot predict the effect, if any, that future sale of shares, or the
availability of shares for future sale, will have on the prevailing market
price for our common stock. Sales of substantial amounts of our common stock in
the public market following this offering, or the perception that these sales
may occur, could adversely affect the prevailing market prices for our common
stock. See "Risk Factors--Sales of additional shares of our common stock into
the public market may cause our stock price to fall."
Upon completion of this offering, we will have shares of our common
stock outstanding, if the underwriters' over-allotment options are exercised in
full. Of those shares, a total of shares, shares if the
underwriters' over-allotment options are exercised in full, will be freely
tradable without restriction or further registration under the Securities Act,
unless purchased or held by our "affiliates" as that term is defined in Rule
144.
All of our executive officers, directors and shareholders, including the
selling shareholders have signed lock-up agreements under which they agreed not
to sell or otherwise transfer, directly or indirectly, any shares of common
stock or any securities convertible into, or exercisable or exchangeable for,
any shares of common stock for a period of 180 days from the date of this
prospectus without the prior written consent of Prudential Securities
Incorporated. These lock-up agreements do not prevent us from granting
additional options under our stock incentive plan. After the expiration of the
180-day period, shares that can be sold under Rule 144 will be eligible for
sale. Prudential Securities Incorporated may, in its sole discretion, at any
time and without notice, release all or any portion of the securities subject
to these lock-up agreements.
Number of shares Date of availability for resale into public market
---------------- --------------------------------------------------
9,000,000 180 days after the date of this prospectus due to a lock-up
agreement our two existing shareholders have with
Prudential Securities. However, Prudential Securities can
waive this restriction at any time and without notice.
Since these shares are held by our affiliates, sales of
these shares will also be subject to the volume limitations
of Rule 144.
In general, under Rule 144 as currently in effect, any person who has
beneficially owned restricted securities for at least one year would be
entitled to sell within any three-month period a number of shares that does not
exceed the greater of:
.1% of the then outstanding shares of common stock; or
. the average weekly trading volume in the common stock during the four
calendar weeks immediately preceding the date on which the notice of the
sale on Form 144 is filed with the Securities and Exchange Commission.
Within 90 days after the date of this prospectus, we intend to file a
Registration Statement on Form S-8 covering an aggregate of approximately
1,566,600 shares of common stock, including the 828,000 shares of common stock
which will then be subject to outstanding options and 366,600 shares of common
stock underlying the warrants granted to David Moss. Additionally, we have
agreed to file a Registration Statement on Form S-3 covering the shares of
common stock underlying the warrants to be granted to Averil Capital Markets
Group, Inc., after these warrants become exercisable. After the effective date
of the Form S-8, shares of common stock issued upon exercise of options granted
pursuant to our stock incentive plan and upon exercise of the warrants granted
to David Moss will be available for sale in the public market. However, these
shares will remain subject to Rule 144 volume limitations applicable to our
affiliates and to the lock-up agreements. Shares of common stock issuable upon
exercise of the warrants to be granted to Averil Capital Markets Group, Inc.
will become exercisable subject to Rule 144 volume limitations, one year after
the date these warrants were granted or the filing of the related Form S-3,
whichever occurs first.
46
UNDERWRITING
We have entered into an underwriting agreement with the underwriters named
below, for whom Prudential Securities Incorporated and CIBC World Markets Corp.
are acting as representatives. We and the selling shareholders are obligated to
sell, and the underwriters are obligated to purchase, all of the shares offered
on the cover page of this prospectus, if any are purchased. Subject to
conditions of the underwriting agreement, each underwriter has severally agreed
to purchase the shares indicated opposite its name:
Number of
Underwriters Shares
- ------------ ---------
Prudential Securities Incorporated....................................
CIBC World Markets Corp. .............................................
----
Total...............................................................
====
The underwriters may sell more shares than the total number of shares offered
on the cover page of this prospectus and they have, for a period of 30 days
from the date of this prospectus, over-allotment options to purchase up to
additional shares from us and up to additional shares from the selling
shareholders. If any additional shares are purchased, the underwriters will
severally purchase the shares in the same proportion as per the table above.
The representatives of the underwriters have advised us and the selling
shareholders that the shares will be offered to the public at the offering
price indicated on the cover page of this prospectus. The underwriters may
allow a concession not in excess of $ per share to selected dealers and such
dealers may reallow a concession not in excess of $ per share to certain
other dealers. After the shares are released for sale to the public, the
representatives may change the offering price and the concessions. The
representatives have informed us and the selling shareholders that the
underwriters do not intend to sell shares to any investor who has granted them
discretionary authority.
We and the selling shareholders have agreed to pay to the underwriters the
following fees, assuming both no exercise and full exercise of the
underwriters' over-allotment options to purchase additional shares:
Total Fees
---------------------------------------------
Fee Without Exercise of Full Exercise of
Per Share Over-Allotment Options Over-Allotment Options
--------- ---------------------- ----------------------
Fees paid by us......... $ $ $
Fees paid by the selling
shareholders........... $ $ $
In addition, we estimate that we will spend approximately $ in expenses
for this offering. We have agreed to indemnify the underwriters against certain
liabilities, including liabilities under the Securities Act, or contribute to
payments that the underwriters may be required to make in respect of these
liabilities.
We, our officers and directors, and all shareholders including our selling
shareholders have entered into lock-up agreements pursuant to which we and they
have agreed not to offer or sell any shares of common stock or securities
convertible into or exchangeable or exercisable for shares of common stock for
a period of 180 days from the date of this prospectus without the prior written
consent of Prudential Securities Incorporated, on behalf of the underwriters.
Prudential Securities Incorporated may, at any time and without notice, waive
the terms of the lock-up agreements specified in the underwriting agreement.
Prior to this offering, there has been no public market for our common stock.
The public offering price, negotiated among Future Media, the selling
shareholders, and the representatives is based upon various factors such as our
financial and operating history and condition, our prospects, the prospects for
the industry we are in and prevailing market conditions.
47
Prudential Securities Incorporated, on behalf of the underwriters, may engage
in the following activities in accordance with applicable securities rules:
. Over-allotments involving sales in excess of the offering size, creating
a short position. Prudential Securities Incorporated may elect to reduce
this short position by exercising some or all of the over-allotment
options.
. Stabilizing and short covering; stabilizing bids to purchase the shares
are permitted if they do not exceed a specified maximum price. After the
distribution of shares has been completed, short covering purchases in
the open market may also reduce the short position. These activities may
cause the price of the shares to be higher than would otherwise exist in
the open market.
. Penalty bids permitting the representatives to reclaim concessions from a
syndicate member for the shares purchased in the stabilizing or short
covering transactions.
Such activities, which may be commenced and discontinued at any time, may be
effected on the Nasdaq National Market, in the over-the-counter market or
otherwise.
Each underwriter has represented that it has complied and will comply with
all applicable laws and regulations in connection with the offer, sale or
delivery of the shares and related offering materials in the United Kingdom,
including:
. the Public Offers of Securities Regulations 1995;
. the Financial Services Act 1986; and
. the Financial Services Act 1986, (Investment Advertisements) (Exemptions)
Order 1996 (as amended).
We have asked the underwriters to reserve shares for sale at the same
offering price directly to our officers, directors, employees and other
business affiliates or related third parties. The number of shares available
for sale to the general public in the offering will be reduced to the extent
such persons purchase the reserved shares.
Prudential Securities Incorporated facilitates the marketing of new issues
online through its PrudentialSecurities.com division. Clients of Prudential
AdvisorSM, a full service brokerage firm program, may view offering terms and a
prospectus online and place orders through their financial advisors.
48
LEGAL MATTERS
Our counsel, Troop Steuber Pasich Reddick & Tobey, LLP, Los Angeles,
California, has rendered an opinion that the common stock offered by us, upon
its sale will be duly and validly issued, fully paid and non-assessable.
Gibson, Dunn & Crutcher LLP, Los Angeles, California, has acted as counsel to
the underwriters in connection with certain legal matters relating to this
offering.
EXPERTS
Ernst & Young LLP, independent auditors, have audited our financial
statements at December 31, 1998 and 1999, and for each of the three years in
the period ended December 31, 1999, as set forth in their report. We have
included our financial statements in the prospectus and elsewhere in the
registration statement in reliance on Ernst & Young LLP's report, given on
their authority as experts in accounting and auditing.
