##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K



|(XBOX) |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED JUNE 30, 2002
|------ |  | ----------------------------------------------------------------------------------------------------------------------------

OR



|(BOX) |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE TRANSITION PERIOD FROM  TO  .
|----- |  | ------------------------------------------------------------------------------------------------------------------------------

COMMISSION FILE NUMBER: 000-32989

BAM! ENTERTAINMENT, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

|                                                                        |  |                                                
|----------------------------------------------------------------------- |  | -----------------------------------------------
|DELAWARE
(STATE OR OTHER JURISDICTION OF
INCORPORATION OR ORGANIZATION) |  | 77-0553117
(I.R.S. EMPLOYER
IDENTIFICATION NO.)

333 WEST SANTA CLARA STREET, SUITE 716
SAN JOSE, CALIFORNIA 95113
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE)

(408) 298-7500
(REGISTRANTS TELEPHONE NUMBER, INCLUDING AREA CODE)

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE EXCHANGE ACT: None

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE EXCHANGE ACT: Common
Stock $0.001 par value

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes (XBOX)  No (BOX)

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of Registrants knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment of this Form 10-K. (BOX)

The aggregate market value of the voting stock held by non-affiliates of
the Registrant was approximately $12.1 million as of September 1, 2002 based
upon the closing price on the Nasdaq National Market reported for such date.
Stock held by each officer and director and by each person who owns 5% or more
of Common Stock have been excluded in that such persons may be deemed to be
affiliates. This determination of affiliate status is not necessarily
conclusive determination for other purposes.

The number of shares of common stock outstanding as of September 1, 2002:
14,599,938

Documents Incorporated by Reference

Portions of the Registrants Definitive Proxy Statement issued in
connection with the 2002 Annual Meeting of the Stockholders of the Registrant
are incorporated by reference into Part III.



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TABLE OF CONTENTS



|                                                                                 |                                                                                                |  |  |  |  |  |  | 
|-------------------------------------------------------------------------------- | ---------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|PART I                                                                          
|                                                                                 | Item 1  Business                                                                             
|                                                                                 | Item 2  Properties                                                                           
|                                                                                 | Item 3  Legal proceedings                                                                    
|                                                                                 | Item 4  Submission of matters to a vote of security holders                                  
|PART II                                                                         
|                                                                                 | Item 5  Market for registrants common equity and related stockholder matters                
|                                                                                 | Item 6  Selected consolidated financial data                                                 
|                                                                                 | Item 7  Managements discussion and analysis of financial condition and results of operations
|                                                                                 | Item 7(a)  Quantitative and qualitative disclosures about market risk                        
|                                                                                 | Item 8  Consolidated financial statements and supplementary data                             
|                                                                                 | Item 9  Changes in and disagreements with accountants on accounting and accounting disclosure
|PART III                                                                        
|                                                                                 | Item 10  Directors and executive officers of the registrant                                  
|                                                                                 | Item 11  Executive compensation                                                              
|                                                                                 | Item 12  Security ownership of certain beneficial owners and management                      
|                                                                                 | Item 13  Certain relationships and related transactions                                      
|PART IV                                                                         
|                                                                                 | Item 14  Controls and procedures                                                             
|                                                                                 | Item 15  Exhibits, financial statement schedules and reports on Form 8-K                     
|SIGNATURES                                                                      
|CERTIFICATIONS                                                                  
|INDEPENDENT AUDITORS REPORT                                                    
|CONSOLIDATED BALANCE SHEETS                                                     
|CONSOLIDATED STATEMENTS OF OPERATIONS                                           
|CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (DEFICIT) AND COMPREHENSIVE LOSS
|CONSOLIDATED STATEMENTS OF CASH FLOWS                                           
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                                      
|                                                                                 | 4. Property and Equipment, Net                                                                
|EXHIBIT 4.4                                                                     
|EXHIBIT 10.8                                                                    
|EXHIBIT 10.9                                                                    
|EXHIBIT 10.10                                                                   
|EXHIBIT 10.11                                                                   
|EXHIBIT 10.44                                                                   
|EXHIBIT 10.45                                                                   
|EXHIBIT 10.46                                                                   
|EXHIBIT 10.47                                                                   
|EXHIBIT 10.49(a)                                                                
|EXHIBIT 10.54(a)                                                                
|EXHIBIT 21.1                                                                    
|EXHIBIT 23.1                                                                    
|EXHIBIT 99.1                                                                    



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|                  |  |                                   |  |                                                                                       |     |  |    |  |  |      |  | 
|----------------- |  | --------------------------------- |  | ------------------------------------------------------------------------------------- | --- |  | -- |  |  | ---- |  | 
|TABLE OF CONTENTS |  |                                   |  |                                                                                       |     |  |    |  |  |     
|                  |  |                                   |  |                                                                                       |     |  |    |  |  | PAGE
|                  |  |                                   |  |                                                                                       |     |  |    |  |  |     
|PART I            |  |                                   |  |                                                                                       |     |  |    |  |  |      |  | 
|                  |  | Item
1.                           |  | Business                                                                              |     |  | 3  | 
|                  |  |                                   |  |                                                                                       |     |  |    |  |  |      |  | 
|                  |  | Item
2.                           |  | Properties                                                                            |     |  | 22 | 
|                  |  |                                   |  |                                                                                       |     |  |    |  |  |      |  | 
|                  |  | Item
3.                           |  | Legal proceedings                                                                     |     |  | 22 | 
|                  |  |                                   |  |                                                                                       |     |  |    |  |  |      |  | 
|                  |  | Item
4.                           |  | Submission of matters to a vote of security holders                                   |     |  | 22 | 
|                  |  |                                   |  |                                                                                       |     |  |    |  |  |      |  | 
|PART II           |  |                                   |  |                                                                                       |     |  |    |  |  |      |  | 
|                  |  |                                   |  |                                                                                       |     |  |    |  |  |      |  | 
|                  |  | Item
5.                           |  | Market for
registrants common equity and related stockholder matters                 |     |  | 23 | 
|                  |  |                                   |  |                                                                                       |     |  |    |  |  |      |  | 
|                  |  | Item
6.                           |  | Selected consolidated financial data                                                  |     |  | 25 | 
|                  |  |                                   |  |                                                                                       |     |  |    |  |  |      |  | 
|                  |  | Item
7.                           |  | Managements
discussion and analysis of financial condition and results of operations |     |  | 26 | 
|                  |  |                                   |  |                                                                                       |     |  |    |  |  |      |  | 
|                  |  | Item
8.                           |  | Consolidated financial statements and supplementary data                              |     |  | 38 | 
|                  |  |                                   |  |                                                                                       |     |  |    |  |  |      |  | 
|                  |  | Item
9.                           |  | Changes in and
disagreements with accountants on accounting and financial disclosure  |     |  | 38 | 
|                  |  |                                   |  |                                                                                       |     |  |    |  |  |      |  | 
|PART III          |  |                                   |  |                                                                                       |     |  |    |  |  |      |  | 
|                  |  |                                   |  |                                                                                       |     |  |    |  |  |      |  | 
|                  |  | Item
10.                          |  | Directors and executive officers of the registrant                                    |     |  | 39 | 
|                  |  |                                   |  |                                                                                       |     |  |    |  |  |      |  | 
|                  |  | Item
11.                          |  | Executive compensation                                                                |     |  | 39 | 
|                  |  |                                   |  |                                                                                       |     |  |    |  |  |      |  | 
|                  |  | Item
12.                          |  | Security ownership of certain beneficial owners and management                        |     |  | 39 | 
|                  |  |                                   |  |                                                                                       |     |  |    |  |  |      |  | 
|                  |  | Item
13.                          |  | Certain relationships and related transactions                                        |     |  | 39 | 
|                  |  |                                   |  |                                                                                       |     |  |    |  |  |      |  | 
|PART IV           |  |                                   |  |                                                                                       |     |  |    |  |  |      |  | 
|                  |  |                                   |  |                                                                                       |     |  |    |  |  |      |  | 
|                  |  | Item
14.                          |  | Controls and procedures                                                               |     |  | 40 | 
|                  |  |                                   |  |                                                                                       |     |  |    |  |  |      |  | 
|                  |  | Item
15.                          |  | Exhibits, financial statement schedules and reports on Form 8-K                       |     |  | 40 | 
|                  |  |                                   |  |                                                                                       |     |  |    |  |  |      |  | 
|                  |  | Signatures                        |  |                                                                                       | 45  | 
|                  |  |                                   |  |                                                                                       |     |  |    |  |  |      |  | 
|                  |  | Certifications                    |  |                                                                                       | 46  | 
|                  |  |                                   |  |                                                                                       |     |  |    |  |  |      |  | 
|                  |  | Consolidated Financial Statements |  |                                                                                       | F-1 | 

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PART I




Item 1  Business

Certain information contained in this Report constitutes forward-looking
statements which involve risks and uncertainties including, but not limited to,
information with regard to our revenues, earnings, spending, margins, cash
flow, orders, inventory, products, actions, plans, strategies and objectives.
The words believes, anticipates, plans, expects, endeavors, may,
will, intends, estimates, and similar expressions are intended to
identify forward-looking statements. These forward-looking statements involve
risks and uncertainties, and our actual results could differ materially from
those anticipated in these forward-looking statements as a result of certain
factors, including, but not limited to, those set forth under Risk Factors
and elsewhere in this Report.

Overview

We are a developer and publisher of interactive entertainment software. We
currently publish titles for most of the popular interactive entertainment
hardware platforms, such as Sonys PlayStation and PlayStation 2, Nintendos
GameCube, N64, Game Boy Color and Game Boy Advance, portable handheld devices
manufactured by Palm and Handspring, and for personal computers or PCs. We are
developing and plan to publish titles for Microsofts Xbox. We were
incorporated in California in October 1999 under the name Bay Area Multimedia,
Inc. We reincorporated in Delaware in September 2000 and changed our name to
BAM! Entertainment, Inc. in December 2000. We commenced operations in October
1999, and shipped our first products in June 2000. We completed our initial
public offering in November 2001.

We license properties from a wide variety of sources, and publish titles based
on the motion picture, sports and television properties of our licensors. We
have entered into strategic license arrangements with entertainment and media
companies that have developed well-known characters and brands and that are
producing popular properties that are expected to form the basis of some of our
future products. Our agreements with licensors and developers generally
require us to make advance royalty payments, and we may be required to spend
money on advertising and promotion. We generally pay royalties based on net
revenues.

We design and develop our titles internally or through third parties with whom
we have established relationships. We believe that the development cycle for
new titles is long, typically ranging from 12 to 24 months, except for
Nintendos Game Boy Advance for which the development cycle typically ranges
from six to nine months. After development of the initial product, we believe
that it may take between six to 12 additional months to develop the product
for, or port the product to, a different hardware platform.

We sell our products to mass merchandisers such as Toys R Us, Target, Kmart,
Wal-Mart and Best Buy, specialty chains such as GameStop, and Electronics
Boutique and independent distributors. Our products are manufactured
exclusively by third parties. We have operations in both the United States and
Europe. International operations are conducted through our offices in England,
where we have an internal product development studio, perform international
sales and marketing activities and manage local third-party developers.

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Products

The following tables set forth our existing titles, which are sold and
available to consumers in North America and Europe except as indicated.

|                                             |  |           |  |                         |  |                 |  |  |  |  |  | 
|-------------------------------------------- |  | --------- |  | ----------------------- |  | --------------- |  |  |  |  |  | 
|Title                                        |  | Genre     |  | Hardware platform       |  | Date of release
|                                             |  |           |  |                         |  |                
|Beast Wars(1)                                |  | Action    |  | Nintendo 64/PlayStation |  | June 2000      
|Contender 2(1)                               |  | Action    |  | PlayStation             |  | October 2000   
|Jimmy Whites Cueball 2(1)                   |  | Sports    |  | PlayStation             |  | October 2000   
|Bad Mojo Jojo (Powerpuff Girls)              |  | Adventure |  | Game Boy Color          |  | November 2000  
|Paint the Townsville Green (Powerpuff Girls) |  | Adventure |  | Game Boy Color          |  | November 2000  
|Sgt. Rock                                    |  | Action    |  | Game Boy Color          |  | November 2000  
|Robot Revenge (Dexters Laboratory)          |  | Adventure |  | Game Boy Color          |  | December 2000  
|Yogi Bear                                    |  | Adventure |  | Game Boy Color          |  | December 2000  
|Battle Him (Powerpuff Girls)                 |  | Adventure |  | Game Boy Color          |  | February 2001  
|Xtreme Wheels                                |  | Sports    |  | Game Boy Color          |  | April 2001     
|Fire Pro Wrestling                           |  | Sports    |  | Game Boy Advance        |  | June 2001      
|Hot Potato                                   |  | Puzzle    |  | Game Boy Advance        |  | June 2001      
|Strike it Rich                               |  | Trivia    |  | Palm/Handspring         |  | July 2001      
|CardTopia                                    |  | Card      |  | Palm/Handspring         |  | July 2001      
|Deesaster Strikes (Dexters Laboratory)      |  | Adventure |  | Game Boy Advance        |  | September 2001 
|Science Aint Fair (Dexters Laboratory)     |  | Adventure |  | PC                      |  | September 2001 
|Mojo Jojo A-Go-Go (Powerpuff Girls)          |  | Adventure |  | PC                      |  | September 2001 
|Sports Illustrated for Kids: Baseball        |  | Sports    |  | Game Boy Advance        |  | September 2001 
|Sports Illustrated for Kids: Football        |  | Sports    |  | Game Boy Advance        |  | September 2001 
|Driven                                       |  | Sports    |  | PlayStation 2           |  | October 2001   
|Chemical X-Traction (Powerpuff Girls)        |  | Adventure |  | PlayStation/Nintendo 64 |  | October 2001   
|Mojo Jojo A-Go-Go (Powerpuff Girls)          |  | Adventure |  | Game Boy Advance        |  | November 2001  
|Ecks v Sever                                 |  | Action    |  | Game Boy Advance        |  | November 2001  
|Driven                                       |  | Sports    |  | Game Boy Advance        |  | November 2001  
|Broken Sword                                 |  | Adventure |  | Game Boy Advance        |  | March 2002     
|Savage Skies(1)                              |  | Action    |  | PlayStation 2           |  | March 2002     
|Driven                                       |  | Sports    |  | GameCube                |  | March 2002     
|Wolfenstein 3D                               |  | Action    |  | Game Boy Advance        |  | March 2002     
|World Rally Championship(1)                  |  | Sports    |  | PlayStation 2           |  | March 2002     
|Mandarks Lab? (Dexters Laboratory)         |  | Adventure |  | PlayStation             |  | April 2002     
|Star X                                       |  | Action    |  | Game Boy Advance        |  | April 2002     
|Way of the Samurai(1)                        |  | Action    |  | PlayStation 2           |  | May 2002       
|Dropship(1)                                  |  | Action    |  | PlayStation 2           |  | May 2002       
|Wipeout Fusion(1)                            |  | Action    |  | PlayStation 2           |  | June 2002      



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|(1) |  | This title is sold and available to consumers only in North America.
|--- |  | --------------------------------------------------------------------

Strategic relationships

We have entered into strategic relationships with entertainment and media
companies that have developed well-known characters and brands and that are
producing popular properties that are expected to form the basis of future
products.

The Cartoon Network.Between March 2000 and December 2001, we entered into four
non-exclusive license agreements that give us the right to develop and
distribute interactive entertainment software based on Warner Bros. Powerpuff
Girls, Dexters Laboratory, Samurai Jackand Yogi Bearproperties on a
multi-national basis. The Powerpuff Girls, Dexters Laboratory, Samurai Jack
and Yogi Beartelevision shows are aired on AOL Time Warners Cartoon Network.
Under these agreements, we are obligated to pay royalties based on a percentage
of net sales of the titles and are obligated to advertise and promote the
titles on the Cartoon Network.

We believe that the Cartoon Network has significant brand awareness among six
to 11 year olds. According to the Cartoon Network, their programs are viewed in
81 million homes around the world. We participate in promotional programs with
the Cartoon Network and certain retailers who advertise on the Cartoon Network
in connection with the release of our products.

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Franchise Films.In April 2000, we entered into a strategic arrangement with
Franchise Films, Inc. Our agreement gives us the exclusive, first look right to
review screenplays acquired by the studio, develop titles based on films
produced from those screenplays and distribute them worldwide. Our agreement
expires upon the later of three years or the theatrical release of the tenth
film on which we base a product. Franchise Films has also agreed to provide us
with free access to any publicity and advertising materials it prepares and
granted us the right to use these materials to promote and advertise our
products. Under the agreement, we agreed to pay Franchise Films royalties based
on the net sales of the titles based on the films we select and we are
obligated to issue 68,738 shares of our common stock following the theatrical
release of each film for which we have developed a title, up to a maximum of
687,375 shares. We have released titles for the Sony PlayStation 2 and Nintendo
Game Boy Advance based on the film title Driven, which was released in April
2001. We have also released a Nintendo Game Boy Advance title based on Ecks v
Sever, a film due to be released in the Fall of 2002, and are developing
additional titles based on this film.

Spyglass Entertainment Group.In October 2000, we entered into a strategic
arrangement with Spyglass Entertainment Group, L.P., the studio that produced
the film The Sixth Sense. Our five-year agreement gives us an exclusive right
of first refusal to develop titles based on films produced by the studio and to
distribute them worldwide. In addition, Spyglass Entertainment Group has agreed
to provide us with free access to any publicity and advertising materials it
prepares and the right to use these materials to promote and advertise our
titles. Under the agreement, we granted Spyglass Entertainment Group a warrant
to purchase up to 470,000 shares of our common stock and agreed to pay the
studio royalties based on the net sales of titles based on its films. We have
commenced development on the first Spyglass Entertainment Group title, Reign of
Fire,for Sonys PlayStation 2, Microsofts Xbox, and Nintendos Game Boy
Advance and GameCube.

Sports Illustrated For Kids.In May 2000, we signed a strategic arrangement
with Time, Inc. for the development of titles utilizing the Sports Illustrated
For Kids brand name. Our four-year, non-exclusive license gives us the right to
publish titles based on popular sports that are appropriate for children ages
seven to 17 and to distribute those titles on a multi-national basis. Our
agreement gives us the right to access a portion of their subscriber base for
market research purposes. Under the agreement, we are obligated to pay a
royalty based on the gross wholesale price of the titles and advertise and
promote the titles in the magazine. In September 2001 we released our first two
titles under this collaboration for Nintendos Game Boy Advance, Sports
Illustrated for Kids Baseballand Sports Illustrated for Kids Football. We plan
to release more baseball titles for Nintendos GameCube and Sonys PlayStation
2 in fiscal 2003.

Aardman Animations Ltd.In January 2002, we entered into a licensing and
publishing partnership with Aardman Animations Limited, creators of Wallace &
Gromitand Chicken Run. Our five-year agreement gives us an exclusive right to
develop titles based on Aardmans intellectual property and to distribute them
worldwide. Under the agreement we will have to pay royalties to Aardman
calculated as a percentage of sales of the developed products, and we are
required to issue them warrants to purchase up to 50,000 shares of common
stock, in pre-determined multiples of either 5,000 or 10,000 shares, upon the
occurrence of certain pre-determined events. We have commenced development of
Wallace & Gromittitles for Sonys PlayStation 2, Nintendos GameCube and Game
Boy Advance, Microsofts Xbox and personal computers.

Southpaw Media Group Inc.In May 2002, we entered into a licensing and
publishing agreement with Southpaw Media Group Inc. Our agreement gives us the
exclusive, first look right to review screenplays to be produced by the studio,
develop titles based on any films, made for television movies, or television
series produced from those screenplays, and distribute them worldwide. Our
agreement expires upon the later of five years or either the theatrical release
or television air-date of the tenth film or television series on which we base
a product, but in no event later than eight years from the date of the
agreement, unless seven films or television series have been released or aired,
respectively, seven years from the date of the agreement, in which event the
agreement would expire at such time. Under the agreement, we will have to pay
royalties to Southpaw calculated as a percentage of sales of the developed
products, and Southpaw was granted a warrant to purchase up to 200,000 shares
of our common stock, of which 15,000 became immediately exercisable upon the
signing of the agreement and the remaining 185,000 only become exercisable in
multiples of 4,625 shares upon each election to produce a title, up to a
maximum ten titles, and multiples of 13,875 shares upon the theatrical release
or television air-date of each film for which we have developed a title. Upon
expiration of the agreement, any unexercised warrants will cease to be
exercisable.

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Riverdeep Inc.In June 2002, we entered into a licensing and publishing
agreement with Riverdeep Inc., owners of the property rights to Carmen
Sandiego. Our agreement gives us an exclusive right to develop titles based on
Carmen Sandiegofor all platforms except personal computers, and to distribute
them worldwide. Under the agreement we will have to pay royalties to Riverdeep
calculated as a percentage of sales of the developed products. The agreement
expires four years after the first commercial distribution of the first title,
or June 2004 if no title is released prior to that date.

Software product design and development

We believe our success will depend in large part on our ability to design and
develop innovative interactive entertainment software based on popular content,
design and develop sequels to our more popular products and offer previously
released products on additional hardware platforms. We pair members of our
internal production staff with internal and external software developers who
have varying design and development capabilities, which we believe provides us
with flexibility to develop titles in a timely, cost-effective manner. Our
software producers take responsibility for the selection of the title concept,
evaluation of the capabilities of the software developer who will prepare the
graphics, artwork and computer code for the title, and the publication,
marketing and distribution of the completed title. The internal and external
software developers are responsible for the completion of technical milestones
such as creation of particular graphics, artwork and sound designs.

Title production and development

At June 30, 2002, our in-house production staff consisted of 40 employees, 5 of
whom work in our San Jose office, 7 of whom work in our Bath, England office,
and 28 of whom work in our London, England development studio. Our in-house
production staff includes 11 software producers who are responsible for
monitoring the progress of our internal software developers as well as the
independent third-party software developers with whom we contract to create
titles. Our production staff evaluates the work of each of the internal and
external software developers through design review, progress evaluation,
milestone review and quality checks. Each milestone submission is reviewed by
our in-house production staff to ensure compliance with the products design
specifications.

Members of our in-house production staff and internal software development team
currently work at our offices in San Jose, California and Bath, England, as
well as at our internal software development studio in London, England.

Internal product development

Members of our internal production and development staff are organized into
teams led by a producer and staffed with software developers who are
responsible for such functions as game design, software programming, art design
and sound design. We believe that this team approach promotes the creative and
cooperative environment necessary to develop innovative and successful titles.

To create a title internally, our software production staff first prepares a
schedule and budget. Our internal software developers then complete the initial
design and concept layout, computer graphic design, two-dimensional and
three-dimensional artwork, programming, prototype testing, sound engineering
and quality control. To successfully complete the production and development of
our interactive entertainment titles, our internal software development team
utilizes a variety of advanced hardware and software development tools,
including sound compression utilities, clay modeling and video compression.
When the development of the title is complete, and our internal production
staff has confirmed that each design milestone has been met, the title is
play-tested by us and sent to the manufacturer for its testing, review and
approval. Once this is obtained, we publish and ship the title to our retailers
and distributors.

We believe that the development process for an original, internally-developed
product for a next generation hardware platform typically takes 12 to 24
months, and for an original, internally-developed product for the Nintento Game
Boy Advance platform, six to nine months. This process is shorter for existing
products currently used on 32-bit and 64-bit hardware platforms. We believe
that it takes approximately six to 12 months to develop an existing title as a
product for a different hardware platform.

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External product development

When we elect to develop a concept or property externally, we contract with an
independent third-party software developer to develop the title under the
supervision of our internal software production staff. When we develop a title
with an independent software developer, we select a title concept and then
evaluate whether the independent developer has sufficient expertise to create
the software code, animation and graphics for that title. After we evaluate the
independent developers capabilities and decide to produce that title with the
developer, our production team prepares a budget, list of development
milestones and a sales and marketing plan. The independent developer then
begins to prepare the software code, graphics and animation for the title. When
the final milestone has been met and our production staff is satisfied that the
title is ready for publication, we publish, distribute and market the title.

Our production staff also works with independent software developers to modify,
or port, existing titles for distribution in a certain country or across
additional platforms. When we decide to port an existing title in this manner,
our internal production staff prepares a list of development milestones and a
budget and marketing plan for the title. Our internal production staff then
works with the independent software developer to ensure that the milestones are
met and the title is ported to a new platform or readied for distribution to a
new country.

Our agreements with independent software developers are typically entered into
on a title-by-title basis and provide for the payment of the greater of a fixed
amount or royalties based on actual sales. We generally pay independent
software developers installments of the fixed advance based on the achievement
of specific development milestones established by our production staff at the
outset of the development process. Royalties in excess of the fixed advance are
generally based on a fixed amount per unit sold. We generally obtain ownership
of the software code and related documentation from our independent software
developers. In instances where we do not retain sole ownership of the source
code, the owner may use or license the code for development of other software
products that may compete directly with our products and we may not have
sufficient rights in the source code to produce derivative products. Upon
completion of the development process, each title is play-tested by us and sent
to the manufacturer for its testing, review and approval. Related artwork, user
instructions, warranty information, brochures and packaging designs are also
developed by third parties under our supervision.

Marketing, sales and distribution

Our marketing, sales and distribution efforts are designed to broaden product
distribution and increase the penetration of our products in domestic and
international markets. We rely in part on the name recognition of the motion
picture, sports and television cartoon properties on which many of our products
are based to attract consumers and obtain shelf space from mass merchandisers.
We supplement our domestic direct sales efforts with third-party distributors,
and in the last year, we have increased our marketing, sales and distribution
efforts in international markets through licensing and third-party distribution
strategies. As of June 30, 2002, our sales and marketing staff consisted of 21
employees, 13 of whom work in our San Jose, California headquarters and 8 of
whom work in our Bath, England office.

Our marketing department implement marketing programs and campaigns for each of
our titles. In preparation for a product launch, our marketing activities may
include print and cooperative retail advertising campaigns, game reviews in
consumer and trade publications, pre-release giveaways, and retail in-store
promotions including demonstrations, videos, over-size displays and posters. We
have selectively included in our marketing efforts radio, television and
Internet advertising campaigns. We also allocate a portion of each of our
products sales and marketing budget for cooperative advertising and market
development with retailers. Many of our titles are launched with a multi-tiered
marketing campaign that is developed on an individual basis to promote product
awareness, customer pre-orders and consumer sell-through.

We seek to extend the life cycle and financial return of many of our products
by marketing those products differently throughout the products life. Although
the product life cycle for each title varies based on a number of factors,
including the quality of the title, the number and quality of competing titles,
and in certain instances seasonality, we typically consider a title as back
catalog six months after its initial release. We utilize marketing programs
appropriate for the particular title, which generally includes progressive
price reductions over time to increase the products longevity in the retail
channel as we shift advertising support to newer releases.

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Domestic activities

We sell our products primarily to mass merchandisers and, to a lesser extent,
to third-party distributors. Our principal customers include Toys R Us,
Kmart, Wal-Mart, GameStop, Best Buy, Electronics Boutique and Target. We do not
have any written agreements or other understandings with any of our customers
that relate to future purchases, so our customers could reduce or terminate
their purchases from us at any time. Revenues from our three largest customers
collectively accounted for approximately 41% of our net revenues for the year
ended June 30, 2002 as compared to 43% from our three largest customers for the
year ended June 30, 2001 and 75% from our three largest customers for the
period from October 7, 1999 (inception) through June 30, 2000.

We believe that we provide terms of sale comparable to competitors in our
industry. We sell our products to retailers and distributors through
independent regional sales representatives who operate on a commission basis.
The sales staff is largely responsible for generating retail demand for our
products by presenting new products to our customers in advance of the
products scheduled release dates. They do this by providing technical advice
with respect to the products and by working closely with retailers and
distributors to sell the products. In addition, we provide technical support
for our products through our customer support department. We typically ship our
products within a short period of time after acceptance of purchase orders from
distributors and other customers. Accordingly, we do not have a material
backlog of unfilled orders and net sales in any quarter are substantially
dependent on orders booked in that quarter. To date we have not experienced any
material warranty claims.

We utilize an electronic data interchange with most of our major domestic
customers to efficiently receive, process and ship customer product orders and
to accurately track and forecast sell-through of our products to consumers in
order to determine whether to order additional products from manufacturers.

International activities

Our international sales and marketing activities are currently conducted from
our office located in Bath, England. Our international marketing activities
include television advertising and publicity campaigns in interactive
entertainment publications, magazines and newspapers. Our first international
titles were introduced during the year ended June 30, 2001. We pursue our
international sales by localizing our products for various international
markets and releasing localized versions of many of our products simultaneously
with the commercial release of corresponding titles in North America. We are
also engaged in software development and production at our internal development
studio in London, England.

In February 2001, we entered into a two-year exclusive license agreement with
Ubi Soft Entertainment S.A. (Ubi Soft), a French distributor of entertainment
and educational multimedia, to distribute, market, and sell certain of our
interactive software products in the Nintendo Game Boy Color format on a
multi-national basis. The agreement also obligates Ubi Soft to make minimum
purchases at a set price per title.

In July 2001, we expanded our relationship with Ubi Soft and signed a
distribution agreement establishing them as the exclusive distributor of all of
our interactive entertainment software products across all hardware platform
formats in a number of European countries. Under this agreement, we are
obligated to pay a distribution fee based on a percentage of the net revenues
from sales of all products in the territory, and assist with marketing the
products.

In the United Kingdom we sell our products primarily to mass merchandisers and,
to a lesser extent, to third-party distributors. Our principal customers
include Game, Dixons, Toys R Us, WH Smiths, EUK, and HMV. Our sales staff is
largely responsible for generating retail demand for our products by presenting
new products to our customers in advance of the products scheduled release
dates. They do this by providing technical advice with respect to the products
and by working closely with retailers and distributors to sell the products. We
typically ship our products within a short period of time after acceptance of
purchase orders from distributors and other customers. Accordingly, we do not
have a material backlog of unfilled orders and net sales in any quarter are
substantially dependent on orders booked in that quarter.

