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