WHERE YOU CAN FIND MORE INFORMATION
We have filed with the Securities and Exchange Commission in Washington,
D.C., a registration statement under the Securities Act with respect to this
offering. This Prospectus does not contain all of the information set forth in
such registration statement and the exhibits thereto. Statements contained in
this prospectus as to the contents of any contract or any other document
referred to are not necessarily complete, and with respect to any contract or
other document filed as an exhibit to such registration statement, reference is
made to the exhibit for a more complete description of the matter involved, and
each such statement is qualified in its entirety by such reference. For further
information about us and the shares offered, please review the registration
statement and the exhibits. A copy of the registration statement, including the
exhibits, may be inspected without charge at the Securities and Exchange
Commission's principal office in Washington, D.C., and copies of all or any
part thereof may be obtained from the Public Reference Section of the
Securities and Exchange Commission at 450 Fifth Street, N.W., Washington, D.C.
20549, upon payment of certain prescribed rates.
When this offering is consummated, we will become subject to the
informational requirements of the Securities Exchange Act and will file reports
and other information with the Securities and Exchange Commission in accordance
with its rules. These reports and other information concerning us may be
inspected and copied at the public reference facilities referred to above as
well as some of the regional offices of the Securities and Exchange Commission.
The Securities and Exchange Commission maintains a web site, which contains
reports, proxy and information statements and other information regarding
issuers that file electronically with the Securities and Exchange Commission at
http://www.sec.gov.
49
INDEX TO FINANCIAL STATEMENTS
Page
----
Report of Ernst & Young LLP, Independent Auditors........................ F-2
Balance Sheets at December 31, 1998 and December 31, 1999................ F-3
Statements of Income for years ended December 31, 1997, 1998 and 1999.... F-4
Statements of Shareholders' Equity for years ended December 31, 1997,
1998 and 1999........................................................... F-5
Statements of Cash Flows for years ended December 31, 1997, 1998 and
1999.................................................................... F-6
Notes to Financial Statements for December 31, 1997, 1998 and 1999....... F-7
F-1
Report of Independent Auditors
The Board of Directors
Future Media Productions, Inc.
We have audited the accompanying balance sheets of Future Media Productions,
Inc. as of December 31, 1998 and 1999 and the related statements of income,
shareholders' equity and cash flows for each of the three years in the period
ended December 31, 1999. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Future Media Productions, Inc.
as of December 31, 1998 and 1999 and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 1999, in
conformity with accounting principles generally accepted in the United States.
/s/ Ernst & Young LLP
Los Angeles, California
February 25, 2000
F-2
FUTURE MEDIA PRODUCTIONS, INC.
BALANCE SHEETS
December 31 Pro Forma
----------------------- December 31,
1998 1999 1999
----------- ----------- ------------
(unaudited)
Assets
Current assets:
Accounts receivable (net of allowance
for doubtful accounts of $163,000 in
1998 and $265,778 in 1999)............ $ 8,035,270 $ 7,202,126
Inventories............................ 726,774 766,868
Prepaid expenses....................... 433,497 284,101
Deferred income taxes.................. 8,000 -- 300,000
----------- ----------- ----------
Total current assets..................... 9,203,541 8,253,095
Property and equipment, net.............. 21,898,093 29,837,448
Investments.............................. -- 2,852,400
Other assets............................. 336,268 145,845
----------- -----------
Total assets............................. $31,437,902 $41,088,788
=========== ===========
Liabilities and Shareholders' Equity
Current liabilities:
Bank overdraft......................... $ 517,258 $ 370,489
Line of credit......................... 1,616,537 1,852,303
Accounts payable--trade................ 2,648,974 2,762,457
Accounts payable--capital equipment.... 4,449,059 1,530,356
Accrued expenses--royalties............ 2,213,294 4,101,760
Accrued expenses....................... 1,032,631 1,043,268
Deferred revenue....................... -- 700,000
Deferred income taxes.................. -- 40,500 --
Current portion of long-term debt...... 3,756,987 3,757,698 --
Current portion of capital lease
obligations........................... 11,666 5,938
Distributions payable.................. -- -- 14,407,386
----------- ----------- ----------
Total current liabilities................ 16,246,406 16,164,769
Long-term debt, less current portion..... 9,084,805 5,327,108
Capital lease obligations, less current
portion................................. 17,479 11,525
Deferred income taxes.................... 90,000 116,000 3,200,000
Commitments
Shareholders' equity:
Preferred stock, no par value:
Authorized shares--5,000,000.........
Issued and outstanding shares--none.. -- --
Common stock, no par value:
Authorized shares--45,000,000........
Issued and outstanding shares--
9,000,000........................... 3,070,000 3,790,000 3,790,000
Retained earnings...................... 2,929,212 17,107,386 --
Note receivable from officer........... -- (1,428,000) (1,428,000)
----------- ----------- ----------
Total shareholders' equity............... 5,999,212 19,469,386 2,362,000
----------- -----------
Total liabilities and shareholders'
equity.................................. $31,437,902 $41,088,788
=========== ===========
The accompanying notes to the financial statements are an integral part of
these statements.
F-3
FUTURE MEDIA PRODUCTIONS, INC.
STATEMENTS OF INCOME
Year Ended December 31
-------------------------------------
1997 1998 1999
----------- ----------- -----------
Net sales to unaffiliated companies.... $23,974,131 $37,962,123 $52,448,072
Net sales to related parties........... 12,068,296 5,349,057 553,799
----------- ----------- -----------
Total net sales........................ 36,042,427 43,311,180 53,001,871
Cost of goods sold..................... 23,132,442 27,304,178 31,937,704
----------- ----------- -----------
Gross profit........................... 12,909,985 16,007,002 21,064,167
Selling, general and administrative
expenses.............................. 4,214,033 4,232,741 4,200,969
Stock related compensation expense..... -- 3,055,000 720,000
Abandoned offering costs............... -- 675,733 --
----------- ----------- -----------
Income from operations................. 8,695,952 8,043,528 16,143,198
Other income (expense):
Interest income...................... 42,105 35,189 670
Interest expense..................... (817,998) (1,263,861) (1,403,694)
----------- ----------- -----------
Other income (expense), net.......... (775,893) (1,228,672) (1,403,024)
----------- ----------- -----------
Income before provision for state
income taxes.......................... 7,920,059 6,814,856 14,740,174
Provision for state income taxes....... 119,900 102,223 2,000
----------- ----------- -----------
Net income............................. $ 7,800,159 $ 6,712,633 $14,738,174
Earnings per share:
Basic................................ $ 0.87 $ 0.75 $ 1.64
=========== =========== ===========
Diluted.............................. $ 0.87 $ 0.71 $ 1.43
=========== =========== ===========
Shares used in computing earnings per
share:
Basic................................ 9,000,000 9,000,000 9,000,000
=========== =========== ===========
Diluted.............................. 9,000,000 9,498,287 10,336,178
=========== =========== ===========
Pro forma net income data (Notes 1 and
7, unaudited):
Income before provision for income
taxes............................... $ 7,920,059 $ 6,814,856 $14,740,174
Pro forma income tax provision....... 3,161,100 2,725,942 5,896,070
----------- ----------- -----------
Pro forma net income................. $ 4,758,959 $ 4,088,914 $ 8,844,104
Pro forma basic earnings per share... $ 0.98
===========
Pro forma diluted earnings per
share............................... $ 0.86
===========
Weighted average shares outstanding--
basic............................... 9,000,000
===========
Weighted average shares outstanding--
diluted............................. 10,336,178
===========
The accompanying notes to the financial statements are an integral part of
these statements.