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Revenues from our international customers collectively accounted for
approximately 11% of our net revenues for the year ended June 30, 2002 as
compared to 10% for the year ended June 30, 2001 and 0% for the period from
October 7, 1999 (inception) through June 30, 2000.

Manufacturing

Nintendo and Sony are the sole manufacturers of the software products sold for
use on their respective hardware platforms. We begin the manufacturing process
by placing a purchase order for the manufacture of our products with Nintendo
or Sony and opening either a letter of credit in favor of the manufacturer or
utilizing our line of credit with the manufacturer. We then send software code
and a prototype of the product to the manufacturer, together with related
artwork, user instructions, warranty information, brochures and packaging
designs for approval, defect testing and manufacture.

Microsoft appoints approved third-party manufacturers to manufacture software
for its hardware platform. Microsoft also offers us the opportunity to enter
into one or more kit licenses, pursuant to which Microsoft would license
software development tools and hardware to assist us in the development of
titles prior to sending these titles to authorized third-party manufacturers
for replication.

The amounts charged by the manufacturers include a manufacturing, printing and
packaging fee, as well as a royalty for the use of the manufacturers name,
proprietary information and technology. All of these fees are subject to
adjustment by the manufacturers at their discretion. Nintendo charges us a
fixed amount for each cartridge that includes the royalty. This amount varies
based, in part, on the memory capacity of the cartridges. Sony charges us a
royalty for every disk manufactured. The manufacturers have the right to
review, evaluate and approve a prototype of each title and the titles
packaging and marketing materials.

Competition

The interactive entertainment software industry is intensely competitive and is
characterized by the frequent introduction of new hardware platforms and
titles. Our competitors vary in size from small companies to large
corporations, including the manufacturers of the hardware platforms. We must
obtain a license from and compete with the hardware platform manufacturers in
order to develop and sell titles for their respective hardware platforms, with
each such manufacturer typically being the largest publisher and seller of
software products for its own hardware platforms. As a result of their
commanding positions in the interactive entertainment industry as the
manufacturers of hardware platforms and publishers of titles for their own
hardware platforms, these manufacturers generally have better bargaining
positions with respect to retail pricing, shelf space and purchases than do any
of their licensees.

In addition to the hardware platform manufacturers, we compete with other
interactive entertainment software companies. Significant competitors include
Acclaim Entertainment, Inc., Activision, Inc., Bandai America Incorporated,
Capcom USA, Inc., Eidos PLC, Electronic Arts Inc., Infogrames, Inc., Konami
Corporation of America, Inc., Midway Games Inc., Namco Ltd., Sega Enterprises,
Inc. (USA), Take-Two Interactive Software, Inc., THQ, Inc., Ubi Soft
Entertainment and Vivendi Universal S.A. Many of these competitors are large
corporations that have significantly greater financial, marketing, personnel
and product development resources than us. Due to these greater resources,
certain of these competitors are able to undertake more extensive marketing
campaigns, adopt more aggressive pricing policies, pay higher fees to licensors
of desirable motion picture, television, sports and character properties and
pay more to third-party software developers than we can. We believe that we are
able to successfully compete with regard to the principal factors of the
interactive entertainment software industry, including



| |  |  | product features;      
| | - |  | -----------------------
|
| |  |  | brand name recognition;
|
| |  |  | rights to properties;  

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| |  |  | access to distribution channels;                
| | - |  | ------------------------------------------------
|
| |  |  | product quality and ease of use;                
|
| |  |  | price;                                          
|
| |  |  | marketing support;                              
|
| |  |  | reviews received from independent reviewers; and
|
| |  |  | quality of customer service.                    

However, any significant increase in the development, marketing and sales
efforts of our competitors could harm our business.

Intellectual property

Our business relies on the hardware platform manufacturers and our
non-exclusive licenses with them to publish titles and manufacture our products
for their hardware platforms. Our existing hardware platform licenses for
Nintendos Game Boy Color and Game Boy Advance, Nintendo 64, Nintendo GameCube,
Sonys PlayStation and PlayStation 2, Segas Dreamcast and Microsofts Xbox
grant us the right to develop, publish and distribute titles for use on the
respective hardware platforms. Each of these hardware platform licenses
requires that we obtain approval for the publication of new titles on a
title-by-title basis and licenses with Nintendo and Sony require that our
titles be manufactured solely by the respective manufacturer and licenses with
Microsoft require that we use certain approved third party manufacturers.
License agreements relating to these rights generally extend for a term of two
to three years. The agreements are terminable upon the occurrence of a number
of factors, including: (1) breach of the agreement by us; (2) our bankruptcy or
insolvency; or (3) our entry into a relationship with, or acquisition by, a
competitor of the manufacturer. We cannot assure you that we will be able to
obtain new or maintain existing licenses on acceptable terms, or at all.

Upon termination of a hardware platform license for any reason other than our
breach or default, the manufacturer has the right to purchase from us, at the
price paid by us, any product inventory manufactured by such manufacturer that
remains unsold for a specified period after termination. We must destroy any
such inventory not purchased by the manufacturer. Upon termination as a result
of our breach or default, we must destroy any remaining inventory, subject to
the right of any of our institutional lenders to sell such inventory for a
specified period.

We hold copyrights on our products, product literature and advertising and
other materials. We rely on common law trademark rights to our name and our
logo. We do not currently hold any patents. We outsource some of our product
development to third-party developers and typically retain all intellectual
property rights related to such projects. No third-party developer has
challenged our ownership interest in the intellectual property rights to
projects we have outsourced, but it is always possible that a third-party
developer could issue such a challenge and prevail. We also license products
developed by third parties and pay royalties on such products.

We regard our products as proprietary and rely primarily on a combination of
copyright, trademark and trade secret laws, confidentiality and nondisclosure
agreements and other methods to protect our proprietary rights. We require our
employees, consultants and other outside individuals and entities, including
employees of third-party developers, to execute confidentiality and
nondisclosure agreements upon the start of employment, consulting or other
contractual relationships with us. These agreements provide that all
confidential information developed or made known to the individual or entity
during the course of the relationship is to be kept confidential and not
disclosed to third parties except in specific circumstances. However, our
ability to police these individuals and entities and enforce these agreements
is costly and uncertain.

We also rely on existing copyright laws to prevent unauthorized distribution of
our products. However, existing copyright laws afford only limited protection.
Policing unauthorized use of our products is difficult and software piracy can
be a persistent problem, especially in certain international markets. We are
aware that unauthorized

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copying occurs within our industry and if a significant amount of unauthorized
copying of our interactive entertainment software products were to occur, our
business would be harmed. In addition, the laws of some countries in which our
products are or may be distributed either do not protect our products and
intellectual property rights to the same extent as the laws of the United
States, or these laws are weakly enforced. Legal protection of our rights may
be ineffective in these countries, and as we leverage our products using
emerging technologies, such as the Internet and online services, our ability to
protect our intellectual property rights, and to avoid infringing the
intellectual property rights of others, becomes more difficult. In addition,
intellectual property laws are less clear with respect to such emerging
technologies. Accordingly, existing intellectual property laws may not provide
adequate protection to our products that are developed in connection with
emerging technologies.

As the number of titles in the interactive entertainment software industry
increases and the features and content of these titles further overlap,
interactive entertainment software developers may increasingly become subject
to infringement claims. Although we make reasonable efforts to ensure that our
products do not violate the intellectual property rights of others, we cannot
assure you that claims of infringement will not be made. Any such claims, with
or without merit, can be time consuming and expensive to defend and we cannot
assure you that infringement claims against us will not result in costly
litigation or require us to license the intellectual property rights of third
parties, either of which could harm us.

We may also be subject to legal proceedings and claims from time to time in the
ordinary course of business, including claims of alleged infringement of the
trademarks and other intellectual property rights of third parties. For
example, we are aware that other parties are utilizing the BAM mark, or marks
that incorporate the letters BAM, in businesses similar to ours, and those
parties may have rights to such mark that are superior to ours. These parties
could challenge our rights to use the name BAM in their markets. In this
event, we could be required to stop using the name in particular markets or to
obtain a license from these parties to use it in such markets.

Our agreements with third-party software developers and property licensors
typically provide for us to be indemnified with respect to certain matters.
However, if any claim is brought by a hardware manufacturer or other party
against us, our software developers or property licensors may not have
sufficient resources to, in turn, indemnify us. In addition, these parties
indemnification of us may not cover the matter that gives rise to the original
claim, and in either case, our business could be harmed.

Employees

As of June 30, 2002, we employed 80 full-time employees, comprising 21 in sales
and marketing, 40 in research and development, and 19 in management, general
and administration. Of the 80 employees, 31 are located in the United States,
and 49 are located in England. None of the employees are represented by a labor
union, and we have experienced no work stoppages. We believe our employee
relations are good.

Risk Factors

In addition to the other information in this Report, the following factors
should be considered in evaluating us and our business.

Because we have a limited operating history, it is difficult to evaluate an
investment in our common stock.

We were organized in October 1999 and released our first interactive
entertainment software product in June 2000. It is difficult to evaluate our
future prospects and an investment in our common stock because we have a
limited operating history and the market for our products is rapidly evolving.
Our prospects are uncertain and must be considered in light of the risks,
expenses and difficulties frequently encountered by companies in the early
stage of development.

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Our future performance will depend upon a number of factors, including our ability to:



| |  |  | expand our customer base;                                                                                                                               
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | secure popular entertainment properties upon which to base future products;                                                                             
|
| |  |  | develop and enhance products in response to new interactive
entertainment hardware platform releases, customer demand and
competitive market conditions;
|
| |  |  | expand our interactive entertainment software development and sales and marketing capabilities;                                                         
|
| |  |  | expand our international operations;                                                                                                                    
|
| |  |  | attract, retain and motivate qualified personnel; and                                                                                                   
|
| |  |  | maintain adequate control of our expenses.                                                                                                              

We have a history of operating losses and may never achieve profitability.

We incurred net losses of $15.7 million for the year ended June 30, 2002, $1.6
million for the year ended June 30, 2001 and $803,000 for the period from
inception through June 30, 2000. We will need to generate significant revenues
to achieve profitability. There can be no assurance that our revenues will grow
in the future or that we will achieve sufficient revenues for profitability. If
our revenues do not grow as quickly as we anticipate, or if our operating
expenses exceed our expectations, our business would be severely harmed.

Our revenues fluctuate due to seasonal demand and the nature of the interactive
entertainment industry.

We have experienced and may continue to experience significant quarterly
fluctuations in net sales and operating results. The interactive entertainment
industry is highly seasonal, with sales typically higher during the fourth and
first calendar quarters. This is due primarily to the increased demand for
games during and immediately following the holiday buying season. Our failure
or inability to introduce products on a timely basis to meet seasonal
fluctuations in demand will harm our business and operating results. Although
we are attempting to reduce the effect of seasonal patterns on our business by
distributing our product release dates more evenly throughout the year, we may
not be successful. These fluctuations, as well as fluctuations caused by other
factors, could cause our stock price to decline.

Our expense levels are based, in part, on our expectations regarding future
sales. Therefore, our operating results would be harmed by a decrease in sales
or a failure to meet our sales expectations. Uncertainties associated with
interactive entertainment software development, lengthy manufacturing lead
times, production delays and the approval process for products by hardware
manufacturers and other licensors make it difficult to predict the quarter in
which our products will ship. As a result of these and other factors, in some
future quarters our operating results may fall below the expectations of
securities analysts and investors. In this event, the trading price of our
common stock could significantly decline.

Our earnings will be affected upon the issuance of shares of our common stock
pursuant to third-party entertainment property license agreements and by a
warrant held by a finance company.

Pursuant to a license agreement with Franchise Films, we are obligated to issue
68,738 shares of our common stock after the release of any film for which we
elect to produce interactive entertainment software products. This agreement
covers up to 10 films or 687,375 shares of common stock. To date, we have
elected to produce titles for three films and have issued 68,738 shares under
this agreement. We are required to issue these shares when the films are
released and will then incur a non-cash charge. If the software product is
released after the release of the film, we will amortize the non-cash charge
over the life of the product, which is expected to be between three and six
months. If the software product is released prior to the release of the film,
we will at each interim period assess whether it is probable that the film will
be released and that the value of the shares to be issued is recoverable
through future sales

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of the product to which it relates. If this is probable, the non-cash charge
will be amortized to licensed costs over the life of the product. In the
alternative, we will expense the non-cash charge at the time of the issuance of
the shares if it is not probable that the value of the shares issued is
recoverable through future sales of the product to which these shares relate.
We cannot estimate the aggregate dollar amount of future non-cash charges as
they are based on our share price at a future point in time. However, these
charges may be substantial. The non-cash charge of $746,000 on the initial
shares issued was fully amortized in the year ended June 30, 2002. Each of
these future charges will affect our gross margins and profitability and may
cause the trading price of our common stock to decline significantly.

In connection with the issuance of warrants pursuant to a license agreement
with Spyglass Entertainment, we incurred a non-cash charge of $354,000. This
charge is being amortized on a straight-line basis over five years and
commenced in October 2000. In connection with these warrants, a further
non-cash charge of $556,000 will be amortized over a period, expected to be
between three and six months, commencing on the release of the subject
interactive entertainment software products. These releases are expected to be
in the first or second fiscal quarter of 2003. Each of these charges will
affect our gross margins and profitability and may cause the trading price of
our common stock to decline significantly.

In connection with a license agreement entered into with Aardman Animations Ltd
we are required to issue warrants to purchase up to 50,000 shares of common
stock, in pre-determined multiples of either 5,000 or 10,000 shares, upon the
occurrence of certain pre-determined events. To date we have issued warrants
to purchase 20,000 shares under this agreement and incurred non-cash charges of
$86,000. Under the agreement, additional warrants to purchase up to an
additional 30,000 shares may be issued, in either multiples of 5,000 or 10,000
shares, contingent upon certain future events occurring relating to the
development and release of products. Upon issuance of the warrants we will
incur an additional non-cash charge. Upon release of the software products on
which the warrants are issued, we will amortize the non-cash charges over the
life of the products, which are expected to be between three and six months. We
cannot estimate the aggregate dollar amount of these future non-cash charges as
they are based on our share price at future points in time. Each of these
charges will affect our gross margins and profitability and may cause the
trading price of our common stock to decline significantly.

In connection with a license agreement entered into with Southpaw Media Group
Inc, we granted a warrant to purchase up to 200,000 shares of our common stock,
of which 15,000 became immediately exercisable upon the signing of the
agreement. The remaining 185,000 will only become exercisable, in multiples of
either 4,625 or 13,875 shares, upon certain future events occurring relating to
the development and release of products. Upon the signing of the agreement,
the warrant for 15,000 shares became exercisable, and we recorded a non-cash
deferred charge of $29,000, which will be amortized on a straight-line basis
over five years. This amortization commenced in May 2002. We will incur
additional non-cash charges as the remaining 185,000 shares become exercisable.
Upon release of the software products on which the warrants are issued, we will
amortize the non-cash charges over the life of the products, which are expected
to be between three and six months. We cannot estimate the aggregate dollar
amount of these future non-cash charges as they are based on our share price at
future points in time. Each of these charges will affect our gross margins and
profitability and may cause the trading price of our common stock to decline
significantly.

Our market is characterized by changing consumer preferences and short product
life cycles. To compete effectively we must continually introduce new products
that achieve market acceptance.

The interactive entertainment software market is characterized by short product
life cycles, changing consumer preferences and frequent introduction of new
products. We believe that our success will be dependent on the production of
successful titles on a continuous basis. We cannot assure you that new products
introduced by us will achieve significant market acceptance or that such
acceptance, if achieved, will be sufficient to permit us to recover development
and other associated costs. Consumer preferences for interactive entertainment
software products are continually changing and are difficult to predict. Even
the most successful titles remain popular for only limited periods of time,
often less than six months. The life cycle of a game generally consists of a
relatively high level of sales during the first few months after introduction,
followed by a decline in sales. Accordingly, we expect that substantially all
of our net sales for a particular year will be generated by titles released in
that year and in the latter part of the prior year.

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The development cycle for new titles is long and during this time the market
appeal of a title may decline.

We believe the development cycle for new titles is long, typically ranging from
12 to 24 months. After development of the initial product, we believe it may
take between six and 12 additional months to develop the product for additional
hardware platforms. In order to distribute a product, we must develop and test
the necessary game software, obtain approval from the manufacturer and licensor
if required, and have the initial order of cartridges or disks manufactured.
During the development cycle, the market appeal of a title or of a property on
which the title is based may decline. If market acceptance is not achieved, we
may grant markdown allowances to maintain our relationship with retailers and
our access to distribution channels. Because we introduce a relatively limited
number of new products in a given period, the failure of one or more of our
products to achieve market acceptance could harm our business.

The introduction of new interactive entertainment hardware platforms creates
risks relating to the development of titles for those hardware platforms.

The interactive entertainment industry is also characterized by rapid
technological change. For example, the 128-bit hardware platform was released
within five years of the release of the 64-bit hardware platform. As a result,
we must continually anticipate these changes and adapt our offerings to
emerging hardware platforms and evolving consumer preferences. Generally,
because of the length of the development cycle, our development efforts must
begin well in advance of the release of new hardware platforms in order to
introduce titles on a timely basis with the release of such hardware platforms.
Further, we have no control over the release dates of new hardware platforms or
the number of units that will be shipped upon such release. It is difficult to
ensure that our schedule for releasing new titles will coincide with the
release of the corresponding hardware platforms. Additionally, if fewer than
expected units of a new hardware platform are produced or shipped, such as
recently occurred with Sonys PlayStation 2, Microsofts Xbox, and Nintendos
Game Boy Advance, developers of titles for those hardware platforms may
experience lower than expected sales.

The introduction of new hardware platforms and technologies can also render
existing titles obsolete and unmarketable. Generally, as more advanced hardware
platforms are introduced, consumer demand for titles for older hardware
platforms diminishes. In addition, a broad range of competing and incompatible
emerging technologies may lead consumers to postpone buying decisions until a
particular hardware platform gains widespread acceptance. As a result of such
reduced consumer demand for titles on older hardware platforms, our titles for
older hardware platforms may not generate sufficient sales to make our titles
profitable.

The development of software products is complex and time consuming and may not
lead to marketable titles.

The development of software products is complex and time consuming. Our
development efforts may not lead to marketable titles or titles that generate
sufficient revenues to recover their development and marketing costs,
especially if a hardware platform does not reach or sustain an expected level
of acceptance. This risk may increase in the future, as continuing increases in
development costs require corresponding increases in net sales in order for us
to maintain profitability.

The technological advancements of the new hardware platforms also allow more
complex software products. As software products become more complex, the risk
of undetected errors in products when first introduced increases. We cannot
assure you that, despite testing, errors will not be found in new products or
releases after shipments have been made, resulting in loss of or delay in
timely market acceptance, product returns, loss of revenues and damage to our
reputation. In the past, we have experienced delays in the introduction of new
titles and we anticipate that we will experience similar delays in the future
in connection with the introduction of additional new titles, including
products currently under development. Because net revenues associated with the
initial shipments of a new product generally constitute a high percentage of
the total net revenues associated with the life of a product, any delay in the
introduction of, or the presence of a defect in, one or more new products could
harm the ultimate success of the products or our business and operating
results.

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The costs of developing and marketing products for interactive entertainment
hardware platforms can be substantial and could harm our business.

The costs associated with the introduction of products for hardware platforms,
such as Nintendos GameCube, Sonys PlayStation 2 and Microsofts Xbox, could
harm our business. We anticipate that it will be more costly to develop titles
for hardware platforms. We also believe the costs of developing and publishing
titles for these hardware platforms may require greater financial and technical
resources than prior development and publishing efforts. Additionally, during
periods of new technology introductions, forecasting our revenues and earnings
is more difficult than in more stable or rising product markets.

If new interactive entertainment hardware platforms fail to achieve significant
market acceptance, it may harm our business.

Our sales are dependent on, among other factors, the popularity and unit sales
of the interactive entertainment hardware platforms of the various
manufacturers. The interactive entertainment industry has experienced periods
of significant growth in consumer interest and popularity, followed by periods
in which consumer demand for interactive entertainment products has slowed.
Unexpected shortfalls in the market acceptance of a particular hardware
platform can significantly harm consumer demand for titles released or
scheduled for release for that hardware platform. Therefore, we are dependent
upon the successful marketing efforts of the manufacturers of the various
hardware platforms to meet financial expectations.

Product returns and markdown allowances could harm our business.

We have experienced, and are exposed to the risk of product returns and
markdown allowances with respect to our customers. The decrease in demand for
products based upon older hardware platforms may lead to a high level of these
product returns and markdown allowances. We allow distributors and retailers to
return defective and damaged products in accordance with negotiated terms. In
addition, from time to time we provide markdown allowances to our customers on
certain unsold merchandise. Product returns and markdown allowances that exceed
our expectations could harm our business.

A substantial portion of our revenues have been derived from a limited number
of products.

To date, a substantial portion of our revenues have been derived from a limited
number of products. Sales of our Powerpuff Girlsproducts accounted for 32% of
our net revenues for the year ended June 30, 2002 and 66% of our net revenues
for the year ended June 30, 2001. Sales of our Beast Warsproduct accounted for
100% of our net revenues for the period from inception through June 30, 2000.
If we fail to replace these titles with additional products generating
significant revenues, our business will be harmed.

Over 40% of our net revenues are derived from sales to our three largest
customers. We could be adversely affected if any of them reduced or terminated
their purchases from us or did not pay their obligations to us.

Revenues from our three largest customers collectively accounted for 41% of our
net revenues for the year ended June 30, 2002 as compared to 43% of our net
revenues for the year ended June 30, 2001 and 75% for the period from inception
through June 30, 2000. For the year ended June 30, 2002, two customers
accounted for 22% and 11%, respectively, of our net revenues, and for the year
ended June 30, 2001, three customers each accounted for between 12% and 17% of
our net revenues. As of June 30, 2002, five customers each accounted for
between 10% and 16% of our net accounts receivable, and as of June 30, 2001,
four customers each accounted for between 10% and 27% of our net accounts
receivable. We have no written agreements or other understandings with any of
our customers that relate to future purchases. Therefore, purchases by these
customers or any others could be reduced or terminated at any time. A
substantial reduction or a termination of purchases by any of our largest
customers would harm us.

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Substantially all of our sales are made on credit, which exposes us to bad
debt.

Our sales are typically made on credit, with terms that vary depending upon the
customer and other factors. While we attempt to carefully monitor the
creditworthiness of our customers and distributors, we bear the risk of their
inability to pay our receivables and of any delay in payment. A business
failure by any of our largest customers, such as occurred with Kmart in January
2002, would harm us, as could a business failure by any of our distributors or
other retailers.

We cannot publish our interactive entertainment software titles without the
approval of hardware manufacturers. Our ability to continue to develop and
market our titles is dependent on the hardware manufacturers continuing to do
business with us.

We are wholly dependent on the manufacturers of interactive entertainment
hardware platforms and our ability to obtain or maintain non-exclusive licenses
with them, both for the rights to publish and to manufacture titles for their
hardware platforms. We are required to obtain a license to develop and publish
titles for each hardware platform for which we develop and publish titles. Each
license specifies the territory to which it applies, and such licenses range
from as broad as multi-national distribution to as narrow as approval on a
title-by-title basis. Our existing hardware platform licenses for Sonys
PlayStation and PlayStation 2, Nintendos Game Boy Color and Game Boy Advance,
Nintendo 64, Nintendo GameCube, and Microsofts Xbox require that we obtain
approval for the publication of new titles on a title-by-title basis. As a
result, the number of titles we are able to publish for these hardware
platforms, along with our ability to time the release of these titles is
dependent upon decisions made by third party manufacturers. Accordingly, our
revenues from titles for these hardware platforms may be limited. Should any
manufacturer choose not to renew or extend our license agreement at the end of
its current term, or if the manufacturer were to terminate our license for any
reason, we would be unable to publish additional titles for that manufacturers
hardware platform.

We are dependent on Sony and Nintendo for the manufacture of products that we
develop for their hardware platforms.

When we develop interactive entertainment software titles for a hardware
platform offered by Sony or Nintendo, the products are manufactured exclusively
by that hardware manufacturer. Our hardware platform licenses with Sony and
Nintendo provide that the manufacturer may change prices for the manufacturing
of products at any time. In addition, these licenses include other provisions
that give the manufacturer substantial control over our costs and the release
of new titles. Since each of the manufacturers is also a publisher of games for
its own hardware platforms and manufactures products for all of its other
licensees, a manufacturer may give priority to its own products or those of our
competitors in the event of insufficient manufacturing capacity. We would be
materially harmed by unanticipated delays in the manufacturing and delivery of
products.

If we cannot retain our key personnel and attract and retain additional key
personnel, our business will be harmed.

Our success has been due to a significant extent on the contributions and
industry experience of our key personnel, in particular our Chief Executive
Officer, Raymond C. Musci, our Vice Chairman, Anthony R. Williams, and our
President, Bernard Stolar. If we fail to retain the services of our key
personnel, our ability to secure additional licenses and develop and sell new
products would be significantly impaired. In addition, our future success will
also depend upon our ability to continue to attract, motivate and retain highly
qualified employees and third-party contractors, particularly software design
and development personnel and outside sales representatives. Competition for
highly skilled employees is intense and we may not be successful in attracting
and retaining such personnel.

We are dependent upon licenses to properties originated and owned by third
parties for the development of our titles.

Many of our titles, such as those from our Powerpuff Girlsseries, Dexters
Laboratory, Driven, Ecks v Sever, and Reign of Fireare based upon
entertainment properties licensed from third parties. We cannot assure you that
we will be able to obtain new licenses, or renew existing ones, on reasonable
terms, if at all. If we are unable to obtain

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licenses for the properties which we believe offer significant consumer appeal,
we would be required to obtain licenses for less popular properties or have to
develop all of our titles based upon internally developed concepts. Titles
based on less popular properties or on internally developed concepts typically
require greater marketing expense in order to establish brand identity and may
not achieve broad market acceptance or prove to be successful.

We are dependent on third-party interactive entertainment software developers
for developing and completing many of our titles.

We rely on third-party interactive entertainment software developers for the
development of a significant number of our interactive entertainment software
titles. Quality third-party developers are continually in high demand. For this
reason, we cannot assure you that the third-party software developers who have
developed titles for us in the past will continue to be available to develop
software for us in the future. Due to the limited number of third-party
software developers and the lack of control that we exercise over them, we
cannot assure you that these developers will complete titles for us on a timely
basis or within acceptable quality standards, if at all.

Our success depends on our ability to effectively manage our growth.

Our operations have rapidly expanded since our inception in October 1999 and we
plan to continue to significantly expand our operations. Our rapid growth has
placed, and will continue to place, significant strain on our management and
operational systems and resources. We anticipate that as our business grows, we
will have to improve and enhance our overall financial and managerial controls,
reporting systems and procedures. We will also need to continue to expand,
train and manage our workforce. Additionally, we will be required to increase
the capacity of our current systems to meet additional demands. An inability to
manage our growth and meet these additional demands will impair the success of
our business.

Obtaining additional capital to fund our operations and finance our growth
could impair the value of your investment.

If we expand more rapidly than currently anticipated or if our working capital
needs exceed our current expectations, we may need to raise additional capital
through public or private equity offerings or debt financings. If we cannot
raise needed funds on acceptable terms, we may not be able to develop or
enhance our products, take advantage of future opportunities or respond to
competitive pressures or unanticipated requirements. To the extent we raise
additional capital by issuing equity securities, our stockholders may
experience substantial dilution. Also, any new equity securities may have
greater rights, preferences or privileges than our existing common stock. A
material shortage of capital may require us to take drastic steps such as
reducing our level of operations, disposing of selected assets or seeking an
acquisition partner.

Our success is highly dependent on our proprietary software and intellectual
property.

We rely primarily on a combination of copyright, trademark and trade secret
laws, employee and third-party nondisclosure agreements and other methods to
protect our proprietary rights. We require our employees, consultants and other
outside individuals and entities to execute confidentiality and nondisclosure
agreements upon the start of employment, consulting or other contractual
relationships with us. However, our ability to police these individuals and
entities and enforce these agreements is costly and uncertain. We are aware
that unauthorized copying occurs within our industry. If a significantly
greater amount of unauthorized copying of our interactive entertainment
software products were to occur, our business would be harmed. We generally
obtain ownership of the software code and related documentation from
third-party software developers. In instances where we do not retain sole
ownership of the source code, the owner may use or license the code for
development of other software products that may compete directly with our
products and we may not have sufficient rights in the source code to produce
derivative products.

We rely on existing copyright laws to prevent unauthorized distribution of our
products. Existing copyright laws afford only limited protection. Policing
unauthorized use of our products is difficult, and software piracy is a
persistent problem, especially in international markets. In addition, the laws
of some countries in which our products are or may be distributed either do not
protect our products and intellectual property rights to the same extent as the

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laws of the United States or are weakly enforced. Legal protection of our
rights may be ineffective in these countries. Any unauthorized use of our
proprietary information could result in costly and time-consuming litigation to
enforce our proprietary rights.

Other parties may assert claims against us that we are infringing upon their
intellectual property rights and we are required to indemnify hardware
manufacturers from certain claims in exchange for the right to purchase titles
and manufacture our software for their hardware application.

We cannot be certain that our products do not infringe upon the intellectual
property rights of others. We may be subject to legal proceedings and claims
from time to time in the ordinary course of our business, including claims of
alleged infringement of the intellectual property rights of third parties. If
our products violate third-party proprietary rights, we cannot assure you that
we would be able to obtain licenses to continue offering such products on
commercially reasonable terms, or at all. In addition, we must indemnify the
hardware manufacturers with respect to all loss, liability and expense
resulting from any claim against them involving the development, marketing,
sale or use of our products. This includes any claims for copyright or
trademark infringement brought against them. As a result, we bear the risk that
the properties upon which our software titles are based, or that the
information and technology licensed from the hardware manufacturer and
incorporated in our software, may infringe the rights of third parties. Any
claims against us or the parties we indemnify relating to the infringement of
third-party proprietary rights, even if not meritorious, could result in the
expenditure of significant financial and managerial resources. Their claims
could also result in injunctions preventing us from offering these products.
Such claims could severely harm our financial condition and ability to compete.
For information concerning pending intellectual property matters, see Business
 Intellectual Property.

The interactive entertainment industry is consolidating. In making
acquisitions, we face significant competition from other companies with greater
financial resources. We also face integration challenges with any companies
that we acquire.

To enhance our product development and distribution capabilities, we may pursue
acquisitions of companies, intellectual property rights and other assets that
can be acquired on acceptable terms and which we believe can be operated or
exploited profitably. We cannot assure you that we will be successful in
identifying suitable acquisition opportunities. As the interactive
entertainment industry continues to consolidate, we face significant
competition in making acquisitions. This may constrain our ability to complete
suitable transactions. Many of our competitors for potential acquisitions have
significant financial and other resources.

If we attempt an acquisition, we cannot assure you that, given the competitive
environment, we will complete the acquisition or that any completed
acquisitions will benefit our business or operations. In addition, the
integration of any newly acquired companys operations with our existing
operations will take management time and effort. There is a possibility that we
may not be successful in integrating operations of any newly acquired
companies. Additionally, there is a risk of loss of key employees, customers
and vendors of any recently acquired companies.

We face risks associated with doing business in foreign countries, including
our ability to generate international demand for our products.

We intend to expand our international sales and marketing activities. This
expansion will require significant management time and attention and financial
resources in order to develop our international operations. We cannot assure
you that we will be able to generate international market demand for our
products. International sales and operations are subject to a number of risks,
including:



| |  |  | international consumer acceptance of existing and proposed titles;                         
| | - |  | -------------------------------------------------------------------------------------------
|
| |  |  | the impact of possible recessions in foreign economies;                                    
|
| |  |  | our ability to protect our intellectual property;                                          
|
| |  |  | the time and costs associated with translating and localizing products for foreign markets;

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| |  |  | foreign currency fluctuations;                                         
| | - |  | -----------------------------------------------------------------------
|
| |  |  | unexpected changes in regulatory requirements;                         
|
| |  |  | difficulties and costs of staffing and managing foreign operations; and
|
| |  |  | political and economic instability.                                    

Any significant downturn in general economic condition which results in a
reduction in discretionary spending could reduce demand for our products and
harm our business.

Our product sales are affected by a retail customers ability and desire to
spend disposable income on the purchase of our software titles. Any significant
downturn in general economic conditions which results in a reduction of
discretionary spending could result in a reduction in demand for our products
and could harm our business. The United States economy is currently undergoing
a period of slowdown, which some observers view as a recession. The United
States and world economic condition has been worsened by the September 11th
terrorist attacks in New York City and Washington, D.C. Moreover, any further
terrorist activities, or the effect of the United States political, economic
or military response to such activities, could result in the further
deterioration of the United States and world economy. Such industry downturns
have been, and may continue to be, characterized by diminished product demand
and erosion of average selling prices. A continued economic downturn or
recession would have a significant adverse effect on our operating results in
future periods.

Our officers and directors own a substantial amount of our common stock and
therefore have substantial influence over our operations and can significantly
influence matters requiring stockholder approval.

Our officers and directors beneficially own approximately 54% of our common
stock. As a result, they have the ability to control all matters requiring
approval by our stockholders, including the election and removal of directors,
approval of significant corporate transactions and the decision of whether a
change in control will occur.

Competition within the interactive entertainment software industry is intense
and poses an ongoing threat to the success of our business.

The interactive entertainment industry is intensely competitive. Many of our
competitors have greater name recognition among consumers and licensors of
entertainment properties, broader product lines and greater financial,
marketing and other resources than us. Accordingly, these competitors may be
able to market their products more effectively, make larger offers or
guarantees in connection with the acquisition of licensed entertainment
properties, adopt more aggressive pricing policies or pay more to third-party
developers. We believe that other technology, entertainment and media companies
are increasing their focus on the interactive entertainment software market,
which might result in greater competition for us. In addition, many of our
competitors are developing online interactive entertainment software products
and interactive networks that will be competitive with our interactive
entertainment software products.

Competitive pressures could have the following effects on us:



| |  |  | as competition for popular entertainment properties increases, our
cost of acquiring licenses for those properties may increase, resulting
in reduced margins;                        
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | as competition for retail shelf space becomes more intense, we may
need to increase our marketing expenditures to maintain sales of our
interactive entertainment software titles; and
|
| |  |  | we could be required to reduce the wholesale unit prices of our
titles.                                                                                                               

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Competition for limited shelf space and promotional resources among interactive
entertainment software publishers is intense and poses an ongoing threat to the
success of our business.

There is intense competition among developers and publishers of interactive
entertainment software products for high quality retail shelf space and
promotional support from retailers. As the number of titles and hardware
platforms increases, competition for shelf space will intensify and may require
us to increase our marketing expenditures. Due to increased competition for
limited shelf space, retailers and distributors are in an increasingly better
position to negotiate favorable terms of sale, including price discounts, price
protection, marketing and display fees and product return policies. Our
products constitute a relatively small percentage of any retailers sales
volume, and we cannot assure you that retailers will continue to purchase our
products or to provide our products with adequate levels of shelf space and
promotional support. As a result of their positions in the industry, the
manufacturers of interactive entertainment hardware platforms generally have
better bargaining positions with respect to retail pricing, shelf space and
retailer accommodations than do any of their licensees, including us.

Government restrictions including the possible adoption of an interactive
entertainment software rating system could harm our business.

Legislation is periodically introduced at the state and federal levels in the
United States and in foreign countries to establish a system for providing
consumers with information about graphic violence and sexually explicit
material contained in interactive entertainment software products. Under such a
system, interactive entertainment software publishers would be expected to
comply by identifying particular products within defined rating categories. In
addition, these publishers would be required to communicate these ratings to
consumers through appropriate package labeling and through advertising and
marketing presentations consistent with each products rating. Many foreign
countries have laws which permit governmental entities to censor the content of
products, including interactive entertainment software. In some instances, we
may be required to modify our products to comply with the requirement of such
governmental entities, which could delay the release of those products in such
countries. These delays could harm our business. We currently voluntarily
submit our products to industry-created review boards and publish their ratings
on our game packaging. Some retailers may refuse to carry titles that bear an
unacceptable rating. We believe that mandatory government-run interactive
entertainment software products rating systems eventually will be adopted in
many countries which represent significant markets or potential markets for us.
Due to the uncertainties in the implementation of such a rating system,
confusion in the marketplace may occur. We are unable to predict what effect,
if any, such a rating system would have on our business.

Potential opposition by consumer advocacy groups to certain software content
could harm our business.

Consumer advocacy groups have in the past opposed sales of interactive
entertainment software products containing graphic violence and sexually
explicit content. These groups have pressed for legislation in these areas and
engaged in public demonstrations and media campaigns. While to date such
actions have not harmed our business, we cannot assure you that these groups
will not target our products in the future. If that occurs, we may be required
to significantly change or discontinue one or more of our titles.

We expect our stock price to be volatile.

Prior to our initial public offering in November 2001, there was no public
market for our common stock. Since our initial public offering the market price
of our common stock has been volatile. We have experienced a decline in the
market price of our common stock from the initial public offering price. The
stock market has experienced significant price and volume fluctuations that
affected the market price for the common stock of many technology,
communications and entertainment and media companies. These market fluctuations
were sometimes unrelated or disproportionate to the operating performance of
these companies. Any significant stock market fluctuations in the future,
whether due to our actual performance or prospects or not, could result in a
further decline in the market price of our common stock.

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Anti-takeover provisions in our charter documents and in Delaware law could
prevent or delay a change in control and, as a result, negatively impact our
stockholders.

Provisions of our certificate of incorporation and bylaws may discourage, delay
or prevent a merger or acquisition or make removal of incumbent directors or
officers more difficult. These provisions may discourage takeover attempts and
bids for our common stock at a premium over the market price. These provisions
include:



| |  |  | the ability of our board of directors to alter our bylaws without stockholder approval;                                                                                                            
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | the restriction on the ability of stockholders to call special meetings;                                                                                                                           
|
| |  |  | the restriction on the ability of our stockholders to act by written consent;                                                                                                                      
|
| |  |  | the establishment of advance notice requirements for nominations
for election to our board of directors or for proposing matters that
can be acted on by stockholders at stockholders meetings; and
|
| |  |  | the establishment of a classified board of directors with
staggered, three-year terms, which prevents a majority of the board
from being elected at one time.                                      

In addition, we are subject to Section 203 of the Delaware General Corporation
Law, which prohibits a publicly held Delaware corporation from engaging in a
merger, asset or stock sale or other transaction with an interested stockholder
for a period of three years following the date such person became an interested
stockholder, unless prior approval of our board of directors is obtained or as
otherwise provided. These provisions of Delaware law also may discourage, delay
or prevent someone from acquiring or merging with us without obtaining the
prior approval of our board of directors, which may cause the market price of
our common stock to decline.

Special note on forward looking statements and reports prepared by analysts.

This Report contains forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995, including statements with
regards to our revenues, earnings, spending, margins, cash flow, orders,
inventory, products, actions, plans, strategies and objectives.
Forward-looking statements include, without limitation, any statement that may
predict, forecast, indicate or simply state future results, performance or
achievements, and may contain the words believe, anticipate, expect,
estimate, intend, plan, project, will be, will continue, will,
result, could, may, might, or any variations of such words with similar
meanings. Any such statements are subject to risks and uncertainties that
would cause our actual results to differ materially from those which are
managements current expectations or forecasts. Such information is subject to
the risk that such expectations or forecasts, or the assumptions underlying
such exceptions or forecasts, become inaccurate. In addition, the risks
included here are not exhaustive. Other sections of this Report may include
additional factors which could adversely impact our business and financial
performance. Moreover, we operate in a very competitive and rapidly changing
environment. New risk factors emerge from time to time and we cannot predict
all such risk factors, nor can we assess the impact of all such risk factors on
our business or the extent to which any factor, or combination of factors, may
cause actual results to differ materially from those contained in any forward
looking statements. Given these risks and uncertainties, investors should not
place undue reliance on forward-looking statements as a prediction of actual
results. Investors should also be aware that while we do, from time to time,
communicate with securities analysts, we do not disclose any material
non-public information or other confidential commercial information to them.
Accordingly, individuals should not assume that we agree with any statement or
report issued by any analyst, regardless of the content of the report. Thus,
to the extent that reports issued by securities analysts contain any
projections, forecasts or opinions, such reports are not our responsibility.

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Item 2  Properties

Our headquarters are located in San Jose, California, where we occupy
approximately 9,533 square feet of office space under a lease which expires in
April 2005. Our development studio is located in London, England, where we
occupy approximately 1,000 square feet under a lease that requires us to give
one month notice of termination. In June 2002, we entered into a lease for
3,214 square feet in London and our development studio relocated to this space
in August 2002. This lease expires in June 2012, although we have the right to
terminate the lease at our option in 2007. We also lease approximately 1,800
square feet for our international sales office located in Bath, England. This
lease expires in 2008 although we have the right to terminate the lease at our
option in 2004. We are currently looking for additional space in Bath. We
believe that our domestic facilities are adequate for our current needs and
suitable additional or substitute space will be available in the future to
replace our existing facilities, if necessary, or accommodate expansion of our
operations.




Item 3  Legal proceedings

From time to time, we may be involved in litigation relating to claims arising
out of our operations in the normal course of business. As of the date of this
filing, we are not a party to any material legal proceedings.




Item 4  Submission of matters to a vote of security holders

No matters were submitted to our security holders to be voted during the last
quarter of the fiscal year ended June 30, 2002.

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PART II




Item 5  Market for registrants common equity and related stockholder matters

Price range of common stock

Our common stock began trading on the Nasdaq National Market on November 15,
2001 after we completed the initial public offering of 5,750,000 shares of our
common stock at $8.00 per share. Our common stock trades under the symbol
BFUN. The following table sets forth, for the periods indicated, the high
and low sale prices for our common stock:

|                                |  |      |       |     |  |   |      | 
|------------------------------- |  | ---- | ----- | --- |  | - | ---- | 
|Fiscal year ended June 30, 2002 |  | High |       | Low
|                                |  |      |       |    
|Second quarter(1)               |  | $    | 10.97 |     |  | $ | 7.55 | 
|Third quarter                   |  | $    | 8.50  |     |  | $ | 3.00 | 
|Fourth quarter                  |  | $    | 3.55  |     |  | $ | 1.92 | 



---

|(1) |  | For the period from November 14, 2001 to December 31, 2001.
|--- |  | -----------------------------------------------------------

As of September 4, 2002, there were 249 holders of records of our common stock
(including holders who are nominees for an undetermined number of beneficial
owners). These figures do not include beneficial owners who hold shares in
nominee name.

Dividends

We have never declared or paid any cash dividends on our capital stock. We
anticipate that we will retain any earnings to support operations and to
finance the growth and development of our business. Therefore, we do not expect
to pay cash dividends on our capital stock in the foreseeable future. Any
future determination relating to our dividend policy will be made at the
discretion of our board of directors and will depend on a number of factors,
including future earnings, capital requirements, financial conditions,
contractual obligations, future prospects and other factors the board of
directors may deem relevant.

Change in securities and use of proceeds.

In November 2001, we completed the initial public offering (the Offering) of
5,750,000 shares of our common stock. The managing underwriters in the
Offering were Jefferies & Company, Inc. and Morgan Keegan & Company, Inc. (the
Underwriters). The shares of common stock sold in the Offering were
registered under the Securities Act of 1933, as amended, on a registration
statement on Form S-1 (Reg. No. 333-62436) (the Registration Statement) that
was declared effective by the Securities and Exchange Commission (the SEC) on
November 14, 2001.

The Offering was terminated after all 5,750,000 shares (including 750,000
shares sold pursuant to the exercise of the Underwriters over-allotment
option) registered under the Registration Statement were sold by us at a
purchase price of $8.00 per share. The aggregate price of the Offering amount
registered and sold was $46.0 million. In connection with the Offering, we
paid an aggregate of approximately $3.2 million in underwriting discounts and
commissions to the Underwriters. Expenses incurred in connection with the
Offering, other than underwriting discounts and commissions, totaled
approximately $3.6 million.

After deducting the underwriting discounts and commissions and the estimated
expenses incurred in connection with the Offering, we received net proceeds of
approximately $39.2 million. Of these proceeds, $11.6 million was unused as of
June 30, 2002, and was held as either cash, cash equivalents or short-term
investments. The following summarizes the use of the remaining $27.6 million:

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| |  |  | $18.6 million for product development                                                                                                      
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | $6.0 million for expansion of sales and marketing activities                                                                               
|
| |  |  | $3.0 million for additional working capital, including payment of
$400,000 of accrued salaries owed to members of our executive
management.

Recent sales of unregistered securities

During the year ended June 30, 2002, we issued unregistered securities as
described below. None of these transactions involved any underwriters,
underwriting discounts or commissions, or any public offering, and we believe
that each transaction was exempt from the registration requirements of the
Securities Act of 1933, as amended, by virtue of Section 4(2) thereof and/or
Regulation D promulgated thereunder. All persons had adequate access, through
their relationships with us, to information about us.

In connection with a finance agreement, we issued a warrant in August 2001 to a
finance company to purchase 100,000 shares of our common stock at an exercise
price equal to the initial public offering price of our common stock, which was
subsequently established at $8.00 per share. The warrant expires in August
2004.

In connection with a sale of unregistered securities in December 2000 pursuant
to Regulation D under the Securities Act of 1933, as amended, we issued a
warrant to a service provider to purchase 141,000 shares of our common stock at
an exercise price of $3.76 per share. The warrant was exercised in full in
December 2001.

In connection with an agreement entered into with a production company during
January 2002, we agreed to issue to the production company warrants to purchase
up to 50,000 shares of our common stock, in pre-determined multiples of either
5,000 or 10,000 shares, upon the occurrence of certain pre-determined events.
Warrants are to be issued at the average closing price of our stock for the
five days immediately prior to the date of issue, have a five year term from
date of issue, and are fully vested and are immediately exercisable upon
issuance. In January 2002, we issued a warrant to purchase 10,000 shares of
our common stock at an exercise price of $5.67 per share under this agreement,
and in March 2002, we issued another warrant to purchase 10,000 shares of our
common stock at an exercise price of $5.88 per share under this agreement.

In May 2002, in connection with a licensing and publishing agreement entered
into with a publishing company, we granted to the production company a warrant,
with a ten year term from the date of issue, to purchase up to 200,000 shares
of our common stock at an exercise price of $2.60, of which 15,000 became
immediately exercisable upon the signing of the agreement, and the remaining
185,000 only become exercisable in multiples of 4,625 shares upon each election
by us to produce a title based on any films, made for television movies, or
television series produced from screenplays to be produced by the studio, up to
a maximum ten titles, and multiples of 13,875 shares upon the theatrical
release or television air-date of each film for which we have developed a
title. Upon expiration of the agreement, any unexercised warrants will cease
to be exercisable. Our agreement expires upon the later of five years or
either the theatrical release or television air-date of the tenth film or
television series on which we base a product, but in no event later than eight
years from the date of the agreement, unless seven films or television series
have been released or aired, respectively, seven years from the date of the
agreement, in which event the agreement would expire at such time.

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Item 6  Selected consolidated financial data

The following selected consolidated statement of operations data for the years
ended June 30, 2002 and 2001 and for the period from October 7, 1999
(inception) through June 30, 2000, and the consolidated balance sheet data as
of June 30, 2002 and 2001 are derived from our audited consolidated financial
statements and notes thereto, included elsewhere herein, and are audited by
Deloitte & Touche LLP, independent public accountants, as set forth in their
report included later in this Report. The consolidated balance sheet as of
June 30, 2000 is derived from audited financial statements that are not
included in this Report. The following data should be read in conjunction with
our consolidated financial statements, including the notes thereto, and
Managements discussion and analysis of financial condition and results of
operations included elsewhere in this Report.

|                                                        |                                                                                       |                                                 |                                                                   |                          |        |                                       |        |                      |        |        |        |       |     |             |       | 
|------------------------------------------------------- | ------------------------------------------------------------------------------------- | ----------------------------------------------- | ----------------------------------------------------------------- | ------------------------ | ------ | ------------------------------------- | ------ | -------------------- | ------ | ------ | ------ | ----- | --- | ----------- | ----- | 
|                                                        |                                                                                       |                                                 |                                                                   |                          |        |                                       |        |                      |        |        |        |       |     | Period from
|                                                        |                                                                                       |                                                 |                                                                   |                          |        | Year ended June 30,                   |        | October 7, 1999     
|                                                        |                                                                                       |                                                 |                                                                   |                          |        |                                       |        | (inception) through,
|Consolidated statement of operations data               |                                                                                       | 2002                                            |                                                                   | 2001                     |        | June 30, 2000                        
|                                                        |                                                                                       |                                                 |                                                                   |                          |        |                                      
|                                                        |                                                                                       |                                                 |                                                                   |                          |        | (in thousands, except per share data)
|Net revenues                                            |                                                                                       | $                                               | 50,734                                                            |                          |        | $                                     | 25,351 |                      |        | $      | 1,377  |      
|Costs and expenses:                                     |                                                                                       |                                                 |                                                                   |                          |        |                                       |        |                      |        |        |        |      
|                                                        | Cost of revenues                                                                      |                                                 |                                                                   |                          |        |                                       |        |                      |        |        |        |       |    
|                                                        |                                                                                       |                                                 | Cost of goods sold                                                |                          |        | 29,826                                |        |                      |        | 14,827 |        |       |     | 807         |      
|                                                        |                                                                                       |                                                 | Royalties, software costs, license costs, and project abandonment |                          |        | 12,794                                |        |                      |        | 2,898  |        |       |     | 248         |      
|                                                        |                                                                                       |                                                 |                                                                   |                          |        |                                       |        |                      |        |        |        |      
|                                                        |                                                                                       |                                                 | Total cost of revenues                                            |                          |        | 42,620                                |        |                      |        | 17,725 |        |       |     | 1,055       |      
|                                                        | Research and development (exclusive of amortization of deferred
stock compensation)   |                                                 |                                                                   | 2,519                    |        |                                       |        | 1,073                |        |        |        | 260   |    
|                                                        | Sales and marketing (exclusive of amortization of deferred stock
compensation)        |                                                 |                                                                   | 11,473                   |        |                                       |        | 4,292                |        |        |        | 132   |    
|                                                        | General and administrative (exclusive of amortization of deferred
stock compensation) |                                                 |                                                                   | 6,293                    |        |                                       |        | 1,996                |        |        |        | 711   |    
|                                                        | Amortization of deferred stock compensation*                                          |                                                 |                                                                   | 1,223                    |        |                                       |        | 618                  |        |        |        |      |    
|                                                        |                                                                                       |                                                 |                                                                   |                          |        |                                       |        |                      |        |        |        |      
|                                                        |                                                                                       |                                                 |                                                                   | Total costs and expenses |        |                                       | 64,128 |                      |        |        | 25,704 |       |     |             | 2,158 | 
|                                                        |                                                                                       |                                                 |                                                                   |                          |        |                                       |        |                      |        |        |        |      
|Loss from operations                                    |                                                                                       |                                                 | (13,394                                                           | )                        |        |                                       | (353   | )                    |        |        | (781   | )    
|                                                        |                                                                                       | Other expense, net                              |                                                                   |                          | (2,279 | )                                     |        |                      | (1,249 | )      |        |       | (22 | )          
|                                                        |                                                                                       |                                                 |                                                                   |                          |        |                                       |        |                      |        |        |        |      
|Net loss                                                |                                                                                       |                                                 | (15,673                                                           | )                        |        |                                       | (1,602 | )                    |        |        | (803   | )    
|                                                        |                                                                                       | Redeemable convertible preferred stock dividend |                                                                   |                          |       |                                       |        |                      | (5,540 | )      |        |       |    |            
|                                                        |                                                                                       |                                                 |                                                                   |                          |        |                                       |        |                      |        |        |        |      
|Net loss attributable to common stockholders            |                                                                                       | $                                               | (15,673                                                           | )                        |        | $                                     | (7,142 | )                    |        | $      | (803   | )    
|                                                        |                                                                                       |                                                 |                                                                   |                          |        |                                       |        |                      |        |        |        |      
|Net loss attributable to common stockholders per share: |                                                                                       |                                                 |                                                                   |                          |        |                                       |        |                      |        |        |        |      
|                                                        | Basic and diluted (1)                                                                 |                                                 | $                                                                 | (1.65                    | )      |                                       | $      | (4.82                | )      |        | $      | (0.96 | )  
|                                                        |                                                                                       |                                                 |                                                                   |                          |        |                                       |        |                      |        |        |        |      
|Shares used in computation:                             |                                                                                       |                                                 |                                                                   |                          |        |                                       |        |                      |        |        |        |      
|                                                        | Basic and diluted                                                                     |                                                 |                                                                   | 9,503                    |        |                                       |        | 1,482                |        |        |        | 834   |    
|                                                        |                                                                                       |                                                 |                                                                   |                          |        |                                       |        |                      |        |        |        |      
|*Amortization of deferred stock compensation:           |                                                                                       |                                                 |                                                                   |                          |        |                                       |        |                      |        |        |        |      
|                                                        | Research and development                                                              |                                                 | $                                                                 | 126                      |        |                                       | $      | 72                   |        |        | $      |      |    
|                                                        | Sales and marketing                                                                   |                                                 |                                                                   | 70                       |        |                                       |        | 28                   |        |        |        |      |    
|                                                        | General and administrative                                                            |                                                 |                                                                   | 1,027                    |        |                                       |        | 518                  |        |        |        |      |    
|                                                        |                                                                                       |                                                 |                                                                   |                          |        |                                       |        |                      |        |        |        |      
|                                                        |                                                                                       | $                                               | 1,223                                                             |                          |        | $                                     | 618    |                      |        | $      |       |      
|                                                        |                                                                                       |                                                 |                                                                   |                          |        |                                       |        |                      |        |        |        |      

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|                                       |  |                |        |      |  |      |        |   |  |   |       |  
|-------------------------------------- |  | -------------- | ------ | ---- |  | ---- | ------ | - |  | - | ----- | -
|                                       |  | June 30,      
|                                       |  |               
|Consolidated balance sheet data        |  | 2002           |        | 2001 |  | 2000
|                                       |  |                |        |      |  |     
|                                       |  | (in thousands)
|Cash and cash equivalents              |  | $              | 4,726  |      |  | $    | 2,170  |   |  | $ | 908   |  
|Working capital                        |  |                | 31,825 |      |  |      | 8,990  |   |  |   | 1,318 |  
|Total assets                           |  |                | 49,467 |      |  |      | 20,992 |   |  |   | 2,712 |  
|Long-term portion of debt              |  |                |       |      |  |      |       |   |  |   |      |  
|Redeemable convertible preferred stock |  |                |       |      |  |      | 17,329 |   |  |   | 2,103 |  
|Total stockholders equity (deficit)   |  |                | 38,856 |      |  |      | (4,669 | ) |  |   | (706  | )



---

|(1) |  | The diluted net loss per share computation excludes potential shares of
common stock issuable upon exercise of options and warrants to purchase
common stock, as their effect would be antidilutive. See Notes 1 and 11
of notes to consolidated financial statements for a detailed explanation
of the determination of the shares used in computing basic and diluted net
loss per share.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




Item 7  Managements discussion and analysis of financial condition and
results of operations

Certain information contained in the following Managements Discussion and
Analysis of Financial Condition and Results of Operations constitute
forward-looking statements within the meaning of the Securities Act and the
Securities Exchange Act, which can be identified by the use of forward-looking
terminology such as believes, anticipates, plans, expects, endeavors,
may, will, intends, estimates, and similar expressions are intended to
identify forward-looking statements. These forward-looking statements involve
risks and uncertainties, and our actual results may differ materially from the
results discussed in the forward-looking statements as a result of certain
factors set forth in Risk Factors and elsewhere in this Report.

OVERVIEW

We develop and publish interactive entertainment software products. We
currently publish titles for most of the popular interactive entertainment
hardware platforms, such as Sonys PlayStation and PlayStation 2, Nintendos
GameCube, N64, Game Boy Color and Game Boy Advance, portable handheld devices
manufactured by Palm and Handspring, and for personal computers or PCs. We are
developing and plan to publish titles for Microsofts Xbox. We were
incorporated in California in October 1999 under the name Bay Area Multimedia,
Inc. We reincorporated in Delaware in September 2000 and changed our name to
BAM! Entertainment, Inc. in December 2000. We commenced operations in October
1999 and shipped our first products in June 2000.

We license properties from a wide variety of sources, and publish titles based
on the motion picture, sports and television properties of our licensors. We
have entered into strategic license arrangements with entertainment and media
companies that have developed well-known characters and brands and that are
producing popular properties that are expected to form the basis of some of our
future products. Our agreements with licensors and developers generally
require us to make advance royalty payments, and we may be required to spend
money on advertising and promotion. We generally pay royalties based on net
revenues.

We design and develop our titles internally or through third parties with whom
we have established relationships. We believe that the development cycle for
new titles is long, typically ranging from 12 to 24 months, except for
Nintendos Game Boy Advance for which the development cycle typically ranges
from six to nine months. After development of the initial product, we believe
that it may take between six to 12 additional months to develop the product
for, or port the product to, a different hardware platform.

We sell our products to mass merchandisers such as Toys R Us, Target, Kmart,
Wal-Mart and Best Buy, specialty chains such as GameStop, Electronics Boutique
and independent distributors. Our products are manufactured exclusively by
third parties. We have operations in both the United States and Europe.
International operations are conducted through our offices in England, where we have an internal product
development studio, perform international sales and marketing activities and
manage local third-party developers.