F-4
FUTURE MEDIA PRODUCTIONS
STATEMENTS OF SHAREHOLDERS' EQUITY
Note
Common Stock Receivable
-------------------- from Retained
Shares Amount Officer Earnings Total
--------- ---------- ----------- ------------ ------------
Balance at January 1,
1997................... 9,000,000 $ 15,000 $ -- $ 13,129,440 $ 13,144,440
Dividends, $1.22 per
share.................. -- -- -- (11,009,020) (11,009,020)
Net income.............. -- -- -- 7,800,159 7,800,159
--------- ---------- ----------- ------------ ------------
Balance at December 31,
1997................... 9,000,000 15,000 -- 9,920,579 9,935,579
Dividends, $1.52 per
share.................. -- -- -- (13,704,000) (13,704,000)
Issuance of stock
warrants............... -- 3,055,000 -- -- 3,055,000
Net income.............. -- -- -- 6,712,633 6,712,633
--------- ---------- ----------- ------------ ------------
Balance at December 31,
1998................... 9,000,000 3,070,000 -- 2,929,212 5,999,212
Dividends, $.06 per
share.................. -- -- -- (560,000) (560,000)
Loan to officer......... -- -- (1,428,000) -- (1,428,000)
Contribution of
capital................ -- 720,000 -- -- 720,000
Net income.............. -- -- -- 14,738,174 14,738,174
--------- ---------- ----------- ------------ ------------
Balance at December 31,
1999................... 9,000,000 $3,790,000 $(1,428,000) $ 17,107,386 $ 19,469,386
========= ========== =========== ============ ============
The accompanying notes to the financial statements are an integral part of
these statements.
F-5
FUTURE MEDIA PRODUCTIONS, INC.
STATEMENTS OF CASH FLOWS
Year Ended December 31
---------------------------------------
1997 1998 1999
----------- ------------ ------------
Operating activities
Net income............................ $ 7,800,159 $ 6,712,633 $ 14,738,174
Adjustments to reconcile net income to
net cash provided by operating
activities:
Depreciation and amortization....... 1,949,838 2,860,789 4,368,177
Stock related compensation expense.. -- 3,055,000 720,000
Provision for bad debts............. 955,243 120,000 120,000
Loss on disposals of property and
equipment.......................... 20,959 57,058 --
Deferred income taxes............... 17,000 22,000 74,500
Changes in operating assets and
liabilities:
Accounts receivable................ (3,195,350) (1,347,486) 713,144
Inventories........................ 1,523,072 (92,276) (40,094)
Prepaid expenses................... (121,019) (123,088) 149,396
Other assets....................... 279,437 (92,411) 190,423
Other receivables.................. -- 275,000 --
Accounts payable................... (850,930) 941,330 113,483
Accrued expenses................... 39,622 408,583 10,637
Accrued expenses--royalties........ 3,090,416 (1,953,206) 1,888,466
----------- ------------ ------------
Net cash provided by operating
activities........................... 11,508,447 10,843,926 23,046,306
Investing activities
Capital expenditures.................. (3,641,686) (6,751,862) (15,226,235)
Purchases of investments.............. -- -- (2,152,400)
Proceeds from disposals of property
and equipment........................ -- 20,000 --
----------- ------------ ------------
Net cash used in investing
activities........................... (3,641,686) (6,731,862) (17,378,635)
Financing activities
Net borrowings (repayments) on line of
credit............................... (103,316) 1,352,893 235,766
Net payments on bank overdraft........ (914,366) (226,150) (146,769)
Proceeds from long-term debt.......... 6,537,612 11,321,000 --
Repayments on long-term debt.......... (6,700,928) (2,844,843) (3,756,986)
Note receivable from officer.......... -- -- (1,428,000)
Payments on capital lease
obligations.......................... (14,221) (10,964) (11,682)
Dividends paid to shareholders........ (6,671,542) (13,704,000) (560,000)
----------- ------------ ------------
Net cash used in financing
activities........................... (7,866,761) (4,112,064) (5,667,671)
Net change in cash and cash
equivalents.......................... -- -- --
Cash and cash equivalents at beginning
of period............................ -- -- --
----------- ------------ ------------
Cash and cash equivalents at end of
period............................... $ -- $ -- $ --
=========== ============ ============
Supplemental disclosures of cash flow
information:
Cash paid during the period for:
Interest........................... $ 817,998 $ 1,121,507 $ 1,403,749
State income taxes................. $ 107,000 $ 61,500 $ 1,800
Supplemental disclosure of non-cash
transactions
During the year ended December 31, 1997, the Company distributed $11,009,020
to shareholders consisting of a $4,337,478 reduction of notes receivable due
from shareholders and cash payments of $6,671,542.
In 1999, the Company agreed to provide replications of two million CD's to
Synthonics partially as part of the Company's investment in Synthonics (valued
at $700,000).
The accompanying notes to the financial statements are an integral part of
these statements.
F-6
FUTURE MEDIA PRODUCTION, INC.
NOTES TO FINANCIAL STATEMENTS
December 31, 1999
1. Business and Summary of Significant Accounting Policies
Description of Business
Future Media Productions, Inc. (the Company) is an independent
manufacturer/replicator of digital versatile discs (DVDs) and compact disks
(CDs) to companies in industries including Internet/online, film and
entertainment, edutainment software, publishing and computer hardware. The
majority of the Company's business is targeted at high volume customers in
these markets.
Pro Forma Balance Sheet Information
The Company is an S Corporation for income tax purposes. The pro forma
unaudited December 31, 1999 information in the accompanying balance sheet
reflects the distribution, in the amount of approximately $14,407,386
(unaudited), to shareholders upon conversion from an S Corporation to a C
Corporation and the establishment of a net deferred tax liability of
approximately $2,900,000 (unaudited), resulting in an approximately $2,700,000
(unaudited) reduction of retained earnings, upon conversion as discussed
further in Note 1, "Income Taxes," and Note 7 to the financial statements.
Estimates and Assumptions
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
affecting the reported amounts in the financial statements and accompanying
notes. Actual results could differ from those estimates, although management
does not believe differences would materially affect the Company's financial
position or results of operations.
Concentration of Credit Risk
The Company manufactures and distributes DVDs and CDs principally to
companies in the Internet/online, film and entertainment, edutainment software,
publishing and computer hardware industries throughout the United States. The
Company grants credit to its customers and does not require collateral. Credit
evaluations are performed periodically as needed. Concentrations of sales and
credit exist and are described in Note 5.
Cash Equivalents
The Company considers all highly liquid investments with maturities of three
months or less when purchased to be cash equivalents.
Inventories
Inventories are stated at the lower of cost (determined on a first-in, first-
out basis) or market.
Property and Equipment
Property and equipment is stated at cost and depreciated over its useful life
ranging from three to ten years using the straight-line method. Maintenance and
repairs are charged to expense as incurred and costs of additions and
betterments increasing useful lives are capitalized. Amortization of leased
property is computed by the straight-line method over the lesser of the asset
life or, life of the lease.
Income Taxes
The Company has elected to be taxed under the S Corporation provisions of the
Internal Revenue Code which provides, in lieu of corporate income taxes, the
shareholders separately account for their pro rata share of
F-7
FUTURE MEDIA PRODUCTIONS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
December 31, 1999
the Company's items of income, deductions, losses and credits. Therefore, these
statements do not include any provision for corporate federal income taxes.
Similar provisions apply for California income tax reporting; however,
California tax law provides for a 1.5% rate on taxable income at the corporate
level. Accordingly, the income tax provision consists of 1.5% tax due on the
California taxable income of the Company offset by certain manufacturing
credits.
In connection with the closing of the proposed public offering, the Company's
S Corporation status will terminate and the Company will be taxed thereafter as
a C Corporation. The pro forma statements of income reflect a provision for
federal and state income taxes as if the Company was a C Corporation for the
periods presented. Upon conversion to a C Corporation, the Company will
establish a net deferred tax liability with an accompanying increase to income
tax expense. If this charge were recorded at December 31, 1999, the amount
would have been approximately $2,700,000 (unaudited), consisting primarily of
timing differences related to depreciation.
Immediately prior to the closing of the proposed public offering, the Company
will enter into a tax indemnification agreement with the existing shareholders
relating to respective income tax liabilities. The tax indemnification
agreement is intended to assure the Company assumes taxes for the related
income giving rise to such taxes and the existing shareholders assume taxes for
which they have received the related income giving rise to such taxes.
Revenue Recognition
Revenues are recorded when products are shipped or orders are completed under
purchase orders or contracts and are due to be shipped but awaiting
instructions from the customer of the shipping destination. Revenues related to
the latter have been insignificant at the end of reporting periods.
Stock-Based Compensation
The Company accounts for employee and director stock options using the
intrinsic value method. Generally, the exercise price of the Company's employee
stock options equals or exceeds the market price of the underlying stock on the
date of grant and no compensation expense is recognized. If the option price is
less than fair value, the Company records compensation expense over the vesting
period of the stock option. Options granted to non-employees are accounted for
using a fair value method. The Company has disclosed the pro forma material
effects of using the fair value method of all options in its financial
statements.
Earnings Per Share
Basic earnings per share has been computed by dividing net income by the
weighted average number of common shares outstanding for the periods presented.
Diluted earnings per share has been computed by dividing net income by
securities or other contracts to issue common stock as if these securities were
exercised or converted to common stock.
F-8
FUTURE MEDIA PRODUCTIONS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
December 31, 1999
The following table sets forth the calculation for basic and diluted earnings
per share for the periods presented:
Year Ended December 31
---------------------------------
1997 1998 1999
---------- ---------- -----------
Earnings:
Net income............................. $7,800,159 $6,712,633 $14,738,174
========== ========== ===========
Shares:
Weighted average shares for basic
earnings per share.................... 9,000,000 9,000,000 9,000,000
Share equivalents for dividends to
stockholders.......................... -- -- 623,641
Stock options and warrants............. -- 498,287 712,537
---------- ---------- -----------
Weighted average shares for diluted
earnings per share.................... 9,000,000 9,498,287 10,336,178
========== ========== ===========
Pro Forma Earnings Per Share (unaudited)
The Company is currently taxed as an S Corporation for federal income and
California franchise tax purposes. Accordingly, the provision for income taxes
for the periods presented reflect primarily state income tax. The pro forma
unaudited earnings per share information is calculated as if the Company had
been subject to tax as a C Corporation for the most recent period presented.
Long-Lived Assets
The Company reviews for the impairment of long-lived assets and certain
identifiable intangibles whenever events or changes in circumstances indicate
the carrying amount of any asset may not be recoverable. An impairment loss
would be recognized when the estimated undiscounted future cash flows expected
to result from the use of the asset and its eventual disposition is less than
the carrying amount. If impairment is indicated, the amount of the loss to be
recorded is based upon an estimate of the difference between the carrying
amount and the fair value of the asset. Fair value is based upon discounted
estimated cash flows expected to result from the use of the asset and its
eventual disposition and other valuation methods. The Company has identified no
such impairment losses.
Comprehensive Income
There were no significant items of comprehensive income and no impact of
these items on the Company's results of operations for the years ended December
31, 1997, 1998 and 1999, and therefore no further disclosures related to this
matter have been made.
Reclassifications
Certain reclassifications have been made to the December 31, 1997 and 1998
financial statements to conform to the presentation in 1999.
2. Inventories
Inventories consisted of the following:
December 31
-------------------
1998 1999
--------- ---------
Raw materials........................................... $ 604,972 $ 668,515
Work-in process and finished goods...................... 121,802 98,353
--------- ---------
$ 726,774 $ 766,868
========= =========
F-9
FUTURE MEDIA PRODUCTIONS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
December 31, 1999
3. Property and Equipment
Property and equipment, net, consisted of the following:
December 31
--------------------------
1998 1999
------------ ------------
Plant equipment......... $ 27,799,629 $ 39,057,036
Computer equipment and
software............... 95,736 237,871
Office furniture and
equipment.............. 83,564 83,558
Automotive equipment.... 71,080 96,865
Leasehold improvements.. 815,912 1,698,122
Leased property under
capital leases......... 57,540 57,540
------------ ------------
28,923,461 41,230,992
Less accumulated
depreciation and
amortization........... (7,025,368) (11,393,544)
------------ ------------
$ 21,898,093 $ 29,837,448
============ ============
4. Investments
On December 21, 1999, the Company purchased, through an underwriting, 648
units of Lions Gate Entertainment, a Canadian motion picture production and
distribution company. Each unit was purchased for $2,550 or a total of
$1,652,400. Each unit consists of one 5.25% Convertible Redeemable Preferred
Stock and 425 warrants. Each share of preferred stock is convertible into 1,000
shares of common stock and each warrant entitles the holder to purchase one
share of Lions Gate common stock at $5.00 per share. The closing quoted market
value per share of Lions Gate on February 28, 2000 was $2.625. The warrants
expire January 2004.
On December 23, 1999, the Company paid in cash $500,000 to Synthonics
Technologies, Inc. (Synthonics) in return for a note receivable convertible
into 11,518,096 shares of Synthonics common stock, which at the time
represented 38% of Synthonics outstanding shares. The Company agreed to
replicate and package up to two million CDs without charge to Synthonics and
establish a catalog company to develop and produce 3D interactive digital
catalogs on behalf of Synthonics for its customers. A member of Synthonics
Board of Directors is also a member of the Company's Board of Directors. The
investment in Synthonics totaling $1,200,000 (including an amount of $700,000
as the fair market value of the replication services to be performed), will be
accounted for under the equity method.
5. Related Party Transactions and Major Customers
During the years ended December 31, 1997 and 1998, a significant portion of
the Company's revenue activity consisted of sales to one affiliated company,
which at the time was partially owned by the shareholders of the Company. Net
sales to this affiliate, an original manufacturer of personal computers, were
$12,068,296, $5,349,057 and $553,799 for the years ended December 31, 1997,
1998 and 1999, respectively, and represented 33.5%, 12.4% and 1.0% of the
Company's net sales, respectively. At December 31, 1998 and 1999, accounts
receivable from this affiliate were $614,538 and $23,103, or 7.5% and 0.3% of
total trade receivables, respectively.
Net sales to the Company's top two unaffiliated customers in 1997 and 1998
and top three unaffiliated customers in 1999 were 35.4%, 47.6% and 55.6% of
total net sales, respectively, including one customer in 1999 which represented
32.1% of total net sales. Accounts receivable in the aggregate from these
significant customers at December 31, 1998 and 1999 were $1,457,142, or 17.9%
and $2,434,045, or 32.5% of total trade receivables, respectively.
F-10
FUTURE MEDIA PRODUCTIONS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
December 31, 1999
During the year ended December 31, 1997, the Company wrote off accounts
receivable balances due from related parties in the aggregate of $670,263, none
of which related to the receivables from the affiliated company discussed
above.
A director of the Company performed services for the Company including
investigation of strategic and financing alternatives. As consideration for
such services, the Company paid to the director $25,000, $101,184 and $0,
including out of pocket expenses during the years ended December 31, 1997, 1998
and 1999. The Company has committed, upon consummation of an offering, to a
cash payment to the director of 0.75% of the gross proceeds of an offering and
additional equity securities, warrants, or other participating interests in the
Company representing 0.25% of the consideration raised in value, priced in
accordance with a Black-Scholes option model, with a minimum amount of warrants
issuable pursuant to this transaction not to be less than $50,000 in value.
After the end of the year, the Company paid a non-refundable retainer of
$60,000 to this director, which will be credited against any transaction fees
payable pursuant to the offering.
During the year ended December 31, 1999, the Company made non-interest
bearing loans totaling $1,427,000 and interest bearing loans totaling
$1,075,000 (interest accrued at the Company's borrowing rate with its major
lender) to its president. These loans were repaid in their entirety during 1999
except for interest accrued, totaling approximately $72,000, which was
subsequently forgiven by the Company's Board of Directors. After the end of
1999, the Company loaned $2,630,000 to this officer with interest at the
Company's borrowing rate with its major lender.
During 1999, advances totaling $2,500,000 were made to one of the Company's
shareholders. This amount was repaid before the end of 1999. In addition, a
loan totaling $1,000,000 was made during 1999 to a company partially owned by
the Company's president and this shareholder. This amount was repaid prior to
the end of 1999.
In connection with stock warrants issued to an officer of the Company (see
Note 9), the Company loaned an officer a total of $1,428,000 under promissory
notes bearing compound interest at the rate of 4.6% per annum. The unpaid
principal balance and any accrued but unpaid interest shall be due and payable
on the earlier of: (1) January 1, 2006; or (2) the fifteenth day following the
date of delivery by the Company to Maker of written demand therefore made at
any time after the later of (a) the closing of a Liquidity Event (as defined),
or (b) if applicable, the expiration of any lock-up period imposed in
connection with such Liquidity Event on the common stock of the Company, or any
successor to the Company, held by Maker.
In 1999, the Company made payments in lieu of lease payments on a new
production facility to a company owned by the Company's president. Such
payments during the year totaled $86,000. Subsequent to December 31, 1999, the
Company expects to enter into a multi-year lease agreement with this company.
Lease payments are expected to be negotiated at rates commensurate with
commercial terms charged for similar properties in the area with increases
based on the Consumer Price Index.