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##### Table of Contents



RESULTS OF OPERATIONS

The following table sets forth the condensed consolidated results of operations
as a percentage of net revenues for the years ended June 30, 2002 and 2001, and
for the period from October 7, 1999 (inception) through June 30, 2000. The
selected consolidated statement of operations data is derived from our audited
consolidated financial statements included elsewhere in this Form 10-K.

|                                             |                                             |                                                 |                                                                   |                          |      |                     |       |             |       |               |       |      |      |                 |       | 
|-------------------------------------------- | ------------------------------------------- | ----------------------------------------------- | ----------------------------------------------------------------- | ------------------------ | ---- | ------------------- | ----- | ----------- | ----- | ------------- | ----- | ---- | ---- | --------------- | ----- | 
|                                             |                                             |                                                 |                                                                   |                          |      |                     |       |             |       |               |       |      |      | Period from    
|                                             |                                             |                                                 |                                                                   |                          |      |                     |       |             |       |               |       |      |      | October 7, 1999
|                                             |                                             |                                                 |                                                                   |                          |      | Year ended June 30, |       | (inception)
|                                             |                                             |                                                 |                                                                   |                          |      |                     |       | through    
|                                             |                                             |                                                 |                                                                   |                          |      | 2002                |       | 2001        |       | June 30, 2000
|                                             |                                             |                                                 |                                                                   |                          |      |                     |       |             |       |              
|Net revenues                                 |                                             |                                                 | 100.0                                                             | %                        |      |                     | 100.0 | %           |       |               | 100.0 | %   
|Costs and expenses:                          |                                             |                                                 |                                                                   |                          |      |                     |       |             |       |               |       |     
|                                             | Cost of revenues                            |                                                 |                                                                   |                          |      |                     |       |             |       |               |       |      |     
|                                             |                                             |                                                 | Cost of goods sold                                                |                          |      | 58.8                |       |             |       | 58.5          |       |      |      | 58.6            |      
|                                             |                                             |                                                 | Royalties, software costs, license costs, and project abandonment |                          |      | 25.2                |       |             |       | 11.4          |       |      |      | 18.0            |      
|                                             |                                             |                                                 |                                                                   |                          |      |                     |       |             |       |               |       |     
|                                             |                                             |                                                 | Total cost of revenues                                            |                          |      | 84.0                |       |             |       | 69.9          |       |      |      | 76.6            |      
|                                             | Research and development (1)                |                                                 |                                                                   | 5.0                      |      |                     |       | 4.2         |       |               |       | 18.9 |     
|                                             | Sales and marketing (1)                     |                                                 |                                                                   | 22.6                     |      |                     |       | 17.0        |       |               |       | 9.6  |     
|                                             | General and administrative (1)              |                                                 |                                                                   | 12.4                     |      |                     |       | 7.9         |       |               |       | 51.6 |     
|                                             | Amortization of deferred stock compensation |                                                 |                                                                   | 2.4                      |      |                     |       | 2.4         |       |               |       |     |     
|                                             |                                             |                                                 |                                                                   |                          |      |                     |       |             |       |               |       |     
|                                             |                                             |                                                 |                                                                   | Total costs and expenses |      |                     | 126.4 |             |       |               | 101.4 |      |      |                 | 156.7 | 
|                                             |                                             |                                                 |                                                                   |                          |      |                     |       |             |       |               |       |     
|Loss from operations                         |                                             |                                                 | (26.4                                                             | )                        |      |                     | (1.4  | )           |       |               | (56.7 | )   
|                                             |                                             | Other expense, net                              |                                                                   |                          | (4.5 | )                   |       |             | (4.9  | )             |       |      | (1.6 | )              
|                                             |                                             |                                                 |                                                                   |                          |      |                     |       |             |       |               |       |     
|Net loss                                     |                                             |                                                 | (30.9                                                             | )                        |      |                     | (6.3  | )           |       |               | (58.3 | )   
|                                             |                                             | Redeemable convertible preferred stock dividend |                                                                   |                          |     |                     |       |             | (21.9 | )             |       |      |     |                
|                                             |                                             |                                                 |                                                                   |                          |      |                     |       |             |       |               |       |     
|Net loss attributable to common stockholders |                                             |                                                 | (30.9                                                             | )%                       |      |                     | (28.2 | )%          |       |               | (58.3 | )%  
|                                             |                                             |                                                 |                                                                   |                          |      |                     |       |             |       |               |       |     



---

|(1) |  | Excludes amortization of deferred stock compensation.
|--- |  | -----------------------------------------------------

Net revenues

Net revenues were $50.7 million, $25.4 million and $1.4 million for the years
ended June 30, 2002 and 2001 and the period from October 7, 1999 (inception)
through June 30, 2000, respectively.

The increase in net revenues each year was primarily attributable to increased
sales of products. We released 23 new products in the year ended June 30, 2002
compared to 11 new products during the year ended June 30, 2001, and two new
products in the period from October 7, 1999 (inception) through June 30, 2000.

To date, a substantial portion of our net revenues has been derived from sales
of a limited number of products. For example, sales of our Powerpuff Girls
titles accounted for 32% of our net revenues for the year ended June 30, 2002,
compared to 66% in the year ended June 30, 2001. Sales of our Beast Wars title
accounted for 100% of net revenues for the period from inception through June
30, 2000. As we expand our product offerings in different periods, we expect
that the percentage attributable to any single license will decrease.

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##### Table of Contents



The following table sets forth our net revenues by customer representing more
than 10% of each periods net revenues for the years ended June 30, 2002 and
2001, and period from October 7, 1999 (inception through June 30, 2000:

|                                                                                       |             |  |               |    |                     |  |      |    |   |  |             |    |  
|-------------------------------------------------------------------------------------- | ----------- |  | ------------- | -- | ------------------- |  | ---- | -- | - |  | ----------- | -- | -
|                                                                                       |             |  |               |    |                     |  |      |    |   |  | Period from
|                                                                                       |             |  | Year ended    |    | October 7, 1999    
|                                                                                       |             |  | June 30,      |    | (inception) through
|                                                                                       |             |  |               |    | June 30,           
|                                                                                       |             |  | 2002          |    | 2001                |  | 2000
|                                                                                       |             |  |               |    |                     |  |     
|                                                                                       |             |  | (percentages)
|Customers:                                                                             |             |  |               |    |                     |  |      |    |   |  |             |   
|                                                                                       | Toys R Us |  |               | 22 | %                   |  |      | 17 | % |  |             | *  |  
|                                                                                       | Kmart       |  |               | 11 |                     |  |      | *  |   |  |             | *  |  
|                                                                                       | Wal-Mart    |  |               | *  |                     |  |      | 14 |   |  |             | 16 | %
|                                                                                       | Target      |  |               | *  |                     |  |      | 12 |   |  |             | *  |  
|                                                                                       | Blockbuster |  |               | *  |                     |  |      | *  |   |  |             | 49 |  
|                                                                                       | KB Toys     |  |               | *  |                     |  |      | *  |   |  |             | 10 |  
|                                                                                       |             |  |               |    |                     |  |      |    |   |  |             |    |  
|Total net revenues
by customer
representing more
than 10% of the
periods net
revenues |             |  | 33            | %  |                     |  | 43   | %  |   |  | 75          | % 
|                                                                                       |             |  |               |    |                     |  |      |    |   |  |             |    |  



---

|* |  | less than 10%
|- |  | -------------

Net revenues to Kmart subsequent to January 22, 2002 were made under Kmarts
debtor-in-possession financing arrangement.

Net revenues by geographical region for the years ended June 30, 2002 and 2001
and the period from October 7, 1999 (inception) through June 30, 2000, is
summarized below:

|                                          |               |   |                |        |      |   |        |        |                     |  |      |  |  |   |             |       | 
|----------------------------------------- | ------------- | - | -------------- | ------ | ---- | - | ------ | ------ | ------------------- |  | ---- |  |  | - | ----------- | ----- | 
|                                          |               |   |                |        |      |   |        |        |                     |  |      |  |  |   | Period from
|                                          |               |   | Year ended     |        |      |   |        |        | October 7, 1999    
|                                          |               |   | June 30,       |        |      |   |        |        | (inception) through
|                                          |               |   |                |        |      |   |        |        | June 30,           
|                                          |               |   | 2002           |        | 2001 |   |        |        |                     |  | 2000
|                                          |               |   |                |        |      |   |        |        |                     |  |     
|                                          |               |   | (in thousands)
|Net revenues from unaffiliated customers: |               |   |                |        |      |   |        |        |                     |  |      |  |  |   |             |      
|                                          | North America |   | $              | 44,965 |      |   | $      | 22,898 |                     |  |      |  |  |   | $           | 1,377 | 
|                                          | Europe        |   |                | 5,769  |      |   |        | 2,453  |                     |  |      |  |  |   |             |      | 
|                                          |               |   |                |        |      |   |        |        |                     |  |      |  |  |   |             |       | 
|Total net revenues                        |               | $ | 50,734         |        |      | $ | 25,351 |        |                     |  |      |  |  | $ | 1,377       |      
|                                          |               |   |                |        |      |   |        |        |                     |  |      |  |  |   |             |       | 

Cost of revenues

Cost of goods sold was $29.8 million, or 59% of net revenues for the year ended
June 30, 2002, compared to $14.8 million, or 59% of net revenues, for the year
ended June 30, 2001, and $807,000, or 59% of net revenues, for the period from
October 7, 1999 (inception) through June 30, 2000.

The increase each year in absolute dollars was due to increased sales of
products. The increase as a percentage of revenue was due to a number of
factors, including price protection and product returns reserved against sales
and lowered introductory prices on certain titles.

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Royalties, software costs, license costs and project abandonment were $12.8
million, or 25% of net revenues, for the year ended June 30, 2002 compared to
$2.9 million, or 11% of net revenues, for the year ended June 30, 2001, and
$248,000, or 18% of net revenues, for the period from October 7, 1999
(inception) through June 30, 2000. The increase each year in absolute dollars
was due to increased sales of products, along with abandonment of a number of
development projects. The increase in these costs as a percentage of revenues
was because of increased software development costs arising from launching new
products for more sophisticated hardware systems, resulting in increased fixed
development costs per unit produced, plus price protection and product returns
reserved against sales, project abandonment, and increased licensed asset
costs.

Research and development

Research and development expenses were $2.5 million, or 5% of net revenues, for
the year ended June 30, 2002, compared to $1.1 million, or 4% of net revenues,
for the year ended June 30, 2001, and $260,000, or 19% of net revenues, for the
period from October 7, 1999 (inception) through June 30, 2000. The increase
each year in absolute dollars was primarily because of the hiring of additional
employees in both our San Jose office and our internal development studio in
London, England.

Sales and marketing

Sales and marketing expenses were $11.5 million, or 23% of net revenues, for
the year ended June 30, 2002, compared to $4.3 million, or 17% of net revenues,
for the year ended June 30, 2001, and $132,000, or 10% of net revenues, for the
period from October 7, 1999 (inception) through June 30, 2000. The increase in
absolute dollars in the year ended June 30, 2002 over the year ended June 30,
2001 was primarily because of seasonally increased advertising and marketing
activities for the 2001 holiday season, expanded marketing activities in
Europe, and increased sales commissions due to higher net revenues. The
increase in absolute dollars in the year ended June 30, 2001 over the period
from October 7, 1999 (inception) through June 30, 2000 was as a result of
commencing marketing activities in Europe, along with increased marketing
activities in the US.

General and administrative

General and administrative expenses were $6.3 million, or 12% of net revenues,
for the year ended June 30, 2002, compared to $2.0 million, or 8% of net
revenues, for the year ended June 30, 2001, and $711,000, or 52% of net
revenues, for the period from October 7, 1999 (inception) through June 30,
2000. The increase in absolute dollars in the year ended June 30, 2002 over the
year ended June 30, 2001 was primarily due to the hiring of additional
personnel, costs associated with being a public company, increased professional
fees and facilities costs, increased travel costs, and increased allowance for
doubtful accounts receivables which included an allowance of $1.1 million
against our receivable balance from Kmart. The increase in absolute dollars in
the year ended June 30, 2001 over the period from October 7, 1999 (inception)
through June 30, 2000 was due to the hiring of additional personnel, increased
professional fees and facilities costs, increased travel costs and increased
allowance for doubtful accounts receivables.

Amortization of deferred stock compensation

Amortization of deferred stock compensation was $1.2 million, or 2% of net
revenues, for the year ended June 30, 2002 compared to $618,000, or 2% of net
revenues for the year ended June 30, 2001, and zero for the period from October
7, 1999 (inception) through June 30, 2000. Amortization of deferred stock
compensation resulted from using the accelerated amortization method to account
for compensatory stock options granted to employees and directors during the
six months ended September 30, 2001.

Other expense, net

Interest income was $328,000, or 1% of net revenues for the year ended June 30,
2002, compared to $58,000 for the year ended June 30, 2001 and $8,000 for the
period from October 7, 1999 (inception) through June 30, 2000. Interest income
in each period relates to interest earned on funds deposited in money market
accounts and increased as a result of the investment of funds raised in our
initial public offering completed in November 2001.

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##### Table of Contents



Interest expense was $2.6 million, or 5% of net revenues, for the year ended
June 30, 2002, compared to $1.3 million, or 5% of net revenues, for the year
ended June 30, 2001, and $39,000 or 3% of net revenues for the period from
October 7, 1999 (inception) through June 30, 2000. The increase in absolute
dollars each year was primarily as a result of funding increased inventory
purchases though short-term borrowings. Interest expense incurred during the
period ended June 30, 2000 is comprised of interest incurred on promissory
notes and through a purchase order funding arrangement with a finance company.
The promissory notes were converted to redeemable convertible preferred stock
in June 2000.

Net expense was $38,000 for the year ended June 30, 2002, compared to $18,000
income in the year ended June 30, 2001 and $9,000 income for the period from
October 7, 1999 (inception) through June 30, 2000, and comprised exchange gains
and losses.

Redeemable convertible preferred stock dividend

In the year ended June 30, 2001, we recorded a non-cash charge of approximately
$5.5 million, or 22% of net revenues, relating to the beneficial conversion
feature of shares of our Series C Preferred Stock issued in May 2001.

Net loss attributable to common shareholders

We incurred a net loss attributable to common stockholders of $15.7 million,
$7.1 million and $803,000 for the years ended June 30, 2002 and 2001 and the
period from inception through June 30, 2000, respectively.

LIQUIDITY AND CAPITAL RESOURCES

In November 2001, we completed our initial public offering, raising $39.2
million net of expenses. Subsequent to the offering, we have used the proceeds
of the initial public offering, cash generated from the sale of products, a
product financing arrangement with a finance company, and short-term
liabilities to finance our operations. Prior to the initial public offering,
we financed our operations primarily through the private sale of equity
securities, cash generated from the sale of products, a product financing
arrangement with a finance company, the issuance of promissory notes to
stockholders, a commercial line of credit and short-term liabilities.

Net cash used in operating activities was $27.1 million for the year ended June
30, 2002, compared to $10.3 million for the year ended June 30, 2001, and $1.7
million for the period from October 7, 1999 (inception) through June 30, 2000.
For these periods, net cash used in operating activities was the result of net
losses and increases in operating assets, primarily accounts receivable,
inventories, prepaid royalties, capitalized software costs and licensed assets,
offset by increases in accruals.

Net cash used in investing activities was $7.3 million for the year ended June
30, 2002, compared to $2.2 million for the year ended June 30, 2001, and
$91,000 for the period from October 7, 1999 (inception) through June 30, 2000.
Net cash used in investing activities during the year ended June 30, 2002,
consisted primarily of the purchase of short-term investments and property and
equipment, and for the comparative periods consisted of the purchase of
property and equipment and other assets.

Net cash provided by financing activities was $36.9 million for the year ended
June 30, 2002, compared to $13.7 million for the year ended June 30, 2001, and
$2.7 million for the period from October 7, 1999 (inception) through June 30,
2000. Net cash provided by financing activities during the year ended June 30,
2002 comprised mostly net proceeds on the sale of 5.75 million shares of common
stock in our initial public offering completed in November 2001, plus the
issuance of common stock arising from the exercise of warrants and options, the
issuance of common stock under our employee stock purchase plan, offset by net
repayments under a finance agreement with a finance company. Net cash provided
by financing activities during the year ended June 30, 2001, consisted
primarily of the sale of redeemable convertible preferred stock, net borrowings
on finance agreements and a line of credit with our bankers. Financing for the
period from October 7, 1999 (inception) through June 30, 2000, consisted
primarily of the sale of common stock, redeemable convertible preferred stock,
promissory notes and net borrowings on finance agreements.

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In October 1999, we issued 580,962 shares of common stock to our principal
stockholder at a price of $0.001 per share. Also, in October 1999, we issued
274,950 shares of common stock at $0.11 per share to consultants in exchange
for services performed valued at approximately $30,000. In each of November
1999 and January 2000, we issued our principal stockholder convertible
promissory notes in the principal amount of $500,000, and in May 2000 issued
him an additional convertible promissory note in the principal amount of
$47,000 for operating capital. Each note bore interest at 7% per annum with
principal and accrued interest due on demand after one year from the date of
issuance. Each note was automatically convertible into shares of our Series A
Preferred Stock upon the initial closing of our Series A Preferred Stock
financing. In June 2000, the notes were converted and our principal stockholder
was issued 482,625 shares of our Series A Preferred Stock for $1.0 million;
these shares are convertible into 2,268,338 shares of our common stock. In June
2000, inclusive of shares issued to our principal stockholder upon the
conversion, we sold and issued 976,220 shares of our Series A Preferred Stock
for $2.1 million; at the same time we issued the Series A Preferred Stock, we
issued 614,060 shares of our common stock at $0.11 per share for $59,000 in
cash and for services valued at $7,000. In December 2000, we sold and issued
294,620 shares of our Series B Preferred Stock for $5.2 million. In May 2001,
we sold and issued 245,659 shares of our Series C Preferred Stock for $5.5
million.

In November 2001 we sold 5.75 million shares of common stock in our initial
public offering. At that date, the 976,220 Series A Preferred Stock, 294,620
Series B Preferred Stock, and 245,659 Series C Preferred Stock converted into
7,127,528 shares of our common stock.

During the year ended June 30, 2002, 20,562 shares of common stock were issued
upon exercise of stock options for proceeds of $9,000, 4,956 shares of common
stock were issued under the employee share purchase plan for proceeds of
$25,000, and a warrant to purchase 141,000 shares of common stock was exercised
for proceeds of $529,000.

In February 2002, we entered into a two year factoring agreement (the
Factoring Agreement) with a finance company, whereby we assign our North
American receivables to the finance company. The finance company is responsible
for collecting customer receivables, and upon collection, remits the funds to
us, less a service fee. Under the Factoring Agreement, we may obtain advances,
subject to the finance companys discretion, in the form of cash or as
collateral for letters of credit, up to a maximum of 75% of outstanding
domestic receivables at any point in time.

Under the terms of the Factoring Agreement, we pay a service fee on all
receivables assigned, with a minimum annual fee of $150,000, and interest at
prime plus 1% on all cash sums advanced. All fees are included in interest
expense. We bear the collection risk on our accounts receivable that are
assigned, unless the finance company approves the receivable at the time of
assignment, in which case the finance company bears a portion of the risk.

The finance company has a security interest in our accounts receivable,
inventory, fixed assets and intangible assets. As of June 30, 2002, we had
$1.4 million in advances outstanding under the Factoring Agreement.

Prior to entering into the Factoring Agreement, we had entered into a finance
agreement (the Finance Agreement) with a different finance company, whereby
we assigned purchase orders entered into with our customers to the finance
company and requested the finance company purchase finished goods to fulfill
such customer purchase orders.

The Finance Agreement, entered into in February 2000, specified that the
finance companys funding commitment with respect to a customer purchase order
should not exceed 60% of the retail purchase order price. Under the Finance
Agreement the finance companys aggregate outstanding funding (i.e., advance of
funds or purchase of finished goods to fulfill customer purchase orders) was
limited to $5.0 million. We were responsible for collecting customer
receivables, bore the risk of loss on all uncollectible accounts, and we were
required to remit customer receipts directly to the finance company up to the
amounts funded by the finance company. We retained collections in excess of
the amounts funded by the finance company.

Under the initial terms of the Finance Agreement, we were required to pay the
finance companys expenses under the contract, a deal fee (consisting of a
transaction and initiation fee equal to 5.0% of the face amounts of letters of
credit issued or other funds advanced by the finance company), a daily
maintenance fee of 0.067%, a materials

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advance fee at prime rate plus 4.0% and a late payment fee where applicable;
all of which are included in interest expense.

In August 2001, we amended the Finance Agreement, initially increasing the
aggregate outstanding funding amount to $10.0 million, and then decreasing the
transaction and initiation fee to 3% until the earlier of the termination of
the agreement or December 31, 2001, if our initial public offering had not
occurred by that date. We completed our initial public offering in November
2001. In connection with this latter amendment and the execution of a $7.0
million factoring arrangement with an affiliate of the finance company, we
issued a warrant to the finance company to purchase 100,000 shares at an
exercise price of $8.00.

Upon the signing of the Finance Agreement, we paid the finance company a
security deposit of $90,000. An extension payment of $50,000 was made when the
contract was amended in December 2000, and a further amendment fee of $120,000
was incurred when the contract was amended in August 2001. These costs were
recorded as interest expense.

Outstanding borrowings under the Finance Agreement were collateralized by
our inventories, accounts receivable, fixed assets and intangible
assets.

The Finance Agreement and the factoring line with the affiliate terminated in
February 2002, and all outstanding amounts funded were fully repaid.
Consequently, the amounts outstanding under the Finance Agreement and the
factoring line with the affiliate of the finance company as of June 30, 2002
were zero. The amount outstanding under the Finance Agreement as of June 30,
2001 was $4.2 million.

As of June 30, 2002, June 30, 2001, and June 30, 2000 we had outstanding
letters of credit issued of $2.3 million, $2.0 million, and $0, respectively.
We do not expect any material losses to result from these off-balance sheet
instruments.

As of June 30, 2002 we had cash and cash equivalents of $4.7 million and
short-term investments of $8.2 million. As of June 30, 2001, we had cash and
cash equivalents of $2.2 million and no short-term investments. As of June 30,
2000, we had cash and cash equivalents of $908,000 and no short-term
investments.

We believe that our current cash and cash equivalents, together with cash
generated by operations, will be sufficient to meet our anticipated cash
requirements though June 30, 2003. If our cash needs exceed our current
expectations we may need to raise additional capital through public or private
equity offerings or debt financings. If available cash, credit and cash
generated from operations is insufficient to satisfy our liquidity requirements
and we cannot raise needed funds on acceptable terms or at all, we may not be
able to develop or enhance our products, take advantage of future opportunities
or respond to competitive pressures or unanticipated requirements. A material
shortage of capital may require us to take drastic steps such as reducing our
level of operations, disposing of selected assets or seeking an acquisition
partner.

Capital expenditures were $908,000 for the year ended June 30, 2002, compared
to $421,000 for the year ended June 30, 2001, and $91,000 for the period from
our inception through June 30, 2000. We did not have any material commitments
for capital expenditures at any of those dates.

Our principal commitments at June 30, 2002 included operating leases,
guaranteed royalty payments and contractual marketing commitments. At June 30,
2002, we had commitments to spend $1.9 million under operating leases, prepay
$2.5 million for royalties under agreements with various content providers and
spend $2.9 million in advertising on the networks and websites of these content
providers. Of these amounts, $3.7 million must be paid no later than June 30,
2003. Guaranteed royalty payments will be applied against any royalties that
may become payable to the content providers.

Critical accounting policies

Financial Reporting Release No. 60, which was recently released by the
Securities and Exchange Commission, requires all companies to include a
discussion of critical accounting policies or methods used in the preparation
of

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financial statements. Note 1 of the Notes to the Consolidated Financial
Statements includes a summary of the significant accounting policies and
methods used in the preparation of our consolidated financial statements. The
following is a brief discussion of the more significant accounting policies and
methods used by us. In addition, Financial Reporting Release No. 61
was also recently released by the Securities and Exchange Commission and
requires all companies include a discussion addressing, among other things,
liquidity, off-balance sheet arrangements, contractual obligations and
commercial commitments.

Use of estimates

The consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States of America.
Certain of our accounting policies require the application of significant
judgment by management in selecting the appropriate assumptions for calculating
financial estimates. These estimates affect the reported amounts of assets and
liabilities at the dates of the financial statements and reported amounts of
revenues and expenses during the reporting periods. By their nature, these
judgments are subject to an inherent degree of uncertainty. The most
significant estimates and assumptions relate to revenue recognition, adequacy
of allowances for returns and price protection, doubtful accounts receivable,
and cooperative advertising, carrying values of inventories, the future
recoverability of prepaid royalties, capitalized software costs and licensed
assets, and foreign currency translation.

Net revenues

We derive our revenues from shipment of finished products to our customers.
Under certain conditions, we may allow customers to exchange and return our
products and from time to time provide price protection or allow returns on
certain unsold merchandise in the form of a credit against amounts due from the
customer. Net revenues from product sales are reflected after deducting the
estimated cost of allowances for returns and price protection as well as
discounts given. These estimates are based upon currently known circumstances
and historical results. The calculation of net revenues will be affected by
many factors, including pricing strategies, the channels through which products
are distributed, product maturity, exchange and return provisions and price
protection.

We recognize revenue in accordance with Statement of Position 97-2, Software
Revenue Recognition,and related interpretations, when persuasive evidence of
an arrangement exists, delivery has occurred, the price has been fixed or is
determinable and collectibility has been reasonably assured.

Our sales are typically made on credit, with terms that vary depending upon the
customer and other factors. If a sale is made on credit, and a significant
portion of the fee is due after our normal payment terms, which are normally 30
to 90 days from invoice date, we account for the fee as not being fixed or
determinable and will not recognize revenue until such time as the fee becomes
due. While we attempt to carefully monitor the creditworthiness of our
customers and distributors, we bear the risk of their inability to pay our
receivables and of any delay in payment. If the collectability of a receivable
becomes uncertain after revenue has been recognized, we will record an
allowance for doubtful accounts against our accounts receivable.

When we recognize revenue, we account for the estimate of future returns and
price protection on the sale, as well as an estimate of cooperative marketing
costs on the sale, as allowances against receivables. We continually monitor,
reassess and adjust the adequacy of all these allowances, along with the
allowance for doubtful accounts, based on known circumstances, historical
results, commitments made, anticipated events and anticipated commitments.
Adjustments to these allowances will affect the reported amounts of revenues
and expenses during the reporting periods the adjustments are made.

We expect that substantially all of our net revenues for a particular quarter
will be generated by titles released in that quarter or in the immediately
prior quarter. The market for interactive entertainment software is
characterized by short product life cycles, changing consumer preferences and
frequent introduction of new products. The life cycle of a title generally
consists of a relatively high level of sales during the first few months after
introduction, followed by a decline in sales, with only a small percentage of
sales occurring more than six months after release.

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We have experienced, and are likely to continue to experience, quarterly
fluctuations in net revenues. The interactive entertainment industry is highly
seasonal, with net revenues typically significantly higher during the fourth
and first calendar quarters, due primarily to the increased demand for titles
during the year-end holiday buying season. A failure or inability to introduce
products on a timely basis to meet seasonal increases in demand will harm our
business and operating results. While we are attempting to reduce the effect
of seasonal patterns on our business by distributing our product release dates
more evenly throughout the year, we may not be successful in this endeavor.

Cost of revenues

Cost of revenues consists of cost of goods sold and royalties, software costs,
license costs and project abandonment.

Cost of goods sold.Cost of goods sold includes manufacturing costs of
finished goods, freight, inventory management costs and inventory obsolescence
costs. Cost of goods sold will vary depending on the volume of products
manufactured and shipped, the mix of products sold and the shipping channel
used.

Royalties, software costs, license costs and project abandonment.Royalties,
software costs, license costs and project abandonment includes royalties paid
to software licensors, software amortization and amortization of non-cash
charges related to warrants and rights to acquire our common stock issued to
certain production companies. These costs will be affected in particular
periods by many factors, including the specific terms or agreements under which
royalties are paid to third parties, the commercial acceptance of products, the
cost of developing a product and the timing of stock and warrants issued
pursuant to the terms of our license agreements as described below.

Our agreements with licensors and developers generally require us to make
advance royalty payments and pay royalties based on product sales, which may
have guaranteed minimum payments. Prepaid royalties are amortized commencing
upon the product release at the greater of the contractual royalty rate based
on actual product sales, or the ratio of current revenues to total projected
revenues. We evaluate the future recoverability of prepaid royalties on a
quarterly basis and expense costs if and when they are deemed unrecoverable.
We cannot assure you that the sales of products for which these royalties are
paid or guaranteed payments are made will be sufficient to cover the amount of
these required payments.

Commencing upon product release, we amortize capitalized software development
costs. We capitalize software development costs subsequent to establishing
technological feasibility of a title. Technological feasibility is evaluated
on a product-by-product basis. For products where proven game engine
technology exists, this may be early in the development cycle. Prior to
establishing technological feasibility, software development costs are expensed
to research and development, and to cost of revenues subsequent to establishing
technological feasibility. The following criteria is used to evaluate
recoverability of software development costs: historical performance of
comparable products; the commercial acceptance of prior products released on a
given hardware platform; orders for a product prior to its release and actual
development costs of a product as compared to forward-looking projections.
Amortization of software development costs is based on the greater of the
proportion of current revenues to total projected revenues or the straight-line
method over the estimated product life, generally three to six months. We
analyze our capitalized costs quarterly and take write-offs when, based on our
estimates, future individual product revenues will not be sufficient to recover
our investment.

Pursuant to a license agreement with a production company, we are obligated to
issue 68,738 shares of our common stock after the release of any film for which
we elect to produce interactive entertainment software products, up to 10 films
or 687,375 shares of common stock. To date, we have elected to produce titles
for three films and have issued 68,738 shares under this agreement for an
aggregate value of $746,000. We are required to issue these shares when the
films are released and will then incur a non-cash charge. If the software
product is released after the release of the film, we will amortize the
non-cash charge over the life of the product, which is typically between three
and six months. If the software product is released prior to the release of
the film, we will at each interim period assess whether it is probable that the
film will be released and that the value of the shares to be issued is
recoverable through future sales of the product to which it relates. If this
is probable, the non-cash charge will be amortized to licensed costs over the
life of the products. In the alternative, we will expense the non-cash charge
at the time of the issuance of the shares if it is not probable that the value
of the shares issued is recoverable through future sales of the product to
which these shares relate. We cannot estimate the aggregate dollar amount of
these

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future non-cash charges as they are based on its share price at a future point
in time, but they may be substantial. All of the $746,000 non-cash charges on
the initial shares issued had been amortized as of June 30, 2002.

In connection with the issuance of warrants pursuant to a separate license
agreement with another production company, we incurred a non-cash charge of
$354,000, which will be amortized on a straight-line basis over five years.
This amortization commenced in October 2000. In connection with these
warrants, a further non-cash charge of $556,000 will be amortized over a period
which is expected to be between three to six months, commencing on the release
of the subject titles, expected to be the first or second fiscal quarter of
2003. Each of these charges will affect our gross margins and profitability.