6. Financing
In February 1997, the Company entered into a credit agreement (Credit
Agreement) with a lender, which was amended in January 1998 and further amended
in April 1998, July 1998, June 1999 and January 2000. The Credit Agreement
currently provides loans based on 80% of the Company's eligible receivables (as
defined) (Receivable Loans), loans based on 90% of the net purchase price of
new equipment purchased and delivered subsequent to June 1999 (Equipment Loans)
and additional revolving loans (Revolving Loans). Under the Credit Agreement
the Company is allowed to borrow the lesser of $30,000,000 or an amount equal
to 80% of the Company's eligible receivables (as defined), $15,000,000 of
Equipment Loans plus the unpaid balance of
F-11
FUTURE MEDIA PRODUCTIONS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
December 31, 1999
the Revolving Loans. The Credit Agreement had an original maturity date of
February 28, 1998 and provided for automatic renewals. In January 1998, the
agreement was amended to have an original maturity of April 30, 1998 and in
January 2000 the maturity date was extended to June 30, 2001, and continues to
provide for automatic renewals. Borrowings under Receivable Loans bear interest
at the prime rate (8.5% at December 31, 1999) plus 2.0% per annum; however, the
interest rate will not be less than 7.0% per annum. Outstanding borrowings
under the Receivable Loans amounted to $1,616,537 at December 31, 1998 and
$1,852,303 at December 31, 1999. The Credit Agreement is secured by accounts
receivable, equipment, inventory and other assets and is personally guaranteed
by the shareholders of the Company. Interest expense related to the Receivable
Loans for the years ended December 31, 1997, 1998 and 1999 was $234,778,
$116,959 and $274,833, respectively.
Under the amendment of April 1998, the Revolving Loans were for an amount of
$15,000,000, which is payable in monthly principal installments of $312,500
through (i) the earlier of the date the Credit Agreement terminates, or is
terminated, or (ii) April 2002. The Revolving Loans bear interest at the prime
rate (8.5% at December 31, 1999) plus 2.0% per annum; however, the interest
rate will not be less than 7.0% per annum. The outstanding balance of the
Revolving Loans was $12,812,500 and $9,062,500 at December 31, 1998 and 1999,
respectively. As part of the Credit Agreement, the Revolving Loans are
collateralized by accounts receivable, equipment, inventory and other assets
and is personally guaranteed by the shareholders of the Company.
Under the amendment of June 1999, amounts borrowed under the Equipment Loans
are to be repaid in 48 equal monthly payments of principal through the earlier
of (i) the earlier of the date the Credit Agreement terminates, or is
terminated or (ii) the date such Equipment Loans have been repaid in full. The
Equipment Loans bear interest at the prime rate (8.5% at December 31, 1999)
plus 2.0% per annum; however, the interest rate will not be less than 7.0% per
annum. At December 31, 1999 no amounts had been borrowed under the Equipment
Loans.
Subsequent to the closing of the offering described in Note 11, the Company
anticipates renegotiating the terms under the Credit Facility, including
maturity dates, covenants, interest rates and personal guarantees.
Future maturities of long-term debt are as follows:
Year ended December 31:
2000........................................................... $ 3,757,697
2001........................................................... 3,758,480
2002........................................................... 1,568,627
-----------
$ 9,084,804
===========
Interest expense incurred for long-term debt was $579,123, $1,142,893 and
$1,125,167 for the years ended December 31, 1997, 1998 and 1999, respectively.
The Company's weighted average interest rate on its debt was 10.5%, 10.4% and
10.1% for the years ended December 31, 1997, 1998 and 1999, respectively.
F-12
FUTURE MEDIA PRODUCTIONS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
December 31, 1999
7. Income Taxes
The provision (benefit) for state income taxes is as follows:
Year Ended December 31
----------------------------
1997 1998 1999
--------- -------- ---------
Current........................................ $ 102,900 $ 80,223 $ (72,500)
Deferred....................................... 17,000 22,000 74,500
--------- -------- ---------
$ 119,900 $102,223 $ 2,000
========= ======== =========
As described in Note 1 to the financial statements, the Company is currently
an S Corporation for federal income and California franchise tax purposes under
Subchapter S of the Internal Revenue Code and the corresponding provisions of
the California statute. In connection with the closing of the proposed public
offering as discussed in Note 11, the Company's S Corporation status will
terminate and the Company will be taxed as a C Corporation. This will result in
the establishment of a provision for income taxes and deferred tax liability of
approximately $2,700,000 (unaudited) upon the closing date. The following
unaudited pro forma income tax information has been determined as if the
Company operated as a C Corporation for the periods presented:
Year Ended December 31
--------------------------------
1997 1998 1999
---------- ---------- ----------
Federal tax provision..................... $2,460,000 $2,115,600 $4,598,935
State income taxes net of federal
benefit.................................. 701,100 602,800 1,297,135
---------- ---------- ----------
Total pro forma income tax provision...... $3,161,100 $2,718,400 $5,896,070
========== ========== ==========
The difference between actual income tax expense and the U. S. Federal
statutory income tax rate is as follows:
Year Ended December 31
---------------------------
1997 1998 1999
------- ------- -------
Statutory rate................................. 34.0 % 34.0 % 34.0 %
State tax provision............................ 1.5 1.5 1.5
Manufacturers credit........................... -- -- (1.5)
S Corporation status........................... (34.0) (34.0) (34.0)
------- ------- -------
Effective tax rate............................. 1.5 % 1.5 % 0.0 %
======= ======= =======
The difference between the unaudited pro forma income tax expense and the
U.S. Federal statutory income tax rate is as follows:
Year Ended December 31
---------------------------
1997 1998 1999
------- ------- -------
Statutory rate................................. 34.0 % 34.0 % 34.0 %
State tax provision............................ 6.0 6.0 6.0
Manufacturers credit........................... -- -- (1.3)
Other.......................................... (0.1) -- 1.3
------- ------- -------
Effective tax rate............................. 39.9 % 40.0 % 40.0 %
======= ======= =======
F-13
FUTURE MEDIA PRODUCTIONS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
December 31, 1999
Deferred income tax assets and liabilities are computed for those differences
having future tax consequences using the currently enacted tax laws and rates.
Income tax expenses equal the current tax payable or refundable for the period,
plus or minus the net change in the deferred tax asset and liabilities
accounts.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes.
Significant components of our deferred tax assets and liabilities are as
follows:
December 31
--------------------
1998 1999
--------- ---------
Bad debt allowance..................................... $ 2,400 $ 4,000
Other.................................................. 5,600 9,000
Credit carryovers...................................... -- 43,000
--------- ---------
Total deferred assets.................................. 8,000 56,000
Depreciation........................................... (90,000) (116,000)
Other.................................................. -- (96,500)
--------- ---------
Total deferred liabilities............................. (90,000) (212,500)
--------- ---------
Net deferred tax liabilities........................... $ (82,000) (156,500)
========= =========
Balance sheet classification:
Current deferred tax assets.......................... $ 8,000 $ --
Current deferred tax liabilities..................... -- 40,500
Long-term deferred tax liabilities................... 90,000 116,000
8. Commitments
The Company leases two office and manufacturing facilities in Valencia,
California, under operating leases. One of the leases expires in February 2002.
The other lease expires in May 2007 and is with a company owned by the
shareholders of the Company. Both leases provide for adjustments to the monthly
base rent periodically, based on the Consumer Price Index.
At December 31 1999, future minimum lease payments required under the lease
arrangement are as follows:
Related Party Other Total
------------- -------- ----------
Year ended December 31:
2000..................................... $ 240,000 $276,638 $ 516,638
2001..................................... 240,000 273,358 513,358
2002..................................... 240,000 49,345 289,345
2003..................................... 240,000 570 240,570
2004..................................... 240,000 -- 240,000
Thereafter............................... 580,000 -- 580,000
---------- -------- ----------
$1,780,000 $599,911 $2,379,911
========== ======== ==========
F-14
FUTURE MEDIA PRODUCTIONS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
December 31, 1999
Total rent expense pursuant to these leases was $395,672, $507,886 and
$504,312 for the years ended December 31, 1997, 1998 and 1999, respectively.
Rental payments to related parties were $140,000 for the year ended December
31, 1997 and $240,000 for both the years ended December 31, 1998 and 1999.