In connection with the issuance of warrants pursuant to a separate license
agreement with another production company, we incurred a non-cash charge of
$86,000. Under the agreement, additional warrants to purchase up to an
additional 30,000 shares may be issued, in either multiples of 5,000 or 10,000
shares contingent upon certain future events occurring relating to the
development and release of products. Upon issuance of the warrants we will
incur an additional non-cash charge. Upon release of the software products on
which the warrants are issued, we will amortize the non-cash charges over the
life of the products, which are expected to be between three and six months. We
cannot estimate the aggregate dollar amount of these future non-cash charges as
they are based on our share price at future points in time.

In connection with the issuance of warrants pursuant to a separate license
agreement with another production company, we granted a warrant to purchase up
to 200,000 shares of our common stock, of which 15,000 became immediately
exercisable upon the signing of the agreement. The remaining 185,000 will only
become exercisable, in multiples of either 4,625 or 13,875 shares, upon certain
future events occurring relating to the development and release of products.
Upon the warrant for 15,000 shares becoming exercisable, we incurred a non-cash
charge of $29,000, which will be amortized on a straight-line basis over five
years. This amortization commenced in May 2002. We will incur additional
non-cash charges as the remaining 185,000 shares become exercisable. Upon
release of the software products on which the warrants are exercisable, we will
amortize the non-cash charges over the life of the products, which are expected
to be between three and six months. We cannot estimate the aggregate dollar
amount of these future non-cash charges as they are based on our share price at
future points in time.

Research and development

Research and development expenses relate to the design and development of new
interactive entertainment software products.Payments made to independent
software developers under development agreements are capitalized to software
development costs once technological feasibility is established or if the
development costs have an alternative future use. Prior to establishing
technological feasibility, software development costs are expensed to research
and development and to cost of revenues subsequent to confirmation of
technological feasibility. Internal development costs are capitalized to
software development costs once technological feasibility is established.
Technological feasibility is evaluated on a product-by-product basis. For
products where proven game engine technology exists, this may occur early in
the development cycle.

Research and development expenses generally consist of salaries, related
expenses for engineering personnel and third-party development costs. We will
continue to develop products both internally and through third parties. In
absolute dollars we expect to see increases in research and development expense
as we expand our product offerings.

Sales and marketing

Sales and marketing expenses consist primarily of salaries and related expenses
for our direct sales force and marketing personnel, commissions to independent
sales staff, marketing programs and advertising campaigns. In absolute dollars
we expect to see increase in sales and marketing expense as revenues increase
and we expand our product offerings and international presence.

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General and administrative

General and administrative expenses consist primarily of salaries and related
expenses for finance and other administrative personnel, facilities and
occupancy charges, professional fees and bad debt expense. Exclusive of bad
debt provisions, we expect our general and administrative expenses to increase
in absolute dollars as we expand our staffing, build our infrastructure, grow
the business and incur costs associated with being a public company. As a
percentage of revenue, we would expect to see a reduction in general and
administrative expenses as revenues increase.

Amortization of deferred stock compensation

Amortization of deferred stock compensation consists of deferred compensation
expenses relating to stock option grants to employees. Deferred compensation
represents the difference between the deemed fair market value of our common
stock at the grant date and the exercise price of the related stock options.
Deferred compensation is represented as a reduction of stockholders equity and
amortized, using a multiple option award valuation and amortization approach,
over the vesting periods of the options, which is generally four years. We
expect to amortize $501,000 during fiscal 2003, $232,000 during fiscal 2004 and
$56,000 during fiscal 2005.

Other expense, net

Other expense, net consists mostly of interest expense net of interest income,
arising on short-term borrowings. Interest expense includes the amortized fair
value of warrants issued to a finance company. We anticipate interest expense
will increase in absolute dollar terms as we grow our business.

Inflation

We do not believe that the relatively moderate rates of inflation experienced
in the United States or in a number of foreign countries in which our products
are sold over the last three years have had a significant effect on our sales
or results of operations. However, we cannot accurately predict the effect of
inflation on future operating results.

Exchange rates

In the year ended June 30, 2002, approximately 90% of net revenues and 85% of
cost of revenues and operating expenses were denominated in U.S. dollars. We
anticipate that in the 2003 fiscal year these percentages will both continue to
exceed 75%. Remaining expenses were mostly denominated in British pounds or
the Euro and consequently we are currently exposed to fluctuations in the U.S.
Dollar to British Pound and Euro exchange rates. We estimate that a 10% change
in foreign exchange rates would have impacted reported annual operating results
by less than $500,000 for the year ended June 30, 2002. Accordingly, we have
not entered into any hedging arrangements. As we expand our international
operations, revenues will be generated and more operating expenses will be
incurred in currencies other than the U.S. Dollar, which will increase
potential exchange rate risk. We anticipate that we may enter into customary
hedging arrangements in the future to reduce this potential risk.




Item 7(a)  Quantitative and qualitative disclosures about market risk

Market risk

Market risk is the potential loss arising from the adverse changes in market
rates and prices, such as interest rates and foreign currency exchange rates.
Changes in interest rates and, in the future, changes in foreign currency
exchange rates have and will have an impact on our results of operations.

Interest rate fluctuations. We do not consider our cash and cash equivalents
to be subject to interest rate risk due to the short maturities of the
instruments in which we have invested. We are exposed to interest rate risk on
our product financing arrangement with a finance company. We do not enter into
derivative securities or other financial instruments for trading or speculative
purposes. We estimate that a 10% change in interest rates would have impacted
our results of operations by less than $200,000 for the year ended June 30,
2002.

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Foreign exchange rate fluctuations. We face market risk to the extent that
changes in foreign currency exchange rates affect our non-U.S. Dollar
functional currency foreign operations. The functional currency for our
foreign operations is the applicable local foreign currency. The translation
of the applicable foreign currencies into U.S. Dollars is performed for balance
sheet accounts using exchange rates in effect at the balance sheet date and for
revenue and expense accounts using a weighted-average exchange rate during the
period. The gains or losses resulting from such translation are reported as a
separate component of equity as accumulated other comprehensive loss, whereas
gains or losses resulting from foreign currency transactions are included in
results of operations. We do not engage in hedging activities with respect to
foreign exchange rate fluctuations.

Recently issued new accounting pronouncements

In April 2001, the Emerging Issues Task Force issued No. 00-25 (EITF 00-25),
Vendor Income Statement Characterization of Consideration Paid to a Reseller
of the Vendors Products, which states that consideration from a vendor to a
reseller of the vendors products is presumed to be a reduction of the selling
prices of the vendors products and, therefore, should be characterized as a
reduction of revenue when recognized in the vendors income statement. That
presumption is overcome and the consideration can be categorized as a cost
incurred if, and to the extent that, a benefit is or will be received from the
recipient of the consideration. That benefit must meet certain conditions
described in EITF 00-25. The consensus should be applied no later than in
annual or interim financial statements for periods beginning after December 15,
2001. In November 2001, the Emerging Issues Task Force issued No. 01-09 (EITF
01-09), Accounting for Consideration Given by a Vendor to a Customer or
Reseller of the Vendors Products, which clarifies and modifies certain items
discussed in EITF 00-25. The consensus should be applied no later than in
annual or interim financial statements for periods beginning after December 15,
2001. We adopted EITF 00-25 and EITF 01-09 during the year ended June 30, 2002
and we believe the adoption did not have a material impact on our consolidated
financial position or results of operations.

In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No.
141, Business Combinations,and SFAS No. 142, Goodwill and Other Intangible
Assets.SFAS No. 141 requires that all business combinations initiated after
June 30, 2001 be accounted for under the purchase method and addresses the
initial recognition and measurement of goodwill and other intangible assets
acquired in a business combination. SFAS No. 142 addresses the initial
recognition and measurement of intangible assets acquired outside of a business
combination and the accounting for goodwill and other intangible assets
subsequent to their acquisition. SFAS No. 142 provides that intangible assets
with finite useful lives be amortized and that goodwill and intangible assets
with indefinite lives not be amortized, but will instead be tested at least
annually for impairment. We are required to adopt SFAS No. 142 no later than
for our fiscal year beginning July 1, 2002. We do not carry any goodwill or
other intangibles on our balance sheet as of June 30, 2002, and therefore the
adoption of SFAS No. 142 will not have a material effect on our consolidated
financial statements.

In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets,which addresses financial accounting and
reporting for the impairment or disposal of long-lived assets. While SFAS No.
144 supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of,it retains many of the
fundamental provisions of SFAS No. 121. SFAS No. 144 also supersedes the
accounting and reporting provisions of APB No. 30, Reporting the Results of
OperationsReporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions,for
the disposal of a segment of a business. However, it retains the requirement in
APB No. 30 to report separately discontinued operations and extends that
reporting to a component of an entity that either has been disposed of (by
sale, abandonment, or in a distribution to owners) or is classified as held for
sale. SFAS No. 144 is effective for fiscal years beginning after December 15,
2001 and interim periods within those fiscal years. The adoption of SFAS No.
144 is not expected to have a material effect on our consolidated financial
statements.

In June 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement
Obligations.SFAS No. 143 addresses financial accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and
the associated asset retirement costs. This statement is effective for fiscal
years beginning after June 15, 2002, however earlier application is permitted.
We will adopt SFAS No. 143 on January 1, 2003. We believe the adoption of this
statement will not have an impact on our financial position or operating
results.

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In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated
with Exit or Disposal Activities, which addresses accounting for restructuring
and similar costs. SFAS No. 146 supercedes previous accounting guidance,
principally Emerging Issues Task Force issue No. 94-3 (EITF 94-3). We are
required to adopt SFAS No. 146 for restructuring activities initiated after
December 31, 2002. SFAS No. 146 requires that the liability for costs
associated with an exit or disposal activity be recognized when the liability
is incurred. Under EITF 94-3, a liability for an exit cost was recognized at
the date of the companys commitment to an exit plan. SFAS No. 146 also
established that the liability should initially be measured and recorded at
fair value. Accordingly, SFAS 146 may affect the timing of recognizing future
restructuring plans. We have never initiated any restructuring plans, and
therefore do not expect the adoption of SFAS No. 146 to have a material effect
on our consolidated financial statements.




Item 8  Consolidated financial statements and supplementary data

The information required by this Item 8 is incorporated by reference to our
Consolidated Financial Statements and Independent Auditors Report beginning at
page F-1 of this Report.




Item 9  Changes in and disagreements with accountants on accounting and
accounting disclosure

None.

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PART III




Item 10  Directors and executive officers of the registrant

The information required by this Item 10 is hereby incorporated by reference
from our definitive proxy statement, to be filed pursuant to Regulation 14A
within 120 days after the end of our 2002 fiscal year.




Item 11  Executive compensation

The information required by this Item 11 is hereby incorporated by reference
from our definitive proxy statement, to be filed pursuant to Regulation 14A
within 120 days after the end of our 2002 fiscal year.




Item 12  Security ownership of certain beneficial owners and management

The information required by this Item 12 is hereby incorporated by reference
from our definitive proxy statement, to be filed pursuant to Regulation 14A
within 120 days after the end of our 2002 fiscal year.




Item 13  Certain relationships and related transactions

The information required by this Item 13 is hereby incorporated by reference
from our definitive proxy statement, to be filed pursuant to Regulation 14A
within 120 days after the end of our 2002 fiscal year.

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PART IV




Item 14  Controls and procedures

There were no significant changes in internal controls or in other factors that
could significantly affect these controls subsequent to managements
evaluation.




Item 15  Exhibits, financial statement schedules and reports on Form 8-K



|(a) |  | The consolidated financial statements and schedules required to be filed
hereunder are indexed on page F-1 hereof.
|--- |  | ------------------------------------------------------------------------------------------------------------------
|   
|(b) |  | Reports on Form 8-K                                                                                               
|   
|    |  | No reports on Form 8-K were filed during the last quarter of the fiscal year
ended June 30, 2002.                 
|   
|(c) |  | Exhibits                                                                                                          
|   
|    |  | The following exhibits are filed as part of this Form 10-K:                                                       

|        |  |                                                                                                                                                                                                                                                                                                                                                 
|------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |  |                                                                                                                                                                                                                                                                                                                                                 
|Number  |  | Description of Exhibit                                                                                                                                                                                                                                                                                                                          
|        |  |                                                                                                                                                                                                                                                                                                                                                 
|3.1     |  | Second Amended and Restated Certificate of Incorporation
(incorporated by reference to the exhibit of the same
number of the Registrants Registration Statement on Form
S-1, as amended (File No. 333-62436), filed with the
Securities and Exchange Commission on June 6, 2001).                                                              
|        |  |                                                                                                                                                                                                                                                                                                                                                 
|3.1(a)  |  | First Amendment to Second Amended and Restated Certificate
of Incorporation of the Registrant dated August 15, 2001
(incorporated by reference to the exhibit of the same
number of the Registrants Registration Statement on Form
S-1, as amended (File No. 333-62436), filed with the
Securities and Exchange Commission on August 15, 2001).
|        |  |                                                                                                                                                                                                                                                                                                                                                 
|3.2     |  | Bylaws of the Registrant (incorporated by reference to the
exhibit of the same number of the Registrants Registration
Statement on Form S-1, as amended (File No. 333-62436),
filed with the Securities and Exchange Commission on June
6, 2001).                                                                                              
|        |  |                                                                                                                                                                                                                                                                                                                                                 
|3.2(a)  |  | Amendment to Bylaws of the Registrant dated December 28,
2000 (incorporated by reference to the exhibit of the same
number of the Registrants Registration Statement on Form
S-1, as amended (File No. 333-62436), filed with the
Securities and Exchange Commission on August 15, 2001).                                                      
|        |  |                                                                                                                                                                                                                                                                                                                                                 
|3.2(b)  |  | Amendment to Bylaws of Registrant dated June 1, 2001
(incorporated by reference to the exhibit of the same
number of the Registrants Registration Statement on Form
S-1, as amended (File No. 333-62436), filed with the
Securities and Exchange Commission on August 15, 2001).                                                               
|        |  |                                                                                                                                                                                                                                                                                                                                                 
|3.2(c)  |  | Amendment to Bylaws of Registrant dated July 31, 2001
(incorporated by reference to the exhibit of the same
number of the Registrants Registration Statement on Form
S-1, as amended (File No. 333-62436), filed with the
Securities and Exchange Commission on August 15, 2001).                                                              
|        |  |                                                                                                                                                                                                                                                                                                                                                 
|4.1     |  | Specimen Common Stock Certificate (incorporated by
reference to the exhibit of the same number of the
Registrants Registration Statement on Form S-1, as amended
(File No. 333-62436), filed with the Securities and
Exchange Commission on September 4, 2001).                                                                                
|        |  |                                                                                                                                                                                                                                                                                                                                                 
|4.2     |  | Warrant to Purchase Shares of Common Stock between the
Registrant and Spyglass Entertainment Group, L.P.
(incorporated by reference to the exhibit of the same
number of the Registrants Registration Statement on Form
S-1, as amended (File No. 333-62436), filed with the
Securities and Exchange Commission on June 6, 2001).              

40



---



##### Table of Contents



|              |  |                                                                                                                                                                                                                                                                                                                                                                               
|------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit       |  |                                                                                                                                                                                                                                                                                                                                                                               
|Number        |  | Description of Exhibit                                                                                                                                                                                                                                                                                                                                                        
|              |  |                                                                                                                                                                                                                                                                                                                                                                               
|4.3           |  | Warrant to Purchase Shares of Common Stock dated May 24,
2001 between the Registrant and K&L 2000 LLC (incorporated
by reference to exhibit number 4.4 of the Registrants
Registration Statement on Form S-1, as amended (File No.
333-62436), filed with the Securities and Exchange
Commission on August 15, 2001).                                                        
|              |  |                                                                                                                                                                                                                                                                                                                                                                               
|4.4           |  | Warrant to Purchase Shares of Common Stock between the
Registrant and Transcap Associates, Inc.                                                                                                                                                                                                                                                                               
|              |  |                                                                                                                                                                                                                                                                                                                                                                               
|4.5           |  | Form of Amended and Restated Warrant to Purchase Shares of
Common Stock dated May 24, 2001 between the Registrant and
Morgan Keegan & Co., Inc. (incorporated by reference to the
exhibit of the same number of the Registrants Registration
Statement on Form S-1, as amended (File No. 333-62436),
filed with the Securities and Exchange Commission on
November 13, 2001).
|              |  |                                                                                                                                                                                                                                                                                                                                                                               
|10.1          |  | Amended and Restated 2000 Stock Incentive Plan
(incorporated by reference to the exhibit of the same
number of the Registrants Registration Statement on Form
S-1, as amended (File No. 333-62436), filed with the
Securities and Exchange Commission on August 15, 2001).                                                                                                   
|              |  |                                                                                                                                                                                                                                                                                                                                                                               
|10.2**        |  | License Agreement #13247-SJ dated December 12, 2001 between
the Registrant and Warner Bros. Consumer Products
(incorporated by reference to the exhibit of the same
number from Registrants Quarterly Report on Form 10-Q for
the quarter ended December 31, 2001).                                                                                                          
|              |  |                                                                                                                                                                                                                                                                                                                                                                               
|10.3**        |  | License and Option Agreement dated January 14, 2002 between
the Registrant, Bam! Entertainment Limited and Aardman
Animations Limited (incorporated by reference to the
exhibit of the same number from Registrants Quarterly
Report on Form 10-Q for the quarter ended March 31, 2002).                                                                                     
|              |  |                                                                                                                                                                                                                                                                                                                                                                               
|10.4          |  | Factoring Agreement dated February 25, 2002 between the
Registrant and Century Business Credit Corporation
(incorporated by reference to the exhibit of the same
number from Registrants Quarterly Report on Form 10-Q for
the quarter ended March 31, 2002).                                                                                                                
|              |  |                                                                                                                                                                                                                                                                                                                                                                               
|10.5          |  | Letter of Credit and Security Agreement dated February 25,
2002 between the Registrant and Century Business Credit
Corporation (incorporated by reference to the exhibit of
the same number from Registrants Quarterly Report on Form
10-Q for the quarter ended March 31, 2002).                                                                                            
|              |  |                                                                                                                                                                                                                                                                                                                                                                               
|10.6          |  | Trademark Collateral Agreement dated February 25, 2002
between the Registrant and Century Business Credit
Corporation (incorporated by reference to the exhibit of
the same number from Registrants Quarterly Report on Form
10-Q for the quarter ended March 31, 2002).                                                                                                     
|              |  |                                                                                                                                                                                                                                                                                                                                                                               
|10.7          |  | Supplement to Factoring or Security Agreement dated
February 25, 2002 between the Registrant and Century
Business Credit Corporation (incorporated by reference to
the exhibit of the same number from Registrants Quarterly
Report on Form 10-Q for the quarter ended March 31, 2002).                                                                                      
|              |  |                                                                                                                                                                                                                                                                                                                                                                               
|10.8          |  | Lease Agreement dated June 5, 2002 among the Registrant,
BAM Entertainment Limited, a subsidiary of the Registrant,
and Nairn Developments Limited, regarding Part Ground Floor
124-130 Southwark Street, London.                                                                                                                                                             
|              |  |                                                                                                                                                                                                                                                                                                                                                                               
|10.9          |  | Lease Agreement dated June 5, 2002 among the Registrant,
BAM Entertainment Limited, a subsidiary of the Registrant,
and Nairn Developments Limited, regarding First Floor
124-130 Southwark Street, London.                                                                                                                                                                   
|              |  |                                                                                                                                                                                                                                                                                                                                                                               
|10.10         |  | Confidential License Agreement for Nintendo GameCube dated
November 9, 2001 between the Registrant and Nintendo of
America, Inc.                                                                                                                                                                                                                                              
|              |  |                                                                                                                                                                                                                                                                                                                                                                               
|10.11*        |  | Exclusive First Look Agreement dated May 16, 2002 between
the Registrant and Southpaw Media Group, Inc.                                                                                                                                                                                                                                                                       
|              |  |                                                                                                                                                                                                                                                                                                                                                                               
|10.12  10.25 |  | [Reserved].                                                                                                                                                                                                                                                                                                                                                                   

41



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##### Table of Contents



|        |  |                                                                                                                                                                                                                                                                                                                                                                                     
|------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |  |                                                                                                                                                                                                                                                                                                                                                                                     
|Number  |  | Description of Exhibit                                                                                                                                                                                                                                                                                                                                                              
|        |  |                                                                                                                                                                                                                                                                                                                                                                                     
|10.26** |  | Sony PlayStation Licensed Publisher Agreement dated
February 2, 2000 between the Registrant and Sony Computer
Entertainment America, Inc. (incorporated by reference to
the exhibit of the same number of the Registrants
Registration Statement on Form S-1, as amended (File No.
333-62436), filed with the Securities and Exchange
Commission on June 6, 2001).                 
|        |  |                                                                                                                                                                                                                                                                                                                                                                                     
|10.27** |  | Amendment to the Licensed Publisher Agreement dated April
1, 2000 between the Registrant and Sony Computer
Entertainment America, Inc. (incorporated by reference to
the exhibit of the same number of the Registrants
Registration Statement on Form S-1, as amended (File No.
333-62436), filed with the Securities and Exchange
Commission on June 6, 2001).                    
|        |  |                                                                                                                                                                                                                                                                                                                                                                                     
|10.28** |  | PlayStation 2 Licensed Publisher Agreement dated April 1,
2000 between the Registrant and Sony Computer Entertainment
America, Inc. (incorporated by reference to the exhibit of
the same number of the Registrants Registration Statement
on Form S-1, as amended (File No. 333-62436), filed with
the Securities and Exchange Commission on June 6, 2001).                       
|        |  |                                                                                                                                                                                                                                                                                                                                                                                     
|10.29** |  | PlayStation 2 Development System Agreement dated August 2,
2000 between the Registrant and Sony Computer Entertainment
America, Inc. (incorporated by reference to the exhibit of
the same number of the Registrants Registration Statement
on Form S-1, as amended (File No. 333-62436), filed with
the Securities and Exchange Commission on June 6, 2001).                      
|        |  |                                                                                                                                                                                                                                                                                                                                                                                     
|10.30** |  | Licensed Publisher Agreement for Game Boy, Game Boy Color
and Game Boy Pocket dated February 18, 2000 between the
Registrant and Nintendo of America, Inc. (incorporated by
reference to the exhibit of the same number of the
Registrants Registration Statement on Form S-1, as amended
(File No. 333-62436), filed with the Securities and
Exchange Commission on June 6, 2001).
|        |  |                                                                                                                                                                                                                                                                                                                                                                                     
|10.31** |  | Licensed Publisher Agreement for Nintendo 64 dated February
18, 2000 between the Registrant and Nintendo of America,
Inc. (incorporated by reference to the exhibit of the same
number of the Registrants Registration Statement on Form
S-1, as amended (File No. 333-62436), filed with the
Securities and Exchange Commission on June 6, 2001).                                 
|        |  |                                                                                                                                                                                                                                                                                                                                                                                     
|10.32   |  | Confidential License Agreement for Game Boy Advance dated
May 21, 2001 between the Registrant and Nintendo of
America, Inc. (incorporated by reference to the exhibit of
the same number of the Registrants Registration Statement
on Form S-1, as amended (File No. 333-62436), filed with
the Securities and Exchange Commission on June 6, 2001).                               
|        |  |                                                                                                                                                                                                                                                                                                                                                                                     
|10.33** |  | Xbox Publisher License Agreement dated November 28, 2000
between the Registrant and Microsoft Corporation
(incorporated by reference to the exhibit of the same
number of the Registrants Registration Statement on Form
S-1, as amended (File No. 333-62436), filed with the
Securities and Exchange Commission on June 6, 2001).                                                 
|        |  |                                                                                                                                                                                                                                                                                                                                                                                     
|10.34** |  | Retail License Agreement #12177-PPG dated March 8, 2000
between the Registrant and Warner Bros. Consumer Products
(incorporated by reference to the exhibit of the same
number of the Registrants Registration Statement on Form
S-1, as amended (File No. 333-62436), filed with the
Securities and Exchange Commission on June 6, 2001).                                         
|        |  |                                                                                                                                                                                                                                                                                                                                                                                     
|10.35** |  | Amendment #1 to Retail License Agreement #12177-PPG dated
November 27, 2000 between the Registrant and Warner Bros.
Consumer Products (incorporated by reference to the exhibit
of the same number of the Registrants Registration
Statement on Form S-1, as amended (File No. 333-62436),
filed with the Securities and Exchange Commission on June
6, 2001).                     
|        |  |                                                                                                                                                                                                                                                                                                                                                                                     
|10.36** |  | License Agreement #12697-DEX dated October 4, 2000 between
the Registrant and Warner Bros. Consumer Products
(incorporated by reference to the exhibit of the same
number of the Registrants Registration Statement on Form
S-1, as amended (File No. 333-62436), filed with the
Securities and Exchange Commission on June 6, 2001).                                              
|        |  |                                                                                                                                                                                                                                                                                                                                                                                     
|10.37   |  | [Reserved].                                                                                                                                                                                                                                                                                                                                                                         
|        |  |                                                                                                                                                                                                                                                                                                                                                                                     
|10.38   |  | [Reserved].                                                                                                                                                                                                                                                                                                                                                                         

42



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##### Table of Contents



|         |  |                                                                                                                                                                                                                                                                                                                                                                                                                             
|-------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit  |  |                                                                                                                                                                                                                                                                                                                                                                                                                             
|Number   |  | Description of Exhibit                                                                                                                                                                                                                                                                                                                                                                                                      
|         |  |                                                                                                                                                                                                                                                                                                                                                                                                                             
|10.39**  |  | Exclusive Output Agreement dated April 7, 2000 between the
Registrant and Franchise Films, Inc. (incorporated by
reference to the exhibit of the same number of the
Registrants Registration Statement on Form S-1, as amended
(File No. 333-62436), filed with the Securities and
Exchange Commission on June 6, 2001).                                                                                                   
|         |  |                                                                                                                                                                                                                                                                                                                                                                                                                             
|10.40    |  | First Amendment to Exclusive Output Agreement dated April
2001 between the Registrant and Franchise Films, Inc.
(incorporated by reference to the exhibit of the same
number of the Registrants Registration Statement on Form
S-1, as amended (File No. 333-62436), filed with the
Securities and Exchange Commission on September 4, 2001).                                                                              
|         |  |                                                                                                                                                                                                                                                                                                                                                                                                                             
|10.41**  |  | License Agreement dated July 12, 2000 between the
Registrant and Time, Inc. for its Sports Illustrated for
Kids division (incorporated by reference to the exhibit of
the same number of the Registrants Registration Statement
on Form S-1, as amended (File No. 333-62436), filed with
the Securities and Exchange Commission on June 6, 2001).                                                                          
|         |  |                                                                                                                                                                                                                                                                                                                                                                                                                             
|10.42**  |  | Exclusive Output Agreement dated October 25, 2000 between
the Registrant and Spyglass Entertainment Group, L.P.
(incorporated by reference to the exhibit of the same
number of the Registrants Registration Statement on Form
S-1, as amended (File No. 333-62436), filed with the
Securities and Exchange Commission on June 6, 2001).                                                                                   
|         |  |                                                                                                                                                                                                                                                                                                                                                                                                                             
|10.43    |  | Office Lease dated November 15, 1999 between the Registrant
and Macanan Investments, L.P. First Amendment to Office
Lease dated March 29, 2002 between the Registrant and
Macanan Investments L.P. (incorporated by reference to the
exhibit of the same number of the Registrants Registration
Statement on Form S-1, as amended (File No. 333-62436),
filed with the Securities and Exchange Commission on June
6, 2001).
|         |  |                                                                                                                                                                                                                                                                                                                                                                                                                             
|10.43(a) |  | First Amendment to Office Lease dated July 31, 2001 between
the Registrant and Macanan Investments L.P. (incorporated
by reference to the exhibit of the same number of the
Registrants Registration Statement on Form S-1, as amended
(File No. 333-62436), filed with the Securities and
Exchange Commission on August 15, 2001).                                                                                        
|         |  |                                                                                                                                                                                                                                                                                                                                                                                                                             
|10.43(b) |  | First Amendment to Office Lease dated March 29, 2002
between the Registrant and Macanan Investments L.P.
(incorporated by reference to Exhibit No. 10.2 from
Registrants Quarterly Report on Form 10-Q for the quarter
ended March 31, 2002).                                                                                                                                                                              
|         |  |                                                                                                                                                                                                                                                                                                                                                                                                                             
|10.44    |  | Amended and Restated Employment Agreement dated as of
October 1, 1999 between the Registrant and Raymond C.
Musci.                                                                                                                                                                                                                                                                                                          
|         |  |                                                                                                                                                                                                                                                                                                                                                                                                                             
|10.45    |  | Amended and Restated Employment Agreement dated as of July
1, 2000 between the Registrant and Anthony R. Williams.                                                                                                                                                                                                                                                                                                          
|         |  |                                                                                                                                                                                                                                                                                                                                                                                                                             
|10.46    |  | Executive Employment Agreement dated January 21, 2002
between the Registrant and Bernard Stolar.                                                                                                                                                                                                                                                                                                                            
|         |  |                                                                                                                                                                                                                                                                                                                                                                                                                             
|10.47    |  | Executive Employment Agreement dated March 5, 2002 between
the Registrant and Yves Legris.                                                                                                                                                                                                                                                                                                                                  
|         |  |                                                                                                                                                                                                                                                                                                                                                                                                                             
|10.48    |  | Agreement for Chairman of Board of Directors dated June 7,
2001 between the Registrant and Robert W. Holmes, Jr.
(incorporated by reference to the exhibit of the same
number of the Registrants Registration Statement on Form
S-1, as amended (File No. 333-62436), filed with the
Securities and Exchange Commission on August 15, 2001).                                                                               
|         |  |                                                                                                                                                                                                                                                                                                                                                                                                                             
|10.49    |  | 2001 Employee Stock Purchase Plan (incorporated by
reference to the exhibit of the same number of the
Registrants Registration Statement on Form S-1, as amended
(File No. 333-62436), filed with the Securities and
Exchange Commission on August 15, 2001).                                                                                                                                                              
|         |  |                                                                                                                                                                                                                                                                                                                                                                                                                             
|10.49(a) |  | Amendment No. 1 to 2001 Employee Stock Purchase Plan.                                                                                                                                                                                                                                                                                                                                                                       
|         |  |                                                                                                                                                                                                                                                                                                                                                                                                                             
|10.50**  |  | Software Distribution Agreement dated February 21, 2001
between BAM Entertainment Limited, a subsidiary of the
Registrant, and Ubi Soft Entertainment, S.A. (incorporated
by reference to the exhibit of the same number of the
Registrants Registration Statement on Form S-1, as amended
(File No. 333-62436), filed with the Securities and
Exchange Commission on August 15, 2001).                                    

43



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##### Table of Contents



|         |  |                                                                                                                                                                                                                                                                                                                                                                                                   
|-------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit  |  |                                                                                                                                                                                                                                                                                                                                                                                                   
|Number   |  | Description of Exhibit                                                                                                                                                                                                                                                                                                                                                                            
|         |  |                                                                                                                                                                                                                                                                                                                                                                                                   
|10.51**  |  | Amendment to Software Distribution Agreement dated April
23, 2001 between BAM Entertainment Limited, a subsidiary of
the Registrant, and Ubi Soft Entertainment, S.A.
(incorporated by reference to the exhibit of the same
number of the Registrants Registration Statement on Form
S-1, as amended (File No. 333-62436), filed with the
Securities and Exchange Commission on August 15, 2001).
|         |  |                                                                                                                                                                                                                                                                                                                                                                                                   
|10.52**  |  | Distribution Agreement dated July 31, 2001 between BAM
Entertainment Limited, a subsidiary of the Registrant, and
Ubi Soft Entertainment, S.A. (incorporated by reference to
the exhibit of the same number of the Registrants
Registration Statement on Form S-1, as amended (File No.
333-62436), filed with the Securities and Exchange
Commission on August 15, 2001).                       
|         |  |                                                                                                                                                                                                                                                                                                                                                                                                   
|10.53    |  | [Reserved].                                                                                                                                                                                                                                                                                                                                                                                       
|         |  |                                                                                                                                                                                                                                                                                                                                                                                                   
|10.54    |  | Form of Indemnification Agreement between the Registrant
and its directors and executive officers (incorporated by
reference to the exhibit of the same number of the
Registrants Registration Statement on Form S-1, as amended
(File No. 333-62436), filed with the Securities and
Exchange Commission on November 13, 2001).                                                                  
|         |  |                                                                                                                                                                                                                                                                                                                                                                                                   
|10.54(a) |  | List of Registrants directors and executive officers who
entered into Indemnification Agreement referenced in
Exhibit 10.54 with the Registrant.                                                                                                                                                                                                                                                 
|         |  |                                                                                                                                                                                                                                                                                                                                                                                                   
|21.1     |  | List of Registrants Subsidiaries.                                                                                                                                                                                                                                                                                                                                                                
|         |  |                                                                                                                                                                                                                                                                                                                                                                                                   
|23.1     |  | Consent of Deloitte & Touche LLP.                                                                                                                                                                                                                                                                                                                                                                 
|         |  |                                                                                                                                                                                                                                                                                                                                                                                                   
|24.1     |  | Power of attorney (included on signature page).                                                                                                                                                                                                                                                                                                                                                   
|         |  |                                                                                                                                                                                                                                                                                                                                                                                                   
|99.1     |  | Certification pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002.                                                                                                                                                                                                                                                                           



---

|*  |  | The Registrant has applied with the Secretary of the Securities and
Exchange Commission for confidential treatment of certain information
pursuant to Rule 24b-2 of the Securities Exchange Act of 1934. The
Registrant has filed separately with its application a copy of the exhibit
including all confidential information, which may be made available for
public inspection pending the Securities and Exchange Commissions review
of the application in accordance with Rule 24b-2.
|-- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|** |  | Confidential treatment has been granted by the Securities and Exchange
Commission with respect to certain information in the exhibit pursuant to
either Rule 406 of the Securities Act of 1933 or Rule 24b-2 of the
Securities Exchange Act of 1934, as the case may be. Such information was
omitted from the filing and filed separately with the Secretary of the
Securities and Exchange Commission.                                                                                   

44



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##### Table of Contents






SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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, in the City of San Jose,
State of California, on September 5, 2002.

| |  |                          |  |                                                            
| |  | ------------------------ |  | -----------------------------------------------------------
| |  | BAM! ENTERTAINMENT, INC.
|
| |  | By:                      |  | /S/ RAYMOND C. MUSCIRaymond C. MusciChief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons in the capacities and on
the dates indicated.

|                                                    |  |                                                                                                    |  |                  
|--------------------------------------------------- |  | -------------------------------------------------------------------------------------------------- |  | -----------------
|Signature                                           |  | Title                                                                                              |  | Date             
|                                                    |  |                                                                                                    |  |                  
|/S/  RAYMOND C. MUSCIRaymond C. Musci               |  | Chief Executive Officer, and Director(Principal Executive Officer)                                 |  | September 5, 2002
|                                                   
|/S/  ANTHONY R. WILLIAMSAnthony R. Williams         |  | Vice Chairman of the Board                                                                         |  | September 5, 2002
|                                                   
|/S/  STEPHEN M. AMBLERStephen M. Ambler             |  | Chief Financial Officer and Vice
President of Finance (Principal
Financial and Accounting Officer) |  | September 5, 2002
|                                                   
|/S/ ROBERT W. HOLMES, JR.
Robert W. Holmes, Jr.     |  | Chairman of the Board                                                                              |  | September 5, 2002
|                                                   
|/S/  GEORGE M. SUNDHEIM, IIIGeorge M. Sundheim, III |  | Director                                                                                           |  | September 5, 2002
|                                                   
|Mark Dyne                                           |  | Director                                                                                           |  |                  
|                                                   
|/S/  DAVID E. TOBINDavid E. Tobin                   |  | Director                                                                                           |  | September 5, 2002
|                                                   
|/S/  ANTHONY G. WILLIAMSAnthony G. Williams         |  | Director                                                                                           |  | September 5, 2002
|                                                   
|/S/  STEVEN J. MASSARSKYSteven J. Massarsky         |  | Director                                                                                           |  | September 5, 2002
|                                                   
|/S/  ROBERT T. SLEZAKRobert T. Slezak               |  | Director                                                                                           |  | September 5, 2002

45



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##### Table of Contents






CERTIFICATIONS

I, Raymond C. Musci, certify that:

1.     I have reviewed this annual report on Form 10-K of BAM! Entertainment, Inc.

2.     Based on my knowledge, this annual 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 annual
report;

3.     Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report.

|                        |  |  |  |                                                             
|----------------------- |  |  |  | ------------------------------------------------------------
|Date: September 5, 2002 |  |  |  |                                                             
|                       
|                        |  |  |  | /s/ RAYMOND C. MUSCIRaymond C. Musci
Chief Executive Officer

I, Stephen M. Ambler, certify that:

1.     I have reviewed this annual report on Form 10-K of BAM! Entertainment, Inc.

2.     Based on my knowledge, this annual 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 annual
report;

3.     Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report.

|                        |  |  |  |                                                                                             
|----------------------- |  |  |  | --------------------------------------------------------------------------------------------
|Date: September 5, 2002 |  |  |  |                                                                                             
|                       
|                        |  |  |  | /s/ STEPHEN M. AMBLERStephen M. Ambler
Chief Financial Officer and Vice President of Finance

46



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##### Table of Contents



BAM! Entertainment, Inc.
Index to Consolidated Financial Statements

|                                                                                                                                                                                                            |  |      |     | 
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | --- | 
|                                                                                                                                                                                                            |  | Page
|                                                                                                                                                                                                            |  |     
|Independent Auditors Report                                                                                                                                                                                |  |      | F-2 | 
|Consolidated Balance Sheets as of June 30, 2002 and 2001                                                                                                                                                    |  |      | F-3 | 
|Consolidated Statements of Operations for the years ended June 30,
2002 and June 30, 2001, and the period from October 7, 1999
(inception) through June 30, 2000                                            |  |      | F-4 | 
|Consolidated Statements of Stockholders Equity (Deficit) and
Comprehensive Loss for the years ended June 30, 2002 and June 30,
2001, and the period from October 7, 1999 (inception) through June
30, 2000 |  |      | F-5 | 
|Consolidated Statements of Cash Flows for the years ended June 30,
2002 and June 30, 2001, and the period from October 7, 1999
(inception) through June 30, 2000                                            |  |      | F-6 | 
|Notes to Consolidated Financial Statements                                                                                                                                                                  |  |      | F-7 | 
|Schedule II  Valuation and qualifying accounts                                                                                                                                                             |  |      | S-1 | 

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##### Table of Contents






INDEPENDENT AUDITORS REPORT

To the Board of Directors and Stockholders of
BAM! Entertainment, Inc.:

We have audited the accompanying consolidated balance sheets of BAM!
Entertainment, Inc. and its subsidiaries (the Company) as of June 30, 2002
and 2001, and the related consolidated statements of operations, stockholders
equity (deficit) and comprehensive loss, and cash flows for the years ended
June, 30, 2002 and 2001 and the period from October 7, 1999 (inception) through
June 30, 2000. Our audits also included the financial statement schedule listed
in item 15(a). These financial statements and financial statement schedule
are the responsibility of the Companys management. Our responsibility is to
express an opinion on the financial statements and financial statement schedule
based on our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of the Company as of June 30, 2002
and 2001, and the results of its operations and its cash flows for the years
ended June, 30, 2002 and 2001 and the period from October 7, 1999 (inception)
through June 30, 2000 in conformity with accounting principles generally
accepted in the United States of America. Also in our opinion, such financial
statement schedule, when considered in relation to the basic consolidated
financial statements taken as a whole, present, fairly, in all material
respects, the information set forth therein.

DELOITTE & TOUCHE LLP
San Jose, California
August 26, 2002

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##### Table of Contents



BAM! ENTERTAINMENT, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS




(in thousands, except share data)

|                                                                                                   |                                                                                                                                                                   |                                      |        |          |        |      |        |        |        |  
|-------------------------------------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------ | ------ | -------- | ------ | ---- | ------ | ------ | ------ | -
|                                                                                                   |                                                                                                                                                                   |                                      |        | June 30,
|                                                                                                   |                                                                                                                                                                   |                                      |        |         
|                                                                                                   |                                                                                                                                                                   |                                      |        | 2002     |        | 2001
|                                                                                                   |                                                                                                                                                                   |                                      |        |          |        |     
|ASSETS                                                                                             |                                                                                                                                                                   |                                      |        |          |        |      |        |       
|Current assets:                                                                                    |                                                                                                                                                                   |                                      |        |          |        |      |        |       
|                                                                                                   | Cash and cash equivalents                                                                                                                                         |                                      | $      | 4,726    |        |      | $      | 2,170  |       
|                                                                                                   | Short-term investments                                                                                                                                            |                                      |        | 8,185    |        |      |        |       |       
|                                                                                                   | Accounts receivable, net of allowance of $3,720 and $1,163 as of June 30, 2002 and 2001, respectively                                                             |                                      |        | 10,183   |        |      |        | 7,372  |       
|                                                                                                   | Inventories                                                                                                                                                       |                                      |        | 3,945    |        |      |        | 1,463  |       
|                                                                                                   | Prepaid royalties, capitalized software costs and licensed assets, net                                                                                            |                                      |        | 12,858   |        |      |        | 5,924  |       
|                                                                                                   | Prepaid expenses and other                                                                                                                                        |                                      |        | 2,539    |        |      |        | 393    |       
|                                                                                                   |                                                                                                                                                                   |                                      |        |          |        |      |        |        |       
|                                                                                                   |                                                                                                                                                                   | Total current assets                 |        |          | 42,436 |      |        |        | 17,322 |  
|Prepaid royalties, capitalized software and licensed assets, net of current portion                |                                                                                                                                                                   |                                      | 5,467  |          |        |      | 1,545  |       
|Property and equipment, net                                                                        |                                                                                                                                                                   |                                      | 987    |          |        |      | 395    |       
|Long-term receivable, net of allowance of $1,080 and $0 as of June 30, 2002 and 2001, respectively |                                                                                                                                                                   |                                      | 547    |          |        |      |       |       
|Other assets                                                                                       |                                                                                                                                                                   |                                      | 30     |          |        |      | 1,730  |       
|                                                                                                   |                                                                                                                                                                   |                                      |        |          |        |      |        |        |       
|Total assets                                                                                       |                                                                                                                                                                   | $                                    | 49,467 |          |        | $    | 20,992 |       
|                                                                                                   |                                                                                                                                                                   |                                      |        |          |        |      |        |       
|LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS EQUITY
(DEFICIT)             |                                                                                                                                                                   |                                      |        |          |        |      |        |       
|Current liabilities:                                                                               |                                                                                                                                                                   |                                      |        |          |        |      |        |       
|                                                                                                   | Accounts payable  trade                                                                                                                                          |                                      | $      | 4,755    |        |      | $      | 1,489  |       
|                                                                                                   | Short-term borrowings                                                                                                                                             |                                      |        | 1,359    |        |      |        | 4,164  |       
|                                                                                                   | Royalties payable                                                                                                                                                 |                                      |        | 528      |        |      |        | 310    |       
|                                                                                                   | Accrued compensation and related benefits                                                                                                                         |                                      |        | 972      |        |      |        | 1,026  |       
|                                                                                                   | Accrued software costs                                                                                                                                            |                                      |        | 1,488    |        |      |        | 781    |       
|                                                                                                   | Accrued expenses  other                                                                                                                                          |                                      |        | 1,509    |        |      |        | 562    |       
|                                                                                                   |                                                                                                                                                                   |                                      |        |          |        |      |        |        |       
|                                                                                                   |                                                                                                                                                                   | Total current liabilities            |        |          | 10,611 |      |        |        | 8,332  |  
|Commitments and contingencies (Note 15)                                                            |                                                                                                                                                                   |                                      |        |          |        |      |        |       
|Redeemable convertible preferred stock, $0.001 par value; shares authorized:                       |                                                                                                                                                                   |                                      |        |          |        |      |        |       
|                                                                                                   | 10,000,000; shares issued and outstanding: 0 and 1,516,499 as of June 30, 2002
and 2001, respectively                                                             |                                      |        |         |        |      |        | 17,329 |       
|Stockholders equity (deficit):                                                                    |                                                                                                                                                                   |                                      |        |          |        |      |        |       
|                                                                                                   | Common stock $0.001 par value; shares authorized; 100,000,000; shares issued and
outstanding: 14,582,756 and 1,538,710 as of June 30, 2002 and 2001,
respectively |                                      |        | 15       |        |      |        | 1      |       
|                                                                                                   | Additional paid-in capital                                                                                                                                        |                                      |        | 62,988   |        |      |        | 5,375  |       
|                                                                                                   | Deferred stock compensation                                                                                                                                       |                                      |        | (789     | )      |      |        | (2,096 | )     
|                                                                                                   | Accumulated deficit                                                                                                                                               |                                      |        | (23,618  | )      |      |        | (7,945 | )     
|                                                                                                   | Accumulated other comprehensive income (loss)                                                                                                                     |                                      |        | 260      |        |      |        | (4     | )     
|                                                                                                   |                                                                                                                                                                   |                                      |        |          |        |      |        |        |       
|                                                                                                   |                                                                                                                                                                   | Total stockholders equity (deficit) |        |          | 38,856 |      |        |        | (4,669 | )
|                                                                                                   |                                                                                                                                                                   |                                      |        |          |        |      |        |        |       
|Total liabilities, redeemable convertible preferred stock and stockholders equity
(deficit)       |                                                                                                                                                                   | $                                    | 49,467 |          |        | $    | 20,992 |       
|                                                                                                   |                                                                                                                                                                   |                                      |        |          |        |      |        |        |       

See notes to consolidated financial statements

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##### Table of Contents



BAM! ENTERTAINMENT, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS




(in thousands, except per share amounts)

|                                                        |                                                                                       |                                                 |                                                                   |                          |        |            |        |                  |        |        |        |       |     |             |       | 
|------------------------------------------------------- | ------------------------------------------------------------------------------------- | ----------------------------------------------- | ----------------------------------------------------------------- | ------------------------ | ------ | ---------- | ------ | ---------------- | ------ | ------ | ------ | ----- | --- | ----------- | ----- | 
|                                                        |                                                                                       |                                                 |                                                                   |                          |        |            |        |                  |        |        |        |       |     | Period from
|                                                        |                                                                                       |                                                 |                                                                   |                          |        | Year ended |        | October 7, 1999 
|                                                        |                                                                                       |                                                 |                                                                   |                          |        | June 30,   |        | (inception)     
|                                                        |                                                                                       |                                                 |                                                                   |                          |        |            |        | through June 30,
|                                                        |                                                                                       |                                                 |                                                                   |                          |        | 2002       |        | 2001             |        | 2000  
|                                                        |                                                                                       |                                                 |                                                                   |                          |        |            |        |                  |        |       
|Net revenues                                            |                                                                                       | $                                               | 50,734                                                            |                          |        | $          | 25,351 |                  |        | $      | 1,377  |      
|Costs and expenses:                                     |                                                                                       |                                                 |                                                                   |                          |        |            |        |                  |        |        |        |      
|                                                        | Cost of revenues                                                                      |                                                 |                                                                   |                          |        |            |        |                  |        |        |        |       |    
|                                                        |                                                                                       |                                                 | Cost of goods sold                                                |                          |        | 29,826     |        |                  |        | 14,827 |        |       |     | 807         |      
|                                                        |                                                                                       |                                                 | Royalties, software costs, license costs, and project abandonment |                          |        | 12,794     |        |                  |        | 2,898  |        |       |     | 248         |      
|                                                        |                                                                                       |                                                 |                                                                   |                          |        |            |        |                  |        |        |        |      
|                                                        |                                                                                       |                                                 | Total cost of revenues                                            |                          |        | 42,620     |        |                  |        | 17,725 |        |       |     | 1,055       |      
|                                                        | Research and development (exclusive of amortization of deferred
stock compensation)   |                                                 |                                                                   | 2,519                    |        |            |        | 1,073            |        |        |        | 260   |    
|                                                        | Sales and marketing (exclusive of amortization of deferred stock
compensation)        |                                                 |                                                                   | 11,473                   |        |            |        | 4,292            |        |        |        | 132   |    
|                                                        | General and administrative (exclusive of amortization of deferred
stock compensation) |                                                 |                                                                   | 6,293                    |        |            |        | 1,996            |        |        |        | 711   |    
|                                                        | Amortization of deferred stock compensation*                                          |                                                 |                                                                   | 1,223                    |        |            |        | 618              |        |        |        |      |    
|                                                        |                                                                                       |                                                 |                                                                   |                          |        |            |        |                  |        |        |        |      
|                                                        |                                                                                       |                                                 |                                                                   | Total costs and expenses |        |            | 64,128 |                  |        |        | 25,704 |       |     |             | 2,158 | 
|                                                        |                                                                                       |                                                 |                                                                   |                          |        |            |        |                  |        |        |        |      
|Loss from operations                                    |                                                                                       |                                                 | (13,394                                                           | )                        |        |            | (353   | )                |        |        | (781   | )    
|                                                        |                                                                                       | Interest income                                 |                                                                   |                          | 328    |            |        |                  | 58     |        |        |       | 8   |            
|                                                        |                                                                                       | Interest expense                                |                                                                   |                          | (2,569 | )          |        |                  | (1,325 | )      |        |       | (39 | )          
|                                                        |                                                                                       | Other income (expense)                          |                                                                   |                          | (38    | )          |        |                  | 18     |        |        |       | 9   |            
|                                                        |                                                                                       |                                                 |                                                                   |                          |        |            |        |                  |        |        |        |      
|Net loss                                                |                                                                                       |                                                 | (15,673                                                           | )                        |        |            | (1,602 | )                |        |        | (803   | )    
|                                                        |                                                                                       | Redeemable convertible preferred stock dividend |                                                                   |                          |       |            |        |                  | (5,540 | )      |        |       |    |            
|                                                        |                                                                                       |                                                 |                                                                   |                          |        |            |        |                  |        |        |        |      
|Net loss attributable to common stockholders            |                                                                                       | $                                               | (15,673                                                           | )                        |        | $          | (7,142 | )                |        | $      | (803   | )    
|                                                        |                                                                                       |                                                 |                                                                   |                          |        |            |        |                  |        |        |        |      
|Net loss attributable to common stockholders per share: |                                                                                       |                                                 |                                                                   |                          |        |            |        |                  |        |        |        |      
|                                                        | Basic and diluted                                                                     |                                                 | $                                                                 | (1.65                    | )      |            | $      | (4.82            | )      |        | $      | (0.96 | )  
|                                                        |                                                                                       |                                                 |                                                                   |                          |        |            |        |                  |        |        |        |      
|Shares used in computation:                             |                                                                                       |                                                 |                                                                   |                          |        |            |        |                  |        |        |        |      
|                                                        | Basic and diluted                                                                     |                                                 |                                                                   | 9,503                    |        |            |        | 1,482            |        |        |        | 834   |    
|                                                        |                                                                                       |                                                 |                                                                   |                          |        |            |        |                  |        |        |        |      
|*Amortization of deferred stock compensation:           |                                                                                       |                                                 |                                                                   |                          |        |            |        |                  |        |        |        |      
|                                                        | Research and development                                                              |                                                 | $                                                                 | 126                      |        |            | $      | 72               |        |        | $      |      |    
|                                                        | Sales and marketing                                                                   |                                                 |                                                                   | 70                       |        |            |        | 28               |        |        |        |      |    
|                                                        | General and administrative                                                            |                                                 |                                                                   | 1,027                    |        |            |        | 518              |        |        |        |      |    
|                                                        |                                                                                       |                                                 |                                                                   |                          |        |            |        |                  |        |        |        |      
|                                                        |                                                                                       | $                                               | 1,223                                                             |                          |        | $          | 618    |                  |        | $      |       |      
|                                                        |                                                                                       |                                                 |                                                                   |                          |        |            |        |                  |        |        |        |      

See notes to consolidated financial statements

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##### Table of Contents



BAM! ENTERTAINMENT, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (DEFICIT)
AND COMPREHENSIVE LOSS




(in thousands, except share amounts)

|                                                                                                                           |  |              |            |            |  |            |    |             |  |              |        |               |  |               |    |               |  |       |        |   |  |   |         |   |  |             |     |       |  |   |         |   |  |   |         |  
|-------------------------------------------------------------------------------------------------------------------------- |  | ------------ | ---------- | ---------- |  | ---------- | -- | ----------- |  | ------------ | ------ | ------------- |  | ------------- | -- | ------------- |  | ----- | ------ | - |  | - | ------- | - |  | ----------- | --- | ----- |  | - | ------- | - |  | - | ------- | -
|                                                                                                                           |  |              |            |            |  |            |    |             |  |              |        |               |  |               |    |               |  |       |        |   |  |   |         |   |  | Accumulated |     | Total |  |   |         |  
|                                                                                                                           |  | Common stock |            | Additional |  | Receivable |    | Deferred    |  |              |        |               |  | other         |    | stockholders' |  | Total
|                                                                                                                           |  |              |            | paid-in    |  | from       |    | stock       |  | Accumulated  |        | comprehensive |  | equity        |    | comprehensive
|                                                                                                                           |  | Shares       |            | Amount     |  | capital    |    | stockholder |  | compensation |        | deficit       |  | income (loss) |    | (deficit)     |  | loss 
|                                                                                                                           |  |              |            |            |  |            |    |             |  |              |        |               |  |               |    |               |  |      
|Issuance of common stock for
note receivable                                                                               |  |              | 580,962    |            |  | $          |   |             |  | $            | 1      |               |  | $             | (1 | )             |  | $     |       |   |  | $ |        |   |  | $           |    |       |  | $ |        |   |  |   |         |  
|Issuance of common stock for
services                                                                                      |  |              | 343,683    |            |  |            |   |             |  |              | 37     |               |  |               |   |               |  |       |       |   |  |   |        |   |  |             |    |       |  |   | 37      |   |  |   |         |  
|Sale of common stock                                                                                                       |  |              | 545,327    |            |  |            | 1  |             |  |              | 59     |               |  |               |   |               |  |       |       |   |  |   |        |   |  |             |    |       |  |   | 60      |   |  |   |         |  
|Net loss and comprehensive Loss                                                                                            |  |              |           |            |  |            |   |             |  |              |       |               |  |               |   |               |  |       |       |   |  |   | (803    | ) |  |             |    |       |  |   | (803    | ) |  | $ | (803    | )
|                                                                                                                           |  |              |            |            |  |            |    |             |  |              |        |               |  |               |    |               |  |       |        |   |  |   |         |   |  |             |     |       |  |   |         |   |  |   |         |  
|Balance, June 30, 2000                                                                                                     |  |              | 1,469,972  |            |  |            | 1  |             |  |              | 97     |               |  |               | (1 | )             |  |       |       |   |  |   | (803    | ) |  |             |    |       |  |   | (706    | ) |  |   |         |  
|Issuance of common stock in
connection with a license
agreement                                                            |  |              | 68,738     |            |  |            |   |             |  |              | 746    |               |  |               |   |               |  |       |       |   |  |   |        |   |  |             |    |       |  |   | 746     |   |  |   |         |  
|Issuance of common stock
warrants in connection with a
license agreement                                                   |  |              |           |            |  |            |   |             |  |              | 910    |               |  |               |   |               |  |       |       |   |  |   |        |   |  |             |    |       |  |   | 910     |   |  |   |         |  
|Issuance of common stock
warrants to a service provider
in connection with Series B
redeemable convertible
preferred stock |  |              |           |            |  |            |   |             |  |              | 283    |               |  |               |   |               |  |       |       |   |  |   |        |   |  |             |    |       |  |   | 283     |   |  |   |         |  
|Issuance of common stock
warrants to a service provider
in connection with Series C
redeemable convertible
preferred stock |  |              |           |            |  |            |   |             |  |              | 159    |               |  |               |   |               |  |       |       |   |  |   |        |   |  |             |    |       |  |   | 159     |   |  |   |         |  
|Issuance of common stock
warrants to a service provider
in connection with a proposed
initial public offering              |  |              |           |            |  |            |   |             |  |              | 456    |               |  |               |   |               |  |       |       |   |  |   |        |   |  |             |    |       |  |   | 456     |   |  |   |         |  
|Issuance of stock options to
consultant                                                                                    |  |              |           |            |  |            |   |             |  |              | 10     |               |  |               |   |               |  |       |        |   |  |   |        |   |  |             |    |       |  |   | 10      |   |  |   |         |  
|Deferred stock compensation                                                                                                |  |              |           |            |  |            |   |             |  |              | 2,714  |               |  |               |   |               |  |       | (2,714 | ) |  |   |        |   |  |             |    |       |  |   |        |   |  |   |         |  
|Collection of note receivable
From stockholder                                                                             |  |              |           |            |  |            |   |             |  |              |       |               |  |               | 1  |               |  |       |       |   |  |   |        |   |  |             |    |       |  |   | 1       |   |  |   |         |  
|Amortization of deferred stock
compensation                                                                                |  |              |           |            |  |            |   |             |  |              |       |               |  |               |   |               |  |       | 618    |   |  |   |        |   |  |             |    |       |  |   | 618     |   |  |   |         |  
|Net loss                                                                                                                   |  |              |           |            |  |            |   |             |  |              |       |               |  |               |   |               |  |       |       |   |  |   | (1,602  | ) |  |             |    |       |  |   | (1,602  | ) |  |   | (1,602  | )
|Redeemable convertible
preferred stock dividend                                                                            |  |              |           |            |  |            |   |             |  |              |       |               |  |               |   |               |  |       |       |   |  |   | (5,540  | ) |  |             |    |       |  |   | (5,540  | ) |  |   |         |  
|Change in accumulated other
comprehensive income (loss)                                                                    |  |              |           |            |  |            |   |             |  |              |       |               |  |               |   |               |  |       |       |   |  |   |        |   |  |             | (4  | )     |  |   | (4      | ) |  |   | (4      | )
|                                                                                                                           |  |              |            |            |  |            |    |             |  |              |        |               |  |               |    |               |  |       |        |   |  |   |         |   |  |             |     |       |  |   |         |   |  |   |         |  
|Comprehensive loss                                                                                                         |  |              |           |            |  |            |   |             |  |              |       |               |  |               |   |               |  |       |       |   |  |   |        |   |  |             |    |       |  |   |        |   |  | $ | (1,606  | )
|                                                                                                                           |  |              |            |            |  |            |    |             |  |              |        |               |  |               |    |               |  |       |        |   |  |   |         |   |  |             |     |       |  |   |         |   |  |   |         |  
|Balance, June 30, 2001                                                                                                     |  |              | 1,538,710  |            |  |            | 1  |             |  |              | 5,375  |               |  |               |   |               |  |       | (2,096 | ) |  |   | (7,945  | ) |  |             | (4  | )     |  |   | (4,669  | ) |  |   |         |  
|Issuance of common stock in
initial public offering, net
of issuance costs of $6.8
million                                 |  |              | 5,750,000  |            |  |            | 6  |             |  |              | 39,151 |               |  |               |   |               |  |       |       |   |  |   |        |   |  |             |    |       |  |   | 39,157  |   |  |   |         |  
|Conversion of preferred stock
upon completion of initial
public offering                                                   |  |              | 7,127,528  |            |  |            | 7  |             |  |              | 17,322 |               |  |               |   |               |  |       |       |   |  |   |        |   |  |             |    |       |  |   | 17,329  |   |  |   |         |  
|Exercise of stock options                                                                                                  |  |              | 20,562     |            |  |            |   |             |  |              | 9      |               |  |               |   |               |  |       |       |   |  |   |        |   |  |             |    |       |  |   | 9       |   |  |   |         |  
|Issuance of common stock under
employee stock purchase plan                                                                |  |              | 4,956      |            |  |            |   |             |  |              | 25     |               |  |               |   |               |  |       |       |   |  |   |        |   |  |             |    |       |  |   | 25      |   |  |   |         |  
|Issuance of common stock from
exercise of warrants                                                                         |  |              | 141,000    |            |  |            | 1  |             |  |              | 528    |               |  |               |   |               |  |       |       |   |  |   |        |   |  |             |    |       |  |   | 529     |   |  |   |         |  
|Issuance of stock options to
consultant                                                                                    |  |              |           |            |  |            |   |             |  |              | 62     |               |  |               |   |               |  |       |       |   |  |   |        |   |  |             |    |       |  |   | 62      |   |  |   |         |  
|Issuance of common stock
warrants in connection with a
license agreement                                                   |  |              |           |            |  |            |   |             |  |              | 86     |               |  |               |   |               |  |       |       |   |  |   |        |   |  |             |    |       |  |   | 86      |   |  |   |         |  
|Issuance of common stock
warrants in connection with a
license agreement                                                   |  |              |           |            |  |            |   |             |  |              | 29     |               |  |               |   |               |  |       |       |   |  |   |        |   |  |             |    |       |  |   | 29      |   |  |   |         |  
|Deferred stock compensation                                                                                                |  |              |           |            |  |            |   |             |  |              | 129    |               |  |               |   |               |  |       | (129   | ) |  |   |        |   |  |             |    |       |  |   |        |   |  |   |         |  
|Deferred stock compensation
credit on cancellations                                                                        |  |              |           |            |  |            |   |             |  |              | (213   | )             |  |               |   |               |  |       | 129    |   |  |   |        |   |  |             |    |       |  |   | (84     | ) |  |   |         |  
|Amortization of deferred stock
compensation                                                                                |  |              |           |            |  |            |   |             |  |              |       |               |  |               |   |               |  |       | 1,307  |   |  |   |        |   |  |             |    |       |  |   | 1,307   |   |  |   |         |  
|Issuance of common stock
warrants to a service
provider in connection with a
finance agreement                             |  |              |           |            |  |            |   |             |  |              | 485    |               |  |               |   |               |  |       |       |   |  |   |        |   |  |             |    |       |  |   | 485     |   |  |   |         |  
|Net loss                                                                                                                   |  |              |           |            |  |            |   |             |  |              |       |               |  |               |   |               |  |       |       |   |  |   | (15,673 | ) |  |             |    |       |  |   | (15,673 | ) |  |   | (15,673 | )
|Change in accumulated other
comprehensive income (loss)                                                                    |  |              |           |            |  |            |   |             |  |              |       |               |  |               |   |               |  |       |       |   |  |   |        |   |  |             | 264 |       |  |   | 264     |   |  |   | 264     |  
|                                                                                                                           |  |              |            |            |  |            |    |             |  |              |        |               |  |               |    |               |  |       |        |   |  |   |         |   |  |             |     |       |  |   |         |   |  |   |         |  
|Comprehensive loss                                                                                                         |  |              |           |            |  |            |   |             |  |              |       |               |  |               |   |               |  |       |       |   |  |   |        |   |  |             |    |       |  |   |        |   |  | $ | (15,409 | )
|                                                                                                                           |  |              |            |            |  |            |    |             |  |              |        |               |  |               |    |               |  |       |        |   |  |   |         |   |  |             |     |       |  |   |         |   |  |   |         |  
|Balance, June 30, 2002                                                                                                     |  |              | 14,582,756 |            |  | $          | 15 |             |  | $            | 62,988 |               |  | $             |   |               |  | $     | (789   | ) |  | $ | (23,618 | ) |  | $           | 260 |       |  | $ | 38,856  |   |  |   |         |  
|                                                                                                                           |  |              |            |            |  |            |    |             |  |              |        |               |  |               |    |               |  |       |        |   |  |   |         |   |  |             |     |       |  |   |         |   |  |   |         |  