Subsequent to December 31, 1999, the Company expects to enter into a multi-
year lease agreement for a new production facility and negotiated a termination
of its lease agreement for one of its existing facilities. The new lease is
expected to be a multi-year operating lease with a company owned by the
shareholders of the Company to be negotiated at rates commensurate with
commercial terms charged for similar properties with periodic adjustments to
the monthly base rent based on the Consumer Price Index. The Company does not
expect to incur significant expenses in terminating its existing lease under
the terms of the agreement with the current landlord.
9. Stockholders' Equity
Stock Options
In April 1998, the Company adopted a Stock Incentive Plan (Stock Plan). Each
executive officer, employee, non-employee director or consultant of the Company
or any of its future subsidiaries is eligible to be considered for the grant of
awards under the Stock Plan. A maximum of 1,200,000 shares of common stock may
be issued pursuant to awards granted under the Stock Plan, subject to certain
adjustments to prevent dilution. Any shares of common stock subject to an
award, which for any reason expires or terminates unexercised, are again
available for issuance under the Stock Plan. The options vest generally at
periods up to 5 years. The Stock Plan will be administered by the Company's
Board of Directors or by a committee of two or more non-employee directors
appointed by the Board of Directors. The Stock Plan authorizes the grant of
nonqualified stock options, incentive stock options, stock appreciation rights,
restricted stock and stock bonuses. No stock appreciation rights are
outstanding at December 31, 1999.
A summary of the Company's stock option activity, and related information is
as follows:
Outstanding Stock Options
-----------------------------
Weighted
Average
Exercise Range of
Number Price Exercise
of Per Prices Per
Options Share Share
------- -------- ------------
Outstanding at January 1, 1998................... -- $ -- $ --
Granted........................................ 828,000 11.35 11.20-11.90
------- ------ ------------
Outstanding at December 31, 1998................. 828,000 11.35 11.20-11.90
------- ------ ------------
Outstanding at December 31, 1999................. 828,000 $11.35 $11.20-11.90
======= ====== ============
Exercisable at:
December 31, 1998.............................. -- $ -- $ --
======= ====== ============
December 31, 1999.............................. 214,500 $11.37 $11.20-11.90
======= ====== ============
At December 31, 1999, 372,000 shares were available for future grant. The
weighted average remaining contractual life for the outstanding options is 8.46
years at December 31, 1999.
If the Company had elected to recognize compensation expense based on the
fair value of the options granted at grant date for its stock-based
compensation plans, the Company's net income would have been
F-15
FUTURE MEDIA PRODUCTIONS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
December 31, 1999
reduced by approximately $350,000 and $600,000 for the years ended December 31,
1998 and 1999, respectively, and basic and diluted earnings per share would
have been $0.71 and $0.67, respectively, for the year ended December 31, 1998,
and $1.57 and $1.37, respectively, for the year ended December 31, 1999. The
fair value of the options is estimated using a minimum value option pricing
model with the following weighted average assumptions for grants in 1998:
dividend yield of 0.0%; risk free interest rate of 6.0%; and expected life of
5.0 years.
Warrants
On January 1, 1998, the Company granted to one of its officers warrants to
purchase 366,600 shares of common stock. Each warrant provides for the purchase
of one share of common stock at $0.0017 per share, resulting in stock warrant
compensation expense of $3,055,000 for the year ended December 31, 1998, with
the warrants expiring on December 31, 2007. These warrants have no voting
rights, dividend rights or preferences until such time as they are exercised
for shares of common stock. As of December 31, 1999 no warrants have been
exercised.
Stock Related Compensation Expense
In 1999, the shareholders of the Company committed to give 30,000 shares of
their stock to a director for services to the Company. For the year ended
December 31, 1999, the Company has recorded stock related compensation expense
of $720,000 for this commitment based on the estimated fair value of the shares
given, and a contribution to capital for the same amount from the shareholders.
10. Fair Value of Financial Instruments
In estimating its fair value disclosures for financial statements, the
Company used the following methods and assumptions:
Cash and cash equivalents: The carrying amount approximates fair value.
Accounts receivable, other receivables, accounts payable and accounts
payable-equipment: The carrying amount approximates fair value. The fair
value of the note receivable from officer discounted at the Company's
borrowing rate is approximately $1,096,000.
Line of credit and long-term debt: The carrying amounts of the Company's
borrowings under its short-term revolving credit arrangements approximate
their fair value. The fair values of the Company's long-term debts are
estimated using discounted cash flow analyses, based on the Company's
current incremental borrowing rates for similar types of borrowing
arrangements. The carrying amounts of long-term debts approximate their
fair values.
11. Proposed Initial Public Offering
On January 27, 2000, the Company's Board of Directors authorized the filing
of a registration statement with the Securities and Exchange Commission,
relating to an initial public offering of shares of the Company's unissued
common stock and shares to be sold by selling shareholders.
The S Corporation status of the Company will terminate upon the closing of
the offering and, thereafter, the Company will be subject to federal and state
income taxes. As a result of terminating its S Corporation status, the Company
will pay a distribution of the retained earnings balance prior to closing to
its shareholders.
F-16
- -------------------------------------------------------------------------------
Until , all dealers effecting transactions in these securities, whether
or not participating in this offering, may be required to deliver a
prospectus. This is in addition to the obligation of dealers to deliver a
prospectus when acting as underwriters and with respect to their unsold
allotments or subscriptions.
- -------------------------------------------------------------------------------
[LOGO OF FUTURE MEDIA APPEARS HERE]
Prudential Volpe Securities
a unit of Prudential Securities
CIBC World Markets
- -------------------------------------------------------------------------------
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
Item 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The following table itemizes the expenses incurred by the Registrant in
connection with the issuance and distribution of the Securities being
registered, other than underwriting discounts. All the amounts shown are
estimates except the Securities and Exchange Commission registration fee and
the NASD filing fee.
Registration fee--Securities and Exchange Commission................ $18,480
NASD filing fee.....................................................
Nasdaq National Market fee..........................................
Accounting fees and expenses........................................
Legal fees and expenses (other than blue sky).......................
Blue sky fees and expenses, including legal fees....................
Printing; stock certificates........................................
Transfer agent and registrar fees...................................
Consulting fees.....................................................
Miscellaneous.......................................................
-------
Total............................................................. $
=======
Item 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
The Registrant's Articles of Incorporation include a provision that
eliminates the personal liability of its directors to the Registrant and its
shareholders for monetary damages for breach of the directors' fiduciary duties
in certain circumstances. This limitation has no effect on a director's
liability (i) for acts or omissions that involve intentional misconduct or a
knowing and culpable violation of law, (ii) for acts or omissions that a
director believes to be contrary to the best interests of the Registrant or its
shareholders or that involve the absence of good faith on the part of the
director, (iii) for any transaction from which a director derived an improper
personal benefit, (iv) for acts or omissions that show a reckless disregard for
the director's duty to the Registrant or its shareholders in circumstances in
which the director was aware, or should have been aware, in the ordinary course
of performing a director's duties, of a risk of a serious injury to the
Registrant or its shareholders, (v) for acts or omissions that constitute an
unexcused pattern of inattention that amounts to an abdication of the
director's duty to the Registrant or its shareholders, (vi) under Section 310
of the California Corporations Code (the "California Code") (concerning
contracts or transactions between the Registrant and a director) or (vii) under
Section 316 of the California Code (concerning directors' liability for
improper dividends, loans and guarantees). The provision does not extend to
acts or omissions of a director in his capacity as an officer. Further, the
provision will not affect the availability of injunctions and other equitable
remedies available to the Registrant's shareholders for any violation of a
director's fiduciary duty to the Registrant or its shareholders.
The Registrant's Articles of Incorporation also include an authorization for
the Registrant to indemnify its agents (as defined in Section 317 of the
California Code), through bylaw provisions, by agreement or otherwise, to the
fullest extent permitted by law. Pursuant to this latter provision, the
Registrant's Bylaws provide for indemnification of the Registrant's directors,
officers and employees. In addition, the Registrant, at its discretion, may
provide indemnification to persons whom the Registrant is not obligated to
indemnify. The Bylaws also allow the Registrant to enter into indemnity
agreements with individual directors, officers, employees and other agents.