See notes to consolidated financial statements

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##### Table of Contents



BAM! ENTERTAINMENT, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS




(in thousands)

|                                                                            |                                                                                             |                            |                                                                   |                                           |       |            |         |                  |       |        |         |       |    |             |        |  
|--------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------- | -------------------------- | ----------------------------------------------------------------- | ----------------------------------------- | ----- | ---------- | ------- | ---------------- | ----- | ------ | ------- | ----- | -- | ----------- | ------ | -
|                                                                            |                                                                                             |                            |                                                                   |                                           |       |            |         |                  |       |        |         |       |    | Period from
|                                                                            |                                                                                             |                            |                                                                   |                                           |       | Year ended |         | October 7, 1999 
|                                                                            |                                                                                             |                            |                                                                   |                                           |       | June 30,   |         | (inception)     
|                                                                            |                                                                                             |                            |                                                                   |                                           |       |            |         | through June 30,
|                                                                            |                                                                                             |                            |                                                                   |                                           |       | 2002       |         | 2001             |       | 2000  
|                                                                            |                                                                                             |                            |                                                                   |                                           |       |            |         |                  |       |       
|Cash flows from operating activities:                                       |                                                                                             |                            |                                                                   |                                           |       |            |         |                  |       |        |         |      
|Net loss                                                                    |                                                                                             | $                          | (15,673                                                           | )                                         |       | $          | (1,602  | )                |       | $      | (803    | )    
|Adjustments to reconcile net loss to net cash used in operating activities: |                                                                                             |                            |                                                                   |                                           |       |            |         |                  |       |        |         |      
|                                                                            | Depreciation and amortization                                                               |                            |                                                                   | 13,137                                    |       |            |         | 1,859            |       |        |         | 12    |   
|                                                                            | Provision for bad debts, sales returns, price protection and cooperative advertising        |                            |                                                                   | 14,660                                    |       |            |         | 1,989            |       |        |         | 77    |   
|                                                                            | Consulting services performed in exchange for common stock and options                      |                            |                                                                   | 62                                        |       |            |         | 10               |       |        |         | 37    |   
|                                                                            | Consulting services performed in exchange for redeemable convertible preferred stock        |                            |                                                                   |                                          |       |            |         |                 |       |        |         | 96    |   
|                                                                            | Other                                                                                       |                            |                                                                   |                                          |       |            |         | (4               | )     |        |         |      |   
|                                                                            | Changes in operating assets and liabilities:                                                |                            |                                                                   |                                           |       |            |         |                  |       |        |         |       |   
|                                                                            |                                                                                             |                            | Accounts receivable                                               |                                           |       | (17,752    | )       |                  |       | (8,062 | )       |       |    | (1,376      | )     
|                                                                            |                                                                                             |                            | Inventories                                                       |                                           |       | (1,958     | )       |                  |       | (1,457 | )       |       |    | (6          | )     
|                                                                            |                                                                                             |                            | Prepaid expenses and other                                        |                                           |       | (1,744     | )       |                  |       | 115    |         |       |    | (52         | )     
|                                                                            |                                                                                             |                            | Prepaid royalties, capitalized software costs and licensed assets |                                           |       | (21,854    | )       |                  |       | (6,581 | )       |       |    | (368        | )     
|                                                                            |                                                                                             |                            | Accounts payable  trade                                          |                                           |       | 2,437      |         |                  |       | 1,371  |         |       |    | 118         |       
|                                                                            |                                                                                             |                            | Royalties payable                                                 |                                           |       | 176        |         |                  |       | 62     |         |       |    | 248         |       
|                                                                            |                                                                                             |                            | Accrued compensation and related benefits                         |                                           |       | (54        | )       |                  |       | 805    |         |       |    | 221         |       
|                                                                            |                                                                                             |                            | Accrued software costs                                            |                                           |       | 687        |         |                  |       | 781    |         |       |    |            |       
|                                                                            |                                                                                             |                            | Accrued expenses  other                                          |                                           |       | 742        |         |                  |       | 444    |         |       |    | 118         |       
|                                                                            |                                                                                             |                            |                                                                   |                                           |       |            |         |                  |       |        |         |      
|                                                                            |                                                                                             |                            |                                                                   | Net cash used in operating activities     |       |            | (27,134 | )                |       |        | (10,270 | )     |    |             | (1,678 | )
|                                                                            |                                                                                             |                            |                                                                   |                                           |       |            |         |                  |       |        |         |      
|Cash flows from investing activities:                                       |                                                                                             |                            |                                                                   |                                           |       |            |         |                  |       |        |         |      
|                                                                            | Purchase of property and equipment                                                          |                            |                                                                   | (908                                      | )     |            |         | (421             | )     |        |         | (91   | ) 
|                                                                            | Purchase of short-term investments                                                          |                            |                                                                   | (8,133                                    | )     |            |         |                 |       |        |         |      |   
|                                                                            | Decrease (increase) in other assets                                                         |                            |                                                                   | 1,700                                     |       |            |         | (1,730           | )     |        |         |      |   
|                                                                            |                                                                                             |                            |                                                                   |                                           |       |            |         |                  |       |        |         |      
|                                                                            |                                                                                             |                            |                                                                   | Net cash used in investing activities:    |       |            | (7,341  | )                |       |        | (2,151  | )     |    |             | (91    | )
|                                                                            |                                                                                             |                            |                                                                   |                                           |       |            |         |                  |       |        |         |      
|Cash flows from financing activities:                                       |                                                                                             |                            |                                                                   |                                           |       |            |         |                  |       |        |         |      
|                                                                            | Net proceeds from issuance of common stock in initial public offering                       |                            |                                                                   | 39,157                                    |       |            |         |                 |       |        |         |      |   
|                                                                            | Advances under short-term borrowings                                                        |                            |                                                                   | 20,322                                    |       |            |         | 14,912           |       |        |         | 610   |   
|                                                                            | Repayments of short-term borrowings                                                         |                            |                                                                   | (23,127                                   | )     |            |         | (11,358          | )     |        |         |      |   
|                                                                            | Net proceeds from exercise of warrants                                                      |                            |                                                                   | 529                                       |       |            |         |                 |       |        |         |      |   
|                                                                            | Net proceeds from issuance of stock under employee stock purchase plan                      |                            |                                                                   | 25                                        |       |            |         |                 |       |        |         |      |   
|                                                                            | Net proceeds from exercise of common stock options                                          |                            |                                                                   | 9                                         |       |            |         |                 |       |        |         |      |   
|                                                                            | Net proceeds from issuance of redeemable convertible preferred stock                        |                            |                                                                   |                                          |       |            |         | 10,128           |       |        |         | 960   |   
|                                                                            | Collection of note receivable from stockholder                                              |                            |                                                                   |                                          |       |            |         | 1                |       |        |         |      |   
|                                                                            | Net proceeds from issuance of promissory note                                               |                            |                                                                   |                                          |       |            |         |                 |       |        |         | 1,047 |   
|                                                                            | Net proceeds from issuance of common stock                                                  |                            |                                                                   |                                          |       |            |         |                 |       |        |         | 60    |   
|                                                                            |                                                                                             |                            |                                                                   |                                           |       |            |         |                  |       |        |         |      
|                                                                            |                                                                                             |                            |                                                                   | Net cash provided by financing activities |       |            | 36,915  |                  |       |        | 13,683  |       |    |             | 2,677  |  
|                                                                            |                                                                                             |                            |                                                                   |                                           |       |            |         |                  |       |        |         |      
|Net increase in cash and cash equivalents                                   |                                                                                             |                            | 2,440                                                             |                                           |       |            | 1,262   |                  |       |        | 908     |      
|Net effect on cash and cash equivalents from change in exchange rates       |                                                                                             |                            | 116                                                               |                                           |       |            |        |                  |       |        |        |      
|Cash and cash equivalents, beginning of period                              |                                                                                             |                            | 2,170                                                             |                                           |       |            | 908     |                  |       |        |        |      
|                                                                            |                                                                                             |                            |                                                                   |                                           |       |            |         |                  |       |        |         |      
|Cash and cash equivalents, end of period                                    |                                                                                             | $                          | 4,726                                                             |                                           |       | $          | 2,170   |                  |       | $      | 908     |      
|                                                                            |                                                                                             |                            |                                                                   |                                           |       |            |         |                  |       |        |         |      
|Supplementary disclosure of cash flow information:                          |                                                                                             |                            |                                                                   |                                           |       |            |         |                  |       |        |         |      
|                                                                            |                                                                                             | Cash paid for income taxes |                                                                   | $                                         |      |            |         | $                |      |        |         | $     |   |            
|                                                                            |                                                                                             |                            |                                                                   |                                           |       |            |         |                  |       |        |         |      
|                                                                            |                                                                                             | Cash paid for interest     |                                                                   | $                                         | 2,069 |            |         | $                | 1,325 |        |         | $     | 39 |            
|                                                                            |                                                                                             |                            |                                                                   |                                           |       |            |         |                  |       |        |         |      
|Noncash investing and financing activities:                                 |                                                                                             |                            |                                                                   |                                           |       |            |         |                  |       |        |         |      
|                                                                            | Conversion of redeemable convertible preferred stock                                        |                            | $                                                                 | 17,329                                    |       |            | $       |                 |       |        | $       |      |   
|                                                                            |                                                                                             |                            |                                                                   |                                           |       |            |         |                  |       |        |         |      
|                                                                            | Issuance of common stock in connection with a finance agreement                             |                            | $                                                                 | 485                                       |       |            | $       |                 |       |        | $       |      |   
|                                                                            |                                                                                             |                            |                                                                   |                                           |       |            |         |                  |       |        |         |      
|                                                                            | Issuance of common stock warrants in connection with license agreements                     |                            | $                                                                 | 115                                       |       |            | $       | 910              |       |        | $       |      |   
|                                                                            |                                                                                             |                            |                                                                   |                                           |       |            |         |                  |       |        |         |      
|                                                                            | Unrealized gain on available-for-sale marketable securities                                 |                            | $                                                                 | 52                                        |       |            | $       |                 |       |        | $       |      |   
|                                                                            |                                                                                             |                            |                                                                   |                                           |       |            |         |                  |       |        |         |      
|                                                                            | Deferred stock compensation, net of cancellations                                           |                            | $                                                                 | (84                                       | )     |            | $       | 2,714            |       |        | $       |      |   
|                                                                            |                                                                                             |                            |                                                                   |                                           |       |            |         |                  |       |        |         |      
|                                                                            | Issuance of common stock in connection with a license agreement                             |                            | $                                                                 |                                          |       |            | $       | 746              |       |        | $       |      |   
|                                                                            |                                                                                             |                            |                                                                   |                                           |       |            |         |                  |       |        |         |      
|                                                                            | Issuance of common stock warrants in connection with a proposed initial public offering     |                            | $                                                                 |                                          |       |            | $       | 456              |       |        | $       |      |   
|                                                                            |                                                                                             |                            |                                                                   |                                           |       |            |         |                  |       |        |         |      
|                                                                            | Issuance of common stock warrants in connection with redeemable convertible preferred
stock |                            | $                                                                 |                                          |       |            | $       | 442              |       |        | $       |      |   
|                                                                            |                                                                                             |                            |                                                                   |                                           |       |            |         |                  |       |        |         |      
|                                                                            | Issuance of common stock for promissory notes                                               |                            | $                                                                 |                                          |       |            | $       |                 |       |        | $       | 1     |   
|                                                                            |                                                                                             |                            |                                                                   |                                           |       |            |         |                  |       |        |         |      
|                                                                            | Conversion of promissory notes to redeemable convertible preferred stock                    |                            | $                                                                 |                                          |       |            | $       |                 |       |        | $       | 1,047 |   
|                                                                            |                                                                                             |                            |                                                                   |                                           |       |            |         |                  |       |        |         |      

See notes to consolidated financial statements

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##### Table of Contents



BAM! ENTERTAINMENT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS




For the years ended June 30, 2002 and 2001, and for the period from October 7,
1999 (inception) through June 30, 2000.

1. Organization and Summary of Significant Accounting Policies

Organization and Business BAM! Entertainment, Inc. and subsidiaries (the
Company) is a developer and publisher of interactive entertainment software
products for popular interactive entertainment hardware platforms and personal
computers. The Company licenses popular properties that have consumer
recognition and appeal from a wide variety of sources and publishes software
based on their motion picture, television, sports and cartoon character
properties. The Company sells its software to mass merchandisers and
independent distributors.

Principles of Consolidation The consolidated financial statements include the
Company and its wholly-owned subsidiaries in the United Kingdom. All
intercompany transactions and balances have been eliminated in consolidation.

Stock Split In May 2000, the Company effected a reverse common stock split of
0.195 to one with an adjusted par value of $0.001. On August 15, 2001, the
Company effected a common stock split of 4.7 to one with an adjusted par value
of $0.001 and increased the number of authorized shares of common stock to
100,000,000 shares and preferred stock to 10,000,000 shares. All common share
and per share amounts in these consolidated financial statements have been
adjusted to give effect to these stock splits.

Foreign Currency Translation The functional currency for the Companys
foreign operations is the applicable local currency. The translation of the
applicable foreign currencies into U.S. dollars is performed for balance sheet
accounts using exchange rates in effect at the balance sheet date and for
revenue and expense accounts using a weighted-average exchange rate during the
period. The gains or losses resulting from such translation are reported as a
separate component of equity as accumulated other comprehensive income (loss),
whereas gains or losses resulting from foreign currency transactions are
included in results of operations.

Use of Estimates The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosures of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Such estimates include, but
are not limited to: allowances for price protection, uncollectible accounts
receivable, sales returns and cooperative advertising; inventory valuations;
recoverability of prepaid royalties, capitalized software costs and licensed
assets; depreciation and amortization; taxes and contingencies. Actual results
could differ from those estimates.

Certain Significant Risks and Uncertainties The Company has experienced
recurring net losses through the year ended June 30, 2002. Net losses for the
years ended June 30, 2002 and 2001 and for the period from October 7, 1999
(inception) through June 30, 2000 were $15,673,000, $1,602,000, and $803,000,
respectively. At June 30, 2002 the Company had an accumulated deficit of
$23,618,000. Continued negative cash flows create uncertainty about the
Companys ability to implement its operating plan. In addition, current market
conditions present uncertainty as to the ability of the Company to secure
financing, if needed, and to reach profitability. If cash and cash equivalents
and short-term investments, together with cash generated from operations are
insufficient to satisfy the Companys liquidity requirements, the Company may
seek to raise additional financing or reduce the scope of its planned product
development and marketing efforts. However, there can be no assurances as to
the availability of additional financing, the terms of such financing if it is
available, or as to the ability of the Company to achieve positive cash flow
from operations. Although there is uncertainty, management believes its cash
and cash equivalents and short-term investments, together with cash generated
form operations are sufficient to meet its anticipated needs for working
capital and capital expenditures at least through June 30, 2003.

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Financial instruments which potentially subject the Company to concentrations
of credit risk consist primarily of cash and cash equivalents and accounts
receivable. Cash and cash equivalents are held with financial institutions and
consist primarily of cash in bank accounts. The Company generates revenue
primarily from large retailers in the United States and generally does not
require its customers to provide collateral or other security to support
accounts receivable. To reduce credit risk, management performs ongoing credit
evaluations of its customers financial condition and maintains allowances for
estimated potential bad debt losses.

The Company participates in a dynamic high-technology industry and believes
that changes in any of the following areas could have a material adverse effect
on the Companys future financial position, results of operations or cash
flows: ability to obtain future financing; advances and trends in new
technologies and industry standards; competitive pressures in the form of new
and more popular products by competitors; changes in the overall demand by
customers and consumers for products offered by the Company; unexpected
quantities of product returns and price protection allowances; changes in
certain strategic relationships or customer relationships; the loss of
significant customers; litigation or claims against the Company based on
intellectual property, patent, product, regulatory or other factors; the
inability to procure the necessary third-party licenses or proprietary software
needed to develop its products; risks associated with changes in domestic and
international economic and/or political conditions or regulations; risks
associated with regulation within the industry; availability of necessary
product components; the Companys ability to attract and retain employees
necessary to support its growth; the Companys reliance on senior management;
the Companys limited operating history; inability to manage the growth of the
business; delays and cost overruns on products under development; risks
associated with development of products by third-party developers; failure to
anticipate changing consumer preferences; dependence on hardware manufacturers
for the provision of the platforms necessary to generate revenue; the Companys
inability to protect its proprietary rights or to avoid claims from other
companies; short product life cycles; and the reliance on platform
manufacturers in manufacturing the Companys products.

Cash and Cash Equivalents The Company considers all highly liquid debt
instruments purchased with maturities at the date of purchase of three months
or less to be cash equivalents. The recorded carrying amounts of the Companys
cash and cash equivalents approximate their fair market value due to their
short maturities.

Short-term investments The Company invests excess cash in what the Company
believes to be high quality and easily marketable instruments to ensure that
cash is readily available for use in its current operations. Accordingly, all
marketable securities are classified as available-for-sale in accordance with
the provisions of Statement of Financial Accounting Standards (SFAS) No. 115.
All investments are reported at fair market value with the related unrealized
holding gains and losses reported as a component of accumulated other
comprehensive income (loss). Unrealized holding gains on the portfolio as of
June 30, 2002 were $52,000.

Inventories Inventories, which consist of finished goods, are stated at the
lower of cost (based upon the first-in, first-out method) or market value. The
Company estimates the net realizable value of slow moving inventories on a
product-by-product basis and charges the excess of cost over net realizable
value to cost of revenues.

Property and Equipment Property and equipment are stated at cost.
Depreciation is computed using the straight-line method over the estimated
useful lives of the assets of three years.

Prepaid Royalties, Capitalized Software Costs and Licensed Assets Advance
royalty payments for intellectual property licenses are capitalized and
recorded as prepaid royalties. Royalty payments for intellectual property
licenses are classified as current assets to the extent they relate to
anticipated sales during the subsequent year and long-term assets if the sales
are anticipated after one year. Royalty payments are based on sales and
royalties are generally payable on a quarterly basis. Prepaid royalties are
amortized to cost of revenues commencing upon the product release at the
greater of the contractual royalty rate based on actual product sales, or the
ratio of current revenues to total projected revenues. The Company evaluates
the future recoverability of prepaid royalties on a quarterly basis and
expenses them to costs of revenue if and when they are deemed unrecoverable.

The Company utilizes both independent software developers (who are paid
advances against future royalties) and internal development teams to develop
its software. The Company accounts for prepaid royalties relating to
development agreements and capitalized software costs in accordance with SFAS
No. 86, Accounting for the Costs of Computer Software to be Sold, Leased, or
Otherwise Marketed.Payments made to independent software

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developers under development agreements are capitalized to software development
costs once technological feasibility is established or if the development costs
have an alternative future use. Prior to establishing technological
feasibility, software development costs are expensed to research and
development and to cost of revenues subsequent to technological feasibility.
Internal development costs are capitalized to software development costs once
technological feasibility is established. Technological feasibility is
evaluated on a product-by-product basis. For products where proven game engine
technology exists, this may occur early in the development cycle.

Commencing upon product release, capitalized software development costs are
amortized to royalties, software costs, license costs and project
abandonment. Software development costs are expensed if and when they are
deemed unrecoverable. The following criteria are used to evaluate
recoverability of software development costs: the commercial acceptance of
prior products released on a given hardware platform; orders for a product
prior to its release; and actual development costs of a product as compared to
forward-looking projections. Amortization of such costs is based on the greater
of the proportion of current revenues to total projected revenues, or the
straight-line method over the estimated product life (generally three to six
months). The Company evaluates the future recoverability of capitalized amounts
on a quarterly basis. Research and development costs are expensed as incurred.

Fair Value of Financial Instruments The Companys financial instruments
include cash equivalents, short-term investments and short-term debt. Cash
equivalents and short term-investments are stated at fair market value, based
on quoted market prices. The recorded carrying amount of the Companys
short-term debt approximates fair value since such debt instruments bear
interest at rates which approximate market rates.

Long-Lived Assets The Company evaluates long-lived assets, such as property
and equipment and certain identifiable intangibles for impairment whenever
events or changes in circumstances indicate that the carrying amount of an
asset may not be recoverable. Recoverability of assets to be held and used is
measured by comparison of the carrying amount of an asset to future
undiscounted net cash flows expected to be generated by the asset. If such
assets are considered to be impaired, the impairment to be recognized is
measured by the amount by which the carrying amount of the assets exceeds the
fair value of the assets, as defined in SFAS No. 121, Accounting for the
Impairment of Long- Lived Assets and for Long- Lived Assets To Be Disposed Of.

Income Taxes The Company accounts for income taxes under an asset and
liability approach. Deferred income taxes reflect the impact of temporary
differences between assets and liabilities recognized for financial reporting
purposes and such amounts recognized for income tax reporting purposes, and
operating loss and other tax credit carryforwards measured by applying
currently enacted tax laws. Valuation allowances are provided when necessary to
reduce net deferred tax assets to an amount that is more likely than not to be
realized in the future.

Stock-Based Compensation The Company accounts for stock-based awards to
employees using the intrinsic value method in accordance with Accounting
Principles Board Opinion (APB) No. 25, Accounting for Stock Issued to
Employees,and to nonemployees using the fair value method in accordance with
SFAS No. 123, Accounting for Stock-Based Compensationand in accordance with
EITF 96-18, Accounting for Equity Instruments That Are Issued To Other Than
Employees for Acquiring, or in Conjunction with Selling, Goods or Services.

Redeemable Convertible Preferred Stock Dividend Beneficial conversion charges
arise in connection with financing arrangements where the Company has issued
redeemable convertible preferred stock at a discount to the deemed fair market
value of the common stock of the Company at the commitment date, which is
generally the date of issuance. Depending on the nature and purpose of the
arrangement, the Company values the beneficial conversion feature by
subtracting the related effective conversion price from the deemed fair value
of the Companys common stock, and then multiplying the difference by the
number of shares of common stock that would be issued upon conversion. The
value of the beneficial conversion feature is limited to the relative fair
value of the converted instrument. The Company records as a deduction of
stockholders equity the value of the beneficial conversion feature and
accretes this value over the expected period that the redeemable convertible
preferred stock becomes convertible.

Revenue Recognition The Company recognizes revenue in accordance with
Statement of Position 97-2, Software Revenue Recognition,and related
interpretations, when persuasive evidence of an arrangement exists, delivery
has occurred, the price has been fixed or is determinable and collectibility
has been reasonably assured. This occurs when finished goods in the form of
software on a cartridge, CD-ROM or similar media are shipped to the customer.

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Under certain conditions, we may allow customers to exchange and return our
products and from time to time provide price protection or allow returns on
certain unsold merchandise in the form of a credit against amounts due from the
customer. On a product by product basis, revenue from product sales is
reflected net of the allowance for returns and price protection. The Company
estimates the amount of future returns, and price protection based upon current
known circumstances and historical results.

Cost of Revenues Cost of revenues includes manufacturing costs of the
finished goods, freight, inventory management costs, royalties incurred,
software amortization and amortization of non-cash charges related to warrants
and rights to acquire common stock issued to production companies.

Advertising Advertising and sales promotion costs are generally expensed as
incurred, except for television airtime and print media costs associated with
media companies which are deferred and charged to expense as the airtime or
advertising space is used for the first time. Advertising costs were
$5,701,000, $2,160,000 and $54,000 for the years ended June 30, 2002 and 2001,
and the period from October 7, 1999 (inception) through June 30, 2000
respectively.

Net Loss per Share Basic earnings/(loss) per share (EPS) excludes dilution
and is computed by dividing net earnings/(loss) attributable to common
shareholders by the weighted average number of common shares outstanding for
the period excluding the weighted average common shares subject to repurchase.
Diluted EPS reflects the potential dilution that could occur if securities or
other contracts to issue common stock (redeemable convertible preferred stock,
common stock options and warrants using the treasury stock method) were
exercised or converted into common stock. Potential common shares in the
diluted EPS computation are excluded in net loss periods as their effect would
be antidilutive.

Comprehensive Income (Loss)  In fiscal 2000, the Company adopted SFAS No. 130,
Reporting Comprehensive Income,which requires that an enterprise report, by
major components and as a single total, the change in its net assets during the
period from nonowner sources. Comprehensive income (loss) for the years ended
June 30, 2002 and 2001, and the period from October 7, 1999 (inception) through
June 30 have been disclosed within the statement of stockholders equity
(deficit).

Recently Adopted and Issued Accounting Pronouncements In June 1998, the
Financial Accounting Standards Board (FASB) issued SFAS No. 133, Accounting for
Derivative Instruments and Hedging Activities.This statement requires
companies to record derivatives on the balance sheet as assets or liabilities,
measured at fair value. Gains or losses resulting from changes in the values of
those derivatives would be accounted for depending on the use of the derivative
and whether it qualifies for hedge accounting. SFAS No. 133 was effective for
the Company beginning in the first quarter of fiscal year 2001. The Company
adopted SFAS No. 133 on July 1, 2001 and the adoption did not have a
significant impact on the Companys consolidated financial statements during
the year ended June 30, 2001.