These indemnity agreements have been entered into with all directors and
provide the maximum indemnification permitted by law. These agreements,
together with the Registrant's Bylaws and Articles of Incorporation, may
require the Registrant, among other things, to indemnify such directors against
certain liabilities that may arise by reason of their status or service as
directors (other than liabilities resulting
II-1
from willful misconduct of a culpable nature), to advance expenses to them as
they are incurred, provided that they undertake to repay the amount advanced if
it is ultimately determined by a court that they are not entitled to
indemnification, and to obtain directors' and officers' insurance if available
on reasonable terms.
The Company and certain of the Company's shareholders (the "Existing
Shareholders") plan to enter into a tax indemnification agreement (the "Tax
Agreement") relating to their respective income tax liabilities. Because the
Company will be fully subject to corporate income taxation after the
termination of the Company's S Corporation status, the reallocation of income
and deductions between the period during which the Company was treated as an S
Corporation and the period during which the Company will be subject to
corporate income taxation may increase the taxable income of one party while
decreasing that of another party. Accordingly, the Tax Agreement is intended to
assure that taxes are borne by the Company on the one hand and the Existing
Shareholders on the other only to the extent that such parties received the
related income. The Tax Agreement generally provides that, if an adjustment is
made to the taxable income of the Company for a year in which it was treated as
an S Corporation, the Company will indemnify the Existing Shareholders and the
Existing Shareholders will indemnify the Company against any increase in the
indemnified party's income tax liability (including interest and penalties and
related costs and expenses), with respect to any tax year to the extent such
increase results in a related decrease in the income tax liability of the
indemnifying party for that year. The Company will also indemnify the Existing
Shareholders for all taxes imposed upon them as the result of their receipt of
an indemnification payment under the Tax Agreement.
Section 317 of the California Code and the Registrant's Bylaws make provision
for the indemnification of officers, directors and other corporate agents in
terms sufficiently broad to indemnify such persons, under certain
circumstances, for liabilities (including reimbursement of expenses incurred)
arising under the Securities Act of 1933 ("Securities Act").
Section of the Underwriting Agreement filed as Exhibit 1.1 hereto sets forth
certain provisions with respect to the indemnification of certain controlling
persons, directors and officers against certain losses and liabilities,
including certain liabilities under the Securities Act.
The Registrant maintains director and officer liability insurance.
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers and controlling persons of the
Registrant pursuant to the foregoing provisions, or otherwise, the Registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Securities
Act and is, therefore, unenforceable.
Reference is made to the following documents filed as exhibits to this
Registration Statement regarding relevant indemnification provisions described
above and elsewhere herein:
Exhibit
Document Number
-------- -------
Proposed form of Underwriting Agreement.............................. 1.1
Registrant's Amended and Restated Articles of Incorporation.......... 3.1
Registrant's Amended and Restated Bylaws............................. 3.2
Registrant's Form of Indemnification Agreement....................... 10.4
Tax Agreement........................................................ 10.5
Item 15. RECENT SALES OF UNREGISTERED SECURITIES.
In August, 1998, the Company issued pursuant to its 1998 Stock Incentive Plan
(the "Stock Plan") stock options to purchase an aggregate of 180,000 shares of
common stock at $11.90 per share to four directors of the Company. The issuance
and sale of these securities is exempt from the registration requirements of
the
II-2
Securities Act pursuant to Section 4(2) of the Securities Act as a transaction
not involving any public offering, and also pursuant to Rule 701 because the
offer and sale of the securities was pursuant to a compensatory benefit plan
relating to compensation.
In May 1998, pursuant to its 1998 Stock Plan the Company issued stock options
to purchase an aggregate of 648,000 shares of common stock at $11.20 per share
to 15 employees of the Company. The issuance and sale of these securities is
exempt from the registration requirements of the Securities Act pursuant to
Section 4(2) of the Securities Act as a transaction not involving any public
offering, and also pursuant Rule 701 because the offer and sale of the
securities was pursuant to a compensatory benefit plan relating to
compensation.
The Company has agreed to issue to Averil Capital Markets Group, Inc.
warrants to purchase shares of common stock equivalent to 0.25% of the gross
proceeds raised in the Offering. The issuance of these warrants was exempt from
registration pursuant to Section 4(2) of the Securities Act as a transaction
not involving any public offering, and also pursuant to Rule 701 because the
offer and sale of the securities was pursuant to a compensatory benefit plan
relating to compensation.
On January 1, 1998 the Company issued warrants to purchase 366,600 shares of
common stock to David Moss, the Company's Vice President--Operations, for
services which had been rendered by Mr. Moss. The issuance of these warrants
was exempt from registration pursuant to Section 4(2) of the Securities Act as
a transaction not involving any public offering, and also pursuant to Rule 701
because the offer and sale of the securities was pursuant to a compensatory
benefit plan relating to compensation.
Item 16. EXHIBITS.
Exhibit
Number Exhibit Description
------- -------------------
1.1 Form of Underwriting Agreement.*
3.1 Amended and Restated Articles of Incorporation of Registrant.
3.2 Amended and Restated Bylaws of Registrant.
4.1 Specimen Stock Certificate of Common Stock of Registrant.*
5.1 Opinion and Consent of Troop Steuber Pasich Reddick & Tobey, LLP.*
10.1 1998 Stock Incentive Plan.
10.2 Form of Registrant's Stock Option Certificate (Non-Statutory Stock
Option).
10.3 Form of Registrant's Stock Option Certificate (Incentive Stock
Option).
10.4 Form of Director and Officer Indemnification Agreement.
10.5 Form of Tax Indemnification Agreement to be entered into among
Registrant and the Existing Shareholders.*
10.6 Employment Agreement, dated August 26, 1998, between the Registrant
and David Moss.
10.7 Warrant Agreement, dated January 1, 1998, between the Registrant and
David Moss.
10.8 Lease Agreement and Notice of Extension thereof, dated August 24,
1994 and June 13, 1996, respectively, between the Registrant and
Hermann Rosen & Florence W. Rosen, Trustees.
10.9 Lease Agreement, dated May 1, 1997, between the Registrant and
Bascal Properties.
10.10 Loan and Security Agreement dated February 26, 1997, between the
Registrant and Greyrock Business Credit.
II-3
Exhibit
Number Exhibit Description
------- -------------------
10.11 Extension Agreement, dated January 16, 1998, between the Registrant
and Greyrock Business Credit.
10.12 Amendment to Loan Agreement, dated April 29, 1998, between the
Registrant and Greyrock Business Credit.
10.13 Extension Agreement, dated September 4, 1998, between the Registrant
and Greyrock Business Credit.
10.14 Amendment to Loan Document, dated June 17, 1999 between the
Registrant and Greyrock Business Capital.
10.15 Amendment to Loan Document, dated January 25, 2000, between the
Registrant and Greyrock Business Capital.
10.16 Comprehensive CD Disc License Agreement, dated October 1, 1996,
between the Registrant and U.S. Phillips Corporation.
10.17 Non-Exclusive Patent License Agreement for Disc Product
Manufacturers, dated June 1, 1996, between the Registrant and
Discovision Associates.
10.18 Letter Agreement, dated June 15, 1998, between the Registrant and
Averil Capital Markets Group, Inc.
10.19 Engagement Agreement, dated June 15, 1998, between the Registrant
and Averil Capital Markets Group, Inc.
10.20 DVD Format and Logo License, dated January 11, 2000, between the
Registrant and Toshiba Corporation.
10.21 DVD Video Disc and DVD Rom Disc Patent License Agreement, dated
October 1, 1999, between the Registrant and U.S. Philips
Corporation.
10.22 Patent License Agreement for the Use of AC-3 Technology in the
Manufacture of DVD Discs, dated October 1, 1999, between Registrant
and U.S. Phillips Corporation.
10.23 Subscription Agreement, dated December 22, 1999, between the
Registrant and Synthonics Technologies, Inc.*
10.24 Letter Agreement, between the Registrant and Lions Gate
Entertainment Corp.*
23.1 Consent of Troop Steuber Pasich Reddick & Tobey, LLP (included in
its opinion filed as Exhibit 5.1 hereto).*
23.2 Consent of Ernst & Young LLP.
24.1 Power of Attorney (included on signature page).
27.1 Financial Data Schedule.
- --------
*To be filed by Amendment.
(b) Financial Statement Schedules
Report of Independent Auditors.
Schedule II Valuation and Qualifying Accounts
II-4
Item 17. UNDERTAKINGS.
(a) The undersigned Registrant hereby undertakes to provide to the
underwriter at the closing specified in the underwriting agreements,
certificates in such denominations and registered in such names as required by
the underwriter to permit prompt delivery to each purchaser.
(b) Insofar as indemnification for liabilities arising under the Securities
Act may be permitted to directors, officers, and controlling persons of the
registrant pursuant to the foregoing provisions, or otherwise, the registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Securities
Act and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
registrant of expenses incurred or paid by a director, officer of controlling
person of the registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the registrant will, unless in
the opinion of its counsel the matter has been settled by a controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the
Securities Act and will be governed by the final adjudication of such issue.
(c) The undersigned registrant hereby undertakes that:
(1) For the purposes of determining any liability under the Securities
Act, the information omitted from the form of prospectus filed as part of
this registration statement in reliance upon Rule 430A and contained in a
form of prospectus filed by the registrant pursuant to Rule 424(b)(1) or
(4) or 497(h) under the Securities Act shall be deemed to be part of this
registration statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the Securities
Act, each post-effective amendment that contains a form of prospectus shall
be deemed to be a new registration statement relating to the securities
offered therein, and the Offering of such securities at that time shall be
deemed to be the initial bona fide offering thereof.
II-5
SIGNATURES
Pursuant to the requirements of the Securities Act, the Registrant certifies
that it has reasonable grounds to believe that it meets all of the requirements
for filing on Form S-1 and has duly caused this Registration Statement to be
signed on its behalf by the undersigned, thereunto duly authorized, in the City
of Los Angeles, State of California, on March 14, 2000.
Future Media Productions, Inc.
/s/ Alex Sandel
By: _________________________________
Alex Sandel
Chairman of the Board,
Chief Executive Officer and
President
POWER OF ATTORNEY
Each person whose signature appears below constitutes and appoints Alex
Sandel and Louis Weiss, and each of them, as his true and lawful attorneys-in-
fact and agents with full power of substitution and resubstitution, for him and
his name, place and stead, in any and all capacities, to sign any or all
amendments (including post effective amendments) to this Registration Statement
and a new Registration Statement filed pursuant to Rule 462(b) of the
Securities Act and to file the same, with all exhibits thereto, and other
documents in connection therewith, with the Securities and Exchange Commission,
granting unto said attorneys-in-fact and agents, and each of them, full power
and authority to do and perform each and every act and thing requisite and
necessary to be done in and about the foregoing, as fully to all intents and
purposes as he might or could do in person, hereby ratifying and confirming all
that said attorneys-in-fact and agents, or either of them, or their
substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Act of 1933, this Registration
Statement has been signed by the following persons in the capacities and on the
dates stated.
Signature Title Date
--------- ----- ----
/s/ Alex Sandel Chairman of the Board, March 14, 2000
______________________________________ Chief Executive Officer
Alex Sandel and President
/s/ Louis Weiss Chief Financial Officer, March 14, 2000
______________________________________ Principal Accounting
Louis Weiss Officer and Secretary
/s/ Sanford R. Cilman Director March 14, 2000
______________________________________
Sanford R. Climan
/s/ Mark Dyne Director March 14, 2000
______________________________________
Mark Dyne
/s/ Diana Maranon Director March 14, 2000
______________________________________
Diana Maranon
II-6
REPORT OF INDEPENDENT AUDITORS
The Board of Directors
Future Media Productions, Inc.
We have audited the financial statements of Future Media Productions, Inc. as
of December 31, 1998 and 1999 and for each of the three years in the period
ended December 31, 1999 and have issued our report thereon dated February 25,
2000 (included elsewhere in this Registration Statement). Our audits also
included the financial statement schedule listed in Item 16(b) of this
Registration Statement. The schedule is the responsibility of the Company's
management. Our responsibility is to express an opinion based on our audits.
In our opinion, the financial statement schedule referred to above as of
December 31, 1998 and 1999 and for each of the three years in the period ended
December 31, 1999, when considered in relation to the basic financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.
/s/ Ernst & Young LLP
Los Angeles, California
February 25, 2000
II-7
SCHEDULE II
FUTURE MEDIA PRODUCTIONS, INC.
VALUATION AND QUALIFYING ACCOUNTS
ALLOWANCE FOR DOUBTFUL ACCOUNTS
For the Years Ended December 31, 1997, 1998 and 1999
Charged Balance
Balance at to Costs Charged at End
Beginning and to Other of
Description of Period Expenses Accounts Deductions(1) Period
- ----------- ---------- -------- -------- ------------- --------
Column A Column B Column C Column D Column E
- -------- ---------- ----------------- ------------- --------
Year Ended December 31,
1997..................... $298,439 $955,243 $ -- $1,003,682 $250,000
Year Ended December 31,
1998..................... 250,000 120,000 -- 207,000 163,000
Year Ended December 31,
1999..................... 163,000 120,000 -- 17,222 265,778
- --------
(1) Uncollectible accounts written off, net of recoveries.
EXHIBIT INDEX
Exhibit
Number Exhibit Description
------- -------------------
1.1 Form of Underwriting Agreement.*
3.1 Amended and Restated Articles of Incorporation of Registrant.
3.2 Amended and Restated Bylaws of Registrant.
4.1 Specimen Stock Certificate of Common Stock of Registrant.*
5.1 Opinion and Consent of Troop Steuber Pasich Reddick & Tobey, LLP.*
10.1 1998 Stock Incentive Plan.
10.2 Form of Registrant's Stock Option Certificate (Non-Statutory Stock
Option).
10.3 Form of Registrant's Stock Option Certificate (Incentive Stock
Option).
10.4 Form of Director and Officer Indemnification Agreement.
10.5 Form of Tax Indemnification Agreement to be entered into among
Registrant and the Existing Shareholders.*
10.6 Employment Agreement, dated August 26, 1998, between the Registrant
and David Moss.
10.7 Warrant Agreement, dated January 1, 1998, between the Registrant and
David Moss.
10.8 Lease Agreement and Notice of Extension thereof, dated August 24,
1994 and June 13, 1996, respectively, between the Registrant and
Hermann Rosen & Florence W. Rosen, Trustees.
10.9 Lease Agreement, dated May 1, 1997, between the Registrant and
Bascal Properties.
10.10 Loan and Security Agreement dated February 26, 1997, between the
Registrant and Greyrock Business Credit.
10.11 Extension Agreement, dated January 16, 1998, between the Registrant
and Greyrock Business Credit.
10.12 Amendment to Loan Agreement, dated April 29, 1998, between the
Registrant and Greyrock Business Credit.
10.13 Extension Agreement, dated September 4, 1998, between the Registrant
and Greyrock Business Credit.
10.14 Amendment to Loan Document, dated June 17, 1999 between the
Registrant and Greyrock Business Capital.
10.15 Amendment to Loan Document, dated January 25, 2000, between the
Registrant and Greyrock Business Capital.
10.16 Comprehensive CD Disc License Agreement, dated October 1, 1996,
between the Registrant and U.S. Phillips Corporation.
10.17 Non-Exclusive Patent License Agreement for Disc Product
Manufacturers, dated June 1, 1996, between the Registrant and
Discovision Associates.
10.18 Letter Agreement, dated June 15, 1998, between the Registrant and
Averil Capital Markets Group, Inc.
10.19 Engagement Agreement, dated June 15, 1998, between the Registrant
and Averil Capital Markets Group, Inc.
10.20 DVD Format and Logo License, dated January 11, 2000, between the
Registrant and Toshiba Corporation.
10.21 DVD Video Disc and DVD Rom Disc Patent License Agreement, dated
October 1, 1999, between the Registrant and U.S. Philips
Corporation.
Exhibit
Number Exhibit Description
------- -------------------
10.22 Patent License Agreement for the Use of AC-3 Technology in the
Manufacture of DVD Discs, dated October 1, 1999, between Registrant
and U.S. Phillips Corporation.
10.23 Subscription Agreement, dated December 22, 1999, between the
Registrant and Synthonics Technologies, Inc.*
10.24 Letter Agreement, between the Registrant and Lions Gate
Entertainment Corp.*
23.1 Consent of Troop Steuber Pasich Reddick & Tobey, LLP (included in
its opinion filed as Exhibit 5.1 hereto).*
23.2 Consent of Ernst & Young LLP.
24.1 Power of Attorney (included on signature page).
27.1 Financial Data Schedule.
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*To be filed by Amendment.