In April 2001, the Emerging Issues Task Force issued No. 00-25 (EITF 00-25),
Vendor Income Statement Characterization of Consideration Paid to a Reseller of
the Vendors Products, which states that consideration from a vendor to a
reseller of the vendors products is presumed to be a reduction of the selling
prices of the vendors products and, therefore, should be characterized as a
reduction of revenue when recognized in the vendors income statement. That
presumption is overcome and the consideration can be categorized as a cost
incurred if, and to the extent that, a benefit is or will be received from the
recipient of the consideration. That benefit must meet certain conditions
described in EITF 00-25. In November 2001, the Emerging Issues Task Force
issued No. 01-09 (EITF 01-09), Accounting for Consideration Given by a Vendor
to a Customer or Reseller of the Vendors Products, which clarifies and
modifies certain items discussed in EITF 00-25. The consensus for both EITF
00-25 and EITF 01-09 should be applied no later than in annual or interim
financial statements for periods beginning after December 15, 2001. The Company
adopted EITF 00-25 and EITF 01-09 during the year ended June 30, 2002 and the
adoption did not have a material impact on our consolidated financial position
or results of operations.

In June 2001, the FASB issued SFAS No. 141, Business Combinations,and SFAS No.
142, Goodwill and Other Intangible Assets.SFAS No. 141 requires that all
business combinations initiated after June 30, 2001 be accounted for under the
purchase method and addresses the initial recognition and measurement of
goodwill and other intangible assets acquired in a business combination. SFAS
No. 142 addresses the initial recognition and measurement of intangible assets
acquired outside of a business combination and the accounting for goodwill and

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other intangible assets subsequent to their acquisition. SFAS No. 142 provides
that intangible assets with finite useful lives be amortized and that goodwill
and intangible assets with indefinite lives not be amortized, but will instead
be tested at least annually for impairment. The Company is required to adopt
SFAS No. 142 no later than for its fiscal year beginning July 1, 2002. The
Company does not carry any goodwill or other intangibles on its balance sheet
as of June 30, 2002, and therefore the adoption of SFAS No. 142 will not have a
material effect on the Companys consolidated financial statements.

In June 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement
Obligations.SFAS No. 143 addresses financial accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and
the associated asset retirement costs. This statement is effective for fiscal
years beginning after June 15, 2002, however earlier application is permitted.
The Company will adopt SFAS No. 143 on January 1, 2003. The Company believes
the adoption of this statement will not have an impact on its financial
position or operating results.

In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets,which addresses financial accounting and
reporting for the impairment or disposal of long-lived assets. While SFAS No.
144 supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to Be Disposed Of,it retains many of the fundamental
provisions of SFAS No. 121. SFAS No. 144 also supersedes the accounting and
reporting provisions of APB No. 30, Reporting the Results of
OperationsReporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions,for
the disposal of a segment of a business. However, it retains the requirement in
APB No. 30 to report separately discontinued operations and extends that
reporting to a component of an entity that either has been disposed of (by
sale, abandonment, or in a distribution to owners) or is classified as held for
sale. SFAS No. 144 is effective for fiscal years beginning after December 15,
2001 and interim periods within those fiscal years. The adoption of SFAS No.
144 is not expected to have a material effect on its consolidated financial
statements.

In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated
with Exit or Disposal Activities, which addresses accounting for restructuring
and similar costs. SFAS No. 146 supercedes previous accounting guidance,
principally Emerging Issues Task Force issue No. 94-3 (EITF 94-3). The
Company is required to adopt SFAS No. 146 for restructuring activities
initiated after December 31, 2002. SFAS No. 146 requires that the liability for
costs associated with an exit or disposal activity be recognized when the
liability is incurred. Under EITF 94-3, a liability for an exit cost was
recognized at the date of the companys commitment to an exit plan. SFAS No.
146 also established that the liability should initially be measured and
recorded at fair value. Accordingly, SFAS 146 may affect the timing of
recognizing future restructuring plans.

2. Short-term investments

The Company has classified all of its short-term investments as
available-for-sale securities, as the sale of such securities may be required
prior to maturity to implement management strategies. The Companys short-term
investments comprise U.S. Government Securities of $3,402,000, Corporate Notes
of $1,058,000 and Foreign Debt Securities of $3,725,000 at June 30, 2002, with
original maturities ranging between 90 days and two years.

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3. Prepaid Royalties, Capitalized Software Costs and Licensed Assets

Prepaid royalties, capitalized software costs and licensed assets consisted of
the following at June 30:

|                           |                   |                            |         |                |         |      |        |       |        |  
|-------------------------- | ----------------- | -------------------------- | ------- | -------------- | ------- | ---- | ------ | ----- | ------ | -
|                           |                   |                            |         | 2002           |         | 2001
|                           |                   |                            |         |                |         |     
|                           |                   |                            |         | (in thousands)
|Prepaid royalties          |                   | $                          | 2,847   |                |         | $    | 1,181  |      
|Capitalized software costs |                   |                            | 14,573  |                |         |      | 4,681  |      
|Licensed assets            |                   |                            | 905     |                |         |      | 1,607  |      
|                           |                   |                            |         |                |         |      |        |      
|                           |                   |                            | 18,325  |                |         |      | 7,469  |      
|Less current portion:      |                   |                            |         |                |         |      |        |      
|                           |                   | Prepaid royalties          |         |                | (1,007  | )    |        |       | (1,181 | )
|                           |                   | Capitalized software costs |         |                | (11,496 | )    |        |       | (3,926 | )
|                           |                   | Licensed assets            |         |                | (355    | )    |        |       | (817   | )
|                           |                   |                            |         |                |         |      |        |      
|                           |                   |                            | (12,858 | )              |         |      | (5,924 | )    
|                           |                   |                            |         |                |         |      |        |      
|                           | Long term portion |                            | $       | 5,467          |         |      | $      | 1,545 |       
|                           |                   |                            |         |                |         |      |        |      

During the years ended June 30, 2002 and 2001, and the period from October 7,
1999 (inception) through June 30, 2000, the Company amortized $9,600,000,
$954,000 and $0 respectively, of capitalized software costs, and recorded
$695,000, $134,000 and $0, respectively, of capitalized software costs and
impaired prepaid royalties as part of project abandonment costs.




4. Property and Equipment, Net

Property and equipment consisted of the following at June 30:

|                                                |  |                |       |      |  |   |      |  
|----------------------------------------------- |  | -------------- | ----- | ---- |  | - | ---- | -
|                                                |  | 2002           |       | 2001
|                                                |  |                |       |     
|                                                |  | (in thousands)
|Furniture, equipment and leasehold improvements |  | $              | 530   |      |  | $ | 145  |  
|Computer equipment                              |  |                | 678   |      |  |   | 305  |  
|Computer software                               |  |                | 213   |      |  |   | 62   |  
|                                                |  |                |       |      |  |   |      |  
|                                                |  |                | 1,421 |      |  |   | 512  |  
|Less accumulated depreciation and amortization: |  |                | (434  | )    |  |   | (117 | )
|                                                |  |                |       |      |  |   |      |  
|Total property and equipment, net               |  | $              | 987   |      |  | $ | 395  |  
|                                                |  |                |       |      |  |   |      |  

5. Long-term receivable

On January 22, 2002 Kmart, a customer of the Company, filed voluntary petitions
for reorganization under chapter 11 of the U.S. Bankruptcy Code. On January
22, 2002 the Company had an accounts receivable balance from Kmart of $1.7
million. The Company is an unsecured creditor, and as such is at risk of not
recovering in full its accounts receivable balance. Accordingly, the Company
has recorded an allowance against the receivable. Kmart has stated that at
earliest it will complete its reorganization in 2003. Accordingly, the Company
has classified the receivable, net of an allowance of $1,080,000 as a long-term
asset. At June 30, 2002 the Company reevaluated the allowance and believes that
the level of the reserves are appropriate. Subsequent to January 22, 2002 Kmart
arranged debtor-in-possession financing and the Company has sold product to
Kmart under this arrangement. Accounts receivables under this financing are
classified as part of accounts receivable in current assets.

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6. Other Assets

Other assets at June 30, 2002 comprise rent deposits of $30,000. Other assets
at June 30, 2001 comprise issuance costs in connection with the Companys
initial public offering of $1,730,000 and was reclassified to shareholders
equity during the year ended June 30, 2002 upon the initial public offerings
completion.

7. Short-term borrowings

Financing Agreement

In February 2002, the Company entered into a two year factoring agreement (the
Agreement) with a finance company, whereby the Company assigns its North
American receivables to the finance company. The finance company is responsible
for collecting customer receivables, and upon collection, remits the funds to
the Company, less a service fee. Under the Agreement, the Company may obtain
advances, subject to the finance companys discretion, in the form of cash or
as collateral for letters of credits, up to a maximum of 75% of outstanding
domestic receivables at any point in time.

Under the terms of the Agreement, the Company pays a service fee on all
receivables assigned, with a minimum annual fee of $150,000, and interest at
prime plus 1% on all cash sums advanced. All fees are included in interest
expense. The Company bears the collection risk on its accounts receivable that
are assigned, unless the finance company approves the receivable at the time of
assignment, in which case the finance company bears a portion of the risk.

The finance company has a security interest in the Companys accounts
receivable, inventory, fixed assets and intangible assets. As of June 30,
2002, the Company had advances of $1,359,000 outstanding under the Agreement.

Prior to entering into the Agreement, the Company had entered into a master
purchase order assignment agreement (the Finance Agreement) with a different
finance company, whereby the Company assigned purchase orders entered into with
its customers to the finance company and requested the finance company purchase
finished goods to fulfill such customer purchase orders.

The Finance Agreement, entered into in February 2000, specified that the
finance companys funding commitment with respect to a customer purchase order
should not exceed 60% of the retail purchase order price. Under the Finance
Agreement the finance companys aggregate outstanding funding (i.e., advance of
funds or purchase of finished goods to fulfill customer purchase orders) was
limited to $5.0 million. The Company was responsible for collecting customer
receivables, bore the risk of loss on all uncollectible accounts, and was
required to remit customer receipts directly to the finance company up to the
amounts funded by the finance company. The Company retained collections in
excess of the amounts funded by the finance company.

Under the initial terms of the Finance Agreement, the Company was required to
pay the finance companys expenses under the contract, a deal fee (consisting
of a transaction and initiation fee equal to 5.0% of the face amounts of
letters of credit issued or other funds advanced by the finance company), a
daily maintenance fee of 0.067%, a materials advance fee at prime rate plus
4.0% and a late payment fee where applicable; all of which are included in
interest expense.

In August 2001, the Company amended the Finance Agreement, initially increasing
the aggregate outstanding funding amount to $10.0 million, and then decreasing
the transaction and initiation fee to 3% until the earlier of the termination
of the agreement or December 31, 2001, if the Companys initial public offering
had not occurred by that date. The Company completed its initial public
offering in November 2001. In connection with this latter amendment and the
execution of a $7.0 million factoring arrangement with an affiliate of the
finance company, the Company issued a warrant to the finance company to
purchase 100,000 shares at an exercise price equal to the initial public
offering price of $8 per share. See also Note 8.

Upon the signing of the Finance Agreement, the Company paid the finance company
a security deposit of $90,000. An extension payment of $50,000 was made when
the contract was amended in December 2000, and a further

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amendment fee of $120,000 was incurred when the contract was amended in August
2001. These costs were recorded as interest expense.

The Finance Agreement and the factoring line with the affiliate terminated in
February 2002, and all outstanding amounts funded were fully repaid. The
amounts outstanding under the Finance Agreement and the factoring line with the
affiliate of the finance company as of June 30, 2002 and 2001 were $0 and
$4,164,000, respectively.

Outstanding borrowings under the above Finance Agreement were collateralized by
inventories, accounts receivable, fixed assets and intangible assets of the
Company.

As of June 30, 2002 and June 30, 2001, the Company had outstanding letters of
credit issued on their behalf of $2,286,000 and $2,019,000 respectively.
Management does not expect any material losses to result from these off-balance
sheet instruments.

Line of Credit

In November 2000, the Company entered into a short-term revolving line of
credit with a bank under which it could borrow up to $1,000,000. In May 2001
all sums borrowed were repaid and the line of credit was closed. Sums borrowed
under the line were secured by restricted cash held in a money market account
with the same bank, and interest was payable on sums borrowed at the banks
base rate, plus 3%.

8. Redeemable Convertible Preferred Stock and Common Stock

Redeemable Convertible Preferred Stock

Under the Companys certificate of incorporation, as amended on August 15,
2001, the Company is authorized to issue 10,000,000 shares of redeemable
convertible preferred stock. The Company issued 976,220 shares of Series A
redeemable convertible preferred stock on June 30, 2000 for cash, services and
through the conversion of promissory notes. On December 28, 2000, the Company
issued 294,620 shares of Series B redeemable convertible preferred stock and on
May 24, 2001, the Company issued 245,659 shares of Series C redeemable
convertible preferred stock. Upon completion of the Companys initial public
offering in November 2001, each outstanding share of the Companys issued
redeemable convertible preferred stock automatically converted into 4.7 shares
of the Companys common stock.

Common Stock

In October 1999, the Company issued 580,962 shares of common stock to its
founder in exchange for a note receivable from the founder. Also in October
1999, the Company issued 274,950 shares at $0.11 per share to consultants in
exchange for services performed valued at $30,000.

In June 2000, an additional 614,060 shares were issued at $0.11 per share in
exchange for cash of $59,000 and services valued at $7,000.

As discussed in Note 15, in April 2001, the Company issued 68,738 shares of
common stock pursuant to a license agreement with a production company. The
Company was obligated to issue 68,738 shares of common stock as one of the
films for which the Company elected to produce software products was released
by the production company. The Company capitalized the cost of this issuance at
the fair market value of the common stock, equal to $746,000, and amortized
this full amount to royalties, software costs, license costs and project
abandonment during the year ended June 30, 2002.

In November 2001, the Company completed its initial public offering, selling
5,750,000 common shares at $8.00 per share. Upon the closing, each outstanding
share of the Companys redeemable convertible preferred stock automatically
converted into 4.7 shares of the Companys common stock, resulting in the
issuance of 7,127,528 shares of common stock.

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During the year ended June 30, 2002, 20,562 shares of the Companys common
stock were issued upon exercise of stock options, 4,956 shares of common stock
were issued under the Companys employee share purchase plan, and 141,000
shares of the Companys common stock were issued upon exercise of a warrant.

Warrants

Warrants to purchase a total of 853,450 and 674,450 shares of common stock were
outstanding as of June 30, 2002 and June 30, 2001, respectively.

Under an agreement (the Agreement) entered into with a production company
during October 2000, the Company obtained the exclusive right of first refusal,
for a period of five years, to develop products based on films produced by the
production company and to distribute them worldwide. In addition, the
production company will provide the Company with free access to any publicity
materials it prepares. In exchange for these rights, the Company will have to
pay royalties to the production company calculated as a percentage of sales of
the developed products. Also, in connection with the Agreement the Company
issued the production company warrants to purchase 470,000 shares of common
stock at an exercise price of $1.06 per share. The warrants expire in September
2006. Under the warrant agreement, 50% of the warrants became vested and
exercisable upon execution of the Agreement, while the remaining warrants
became vested in equal portions in December 2000, representing the dates on
which the production company delivered, in accordance with the Agreement,
written notice that a specific film will be available to be exploited by the
Company and when the Company exercised its right of first refusal for another
film under the Agreement. The fair value of these warrants at the grant date
was estimated to be $708,000, using the Black-Scholes option pricing model with
the following assumptions: expected term equal to six years; risk-free interest
rate of 5.8%; volatility of 95%; and no dividends during the expected term. Of
this amount $354,000 relates to 50% of the warrants that vested upon execution
of the Agreement and will be amortized on a straight-line basis over the
five-year term of the Agreement. The fair value of the remaining 50% of the
warrants has been estimated at the date of vesting using the Black-Scholes
option pricing model with the following assumptions: expected term equal to six
years; risk-free interest rate of 5.0%; volatility of 95%; and no dividends
during the expected term. In December 2000, when the remaining warrants vested,
the fair value of the remaining 50% of the warrants of $556,000 was capitalized
to prepaid royalties, capitalized software costs and licensed assets and will
be amortized over the life of the products (generally between three and six
months) to which it relates when these products are released. During the years
ended June 30, 2002, and June 30, 2001, $71,000 and $48,000, respectively, was
amortized to royalties, software costs, license costs, and project abandonment.

In connection with the Series B redeemable convertible preferred stock
offering, the Company issued warrants to a service provider to purchase 141,000
shares of its common stock at an exercise price of $3.76 per share. The
warrants expired on the earlier of either (i) December 2003, (ii) upon the
completion of a public offering of common stock with aggregate proceeds greater
than $15,000,000 and at a price per share not less than $15.96 per share or
(iii) upon the completion of a subsequent private equity financing or in the
event of a change in control, sale or disposition of substantially all of the
Companys assets or recapitalization, reclassification or reorganization of the
Companys stock resulting in aggregate proceeds greater than $10,000,000 and at
a price per share not less than $7.45 per share. The value of these warrants at
the grant date was estimated using the Black-Scholes option pricing model with
the following assumptions: expected term equal to three years; risk-free
interest rate of 5.1%; volatility of 95%; and no dividends during the expected
term. The fair value of these warrants of $283,000 was recorded as an issuance
cost against the proceeds of the Series B redeemable convertible preferred
stock offering. The warrant was exercised during the year ended June 30, 2002.

In connection with the Series C redeemable convertible preferred stock
offering, the Company issued warrants to a service provider to purchase 16,450
shares of its common stock at an exercise price of $4.80 per share. In November
2001, this warrant was amended to increase the exercise price to $16.50 per
share. The warrants expire in May 2006. The value of these warrants at the
grant date was estimated using the Black-Scholes option pricing model with the
following assumptions: expected term equal to five years; risk-free interest
rate of 5.1%; volatility of 95%; and no dividends during the expected term. The
fair value of these warrants of $159,000 was recorded as an issuance cost
against the proceeds of the Series C redeemable convertible preferred stock
offering.

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The Company calculated the beneficial conversion feature related to the
issuance of the 245,659 shares of Series C redeemable convertible preferred
stock, in accordance with EITF 00-27 Application of Issue No. 98-5 to Certain
Convertible Instrumentsas follows:



| |  |  | The Company calculated the difference between the aggregate deemed
fair market value of the common stock into which the Series C
redeemable convertible preferred stock is convertible of $13,200,000,
and the aggregate purchase price paid for the Series C redeemable
convertible preferred stock of $5,540,000, i.e. $7,660,000, and limited
the amount of the deemed dividend that will be recorded against the
accumulated deficit to the gross amount of proceeds allocated to these
shares of Series C redeemable convertible preferred stock to $5,540,000
in accordance with paragraph 6 of EITF 98-5 Accounting for Convertible
Securities with Beneficial Conversion Features or Contingently
Adjustable Conversion Ratios"
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Since the shares of Series C redeemable convertible preferred stock
were immediately convertible at the date of issue, the Company recorded
the amount of the deemed dividend in the financial statements for the
year ended June 30, 2001.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             

In May 2001, in exchange for legal services rendered by a service provider in
connection with a proposed initial public offering, the Company issued warrants
to purchase 47,000 shares of its common stock at an exercise price of $4.80 per
share. The warrants expire in May 2006. The value of these warrants at the
grant date was estimated using the Black-Scholes option pricing model with the
following assumptions: expected term equal to five years; risk-free interest
rate of 5.1%; volatility of 95%; and no dividends during the expected term. The
fair value of these warrants of $456,000 was capitalized to other assets and
was recorded as an issuance cost in connection with the Companys initial
public offering.

In connection with a Finance Agreement, as described in Note 7, the Company
issued a warrant in August 2001 to a finance company to purchase 100,000 shares
at an exercise price equal to $8 per share, being the initial public offering
price. The fair value of the warrant was initially estimated to be $806,000 at
the time of issuance of the warrant, then subsequently remeasured at $485,000
at the time of the initial public offering using the Black-Scholes option
pricing model with the following assumptions: expected term equal to three
years; risk-free interest rate of 2.9%; volatility of 95%; and no dividends
during the expected term, The fair value was capitalized to prepaid expenses
and was amortized to interest expense over the term of the Finance Agreement,
which ended in February 2002. During the year ended June 30, 2002, the
$485,000 was amortized to interest expense.

In connection with an agreement entered into with a production company during
January 2002, the Company obtained the exclusive right of first refusal, for a
period of five years, to develop products based on certain properties owned by
the production company and to distribute them worldwide. In exchange for these
rights, the Company will have to pay royalties to the production company
calculated as a percentage of sales of the developed products. Also, in
connection with the agreement, the Company is required to issue to the
production company warrants to purchase up to 50,000 shares of common stock, in
pre-determined multiples of either 5,000 or 10,000 shares, upon the occurrence
of certain pre-determined events. Warrants will be issued at the average
closing price of the Companys stock for the five days immediately prior to the
date of issuance, have a five year term from date of issuance, are fully vested
and are immediately exercisable upon issuance. In January 2002, the Company
issued warrants to purchase 10,000 shares of common stock under this agreement,
and in March 2002 the Company issued a warrant to purchase an additional 10,000
shares of common stock under the agreement. The fair value of the warrant to
purchase 10,000 shares issued in January was estimated to be $42,000 at the
grant date, using the Black-Scholes option pricing model with the following
assumptions: expected term equal to five years; risk-free interest rate of
4.3%; volatility of 95%; and no dividends during the expected term. The fair
value of the warrant to purchase 10,000 shares issued in March was estimated to
be $44,000 at the grant date, using the Black-Scholes option pricing model with
the following assumptions: expected term equal to five years; risk-free
interest rate of 4.8%; volatility of 95%; and no dividends during the expected
term. The fair values of the warrants were capitalized to prepaid royalties,
capitalized software costs and licensed assets and will be amortized over the
life of the products (generally between three and six months) to which they
relate when these products are released. As the remaining 30,000 warrants
contingently issuable under this arrangement are dependent upon the occurrence
of certain pre-determined events, the Company will only measure the value of
these warrants in accordance with EITF 96-18 Accounting for Equity Instruments
That Are Issued To Other Than Employees for Acquiring, or in Conjunction with
Selling, Goods or Servicesif and when the warrants are issued. When the
software product is released, the Company will amortize

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##### Table of Contents



the non-cash charge over the life of the product, which is expected to be
between three and six months. The Company cannot estimate the aggregate dollar
amount of these future non-cash charges as they are based on the Companys
share price at a future point in time. During the year ended June 30, 2002, no
amounts were amortized to royalties, software costs, license costs, or project
abandonment.

In May 2002, in connection with a licensing and publishing agreement entered
into with a publishing company, we granted to the production company a warrant,
with a ten year term from the date of issue, to purchase up to 200,000 shares
of our common stock at an exercise price of $2.60, of which 15,000 became
immediately exercisable upon the signing of the agreement, and the remaining
185,000 only become exercisable in multiples of 4,625 shares upon each election
by us to produce a title based on any films, made for television movies, or
television series produced from screenplays to be produced by the publishing
company, up to a maximum ten titles, and multiples of 13,875 shares upon the
theatrical release or television air-date of each film for which we have
developed a title. Upon expiration of the agreement, any unexercised warrants
will cease to be exercisable. Our agreement expires upon the later of five
years or either the theatrical release or television air-date of the tenth film
or television series on which we base a product, but in no event later than
eight years from the date of the agreement, unless seven films or television
series have been released or aired, respectively, seven years from the date of
the agreement, in which event the agreement would expire at such time. The fair
value of the 15,000 shares immediately exercisable upon the signing of the
agreement was estimated to be $29,000 at the grant date, using the
Black-Scholes option pricing model with the following assumptions: expected
term equal to five years; risk-free interest rate of 4.6%; volatility of 95%;
and no dividends during the expected term. This amount will be amortized on a
straight-line basis over the five-year term of the agreement. The fair value of
the remaining 185,000 shares will be calculated as and when shares become
exercisable and will be capitalized to prepaid royalties, capitalized software
costs and licensed assets. As the warrants contingently exercisable under this
arrangement are dependent upon the occurrence of certain pre-determined events,
the Company will only measure the value of these warrants in accordance with
EITF 96-18 Accounting for Equity Instruments That Are Issued To Other Than
Employees for Acquiring, or in Conjunction with Selling, Goods or Servicesif
and when the warrants become exercisable. When the software product is
released, the Company will amortize the non-cash charge over the life of the
product, which is expected to be between three and six months. The Company
cannot estimate the aggregate dollar amount of these future non-cash charges as
they are based on the Companys share price at a future point in time. During
the year ended June 30, 2002, no amounts were amortized to royalties, software
costs, license costs, or project abandonment.

Stock Plans

Under the Companys 2000 Stock Incentive Plan adopted on July 10, 2000, and
amended in May 2001 and in August 2001, the Company may grant options to
purchase or directly issue up to 1,527,500 shares of common stock to employees,
directors and consultants at prices not less than the fair market value (as
determined by the Board of Directors) at the date of grant for incentive stock
options and not less than 85% of fair market value at the date of grant for
nonstatutory stock options. These options generally vest over a four-year
period and expire ten years from the date of grant.

In August 2001, the Company adopted the 2001 Stock Incentive Plan (UK Part)
(the UK Plan) as Schedule A to the 2000 Stock Incentive Plan. The UK Plan
provides for the grant of stock options to UK employees who satisfy certain
criteria. The UK Plan contains certain restrictions intended to comply with UK
taxation laws, including restrictions on exercise, limitations on the size of
options grants, requirements with respect to changes in capitalization and
other matters.

The Board of Directors, in their determination of fair market value on the date
of grant, takes into consideration many factors including, but not limited to,
the Companys stock price on the Nasdaq National Market, the Companys
financial performance, current economic trends, actions by competitors, market
maturity, emerging technologies, near-term backlog and, in certain
circumstances, valuation analyses performed by independent appraisers. These
valuation analyses utilize generally accepted valuation methodologies such as
the income and market approaches to valuing the Companys business.

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Stock option activity, including stock option activity outside the plan, is
summarized as follows:

|                                                                                              |  |                     |           |                  |  |   |      | 
|--------------------------------------------------------------------------------------------- |  | ------------------- | --------- | ---------------- |  | - | ---- | 
|                                                                                              |  | Options outstanding
|                                                                                              |  |                    
|                                                                                              |  | Number of           |           | Weighted average
|                                                                                              |  | shares              |           | exercise price  
|                                                                                              |  |                     |           |                 
|Balances, June 30, 2000                                                                       |  |                     |          |                  |  | $ |     | 
|Granted (weighted average fair value of $3.74 per share)                                      |  |                     | 833,075   |                  |  |   | 3.21 | 
|Cancelled                                                                                     |  |                     | (18,800   | )                |  |   | 0.46 | 
|                                                                                              |  |                     |           |                  |  |   |      | 
|Balances, June 30, 2001 (70,500 shares vested
at a weighted average price of $3.35 per share) |  |                     | 814,275   |                  |  |   | 3.28 | 
|Granted (weighted average fair value of $2.62 per share)                                      |  |                     | 1,060,560 |                  |  |   | 4.61 | 
|Cancelled                                                                                     |  |                     | (117,430  | )                |  |   | 3.94 | 
|Exercised                                                                                     |  |                     | (20,562   | )                |  |   | 0.46 | 
|                                                                                              |  |                     |           |                  |  |   |      | 
|Balances, June 30, 2002                                                                       |  |                     | 1,736,843 |                  |  | $ | 3.95 | 
|                                                                                              |  |                     |           |                  |  |   |      | 

During the years ended June 30, 2002 and 2001, and the period from October 7,
1999 (inception) through June 30, 2000, the Company granted stock options
outside the plan to acquire 268,800, 0, and 0 shares, respectively. There were
stock options outside the plan to acquire 268,800 and 0 shares outstanding as
of June 30, 2002 and 2001, respectively.

Additional information regarding options outstanding as of June 30, 2002 is as
follows:

|                  |  |                     |           |                  |  |                  |     |           |  |                  |       |                |  |  |         |  |  |   |       | 
|----------------- |  | ------------------- | --------- | ---------------- |  | ---------------- | --- | --------- |  | ---------------- | ----- | -------------- |  |  | ------- |  |  | - | ----- | 
|                  |  | Options outstanding |           |                  |  |                  |     |           |  |                 
|                  |  |                     |           |                  |  |                  |     |           |  |                 
|                  |  |                     |           |                  |  | Weighted average |     |           |  |                  |       | Vested options
|                  |  |                     |           |                  |  | Remaining        |     |           |  |                  |       |               
|Range of exercise |  | Number of           |           | contractual life |  | Weighted average |     | Number of |  | Weighted average
|prices            |  | shares              |           | (years)          |  | exercise price   |     | shares    |  | exercise price  
|                  |  |                     |           |                  |  |                  |     |           |  |                 
|$0.00 - $1.00     |  |                     | 130,621   |                  |  |                  | 8.0 |           |  | $                | 0.46  |                |  |  | 74,829  |  |  | $ | 0.46  | 
|$1.01 - $2.00     |  |                     | 171,403   |                  |  |                  | 8.3 |           |  |                  | 1.06  |                |  |  | 71,933  |  |  |   | 1.06  | 
|$2.01 - $3.00     |  |                     | 351,875   |                  |  |                  | 9.8 |           |  |                  | 2.02  |                |  |  |        |  |  |   |      | 
|$3.01 - $4.00     |  |                     | 513,943   |                  |  |                  | 9.4 |           |  |                  | 3.40  |                |  |  | 30,936  |  |  |   | 3.76  | 
|$4.01 - $5.00     |  |                     | 307,850   |                  |  |                  | 9.0 |           |  |                  | 4.75  |                |  |  | 102,616 |  |  |   | 4.79  | 
|$7.01 - $8.00     |  |                     | 94,000    |                  |  |                  | 9.2 |           |  |                  | 7.85  |                |  |  | 47,000  |  |  |   | 8.00  | 
|$11.01 - $12.00   |  |                     | 167,151   |                  |  |                  | 9.1 |           |  |                  | 11.70 |                |  |  | 5,875   |  |  |   | 11.70 | 
|                  |  |                     |           |                  |  |                  |     |           |  |                  |       |                |  |  |        
|                  |  |                     | 1,736,843 |                  |  |                  |     |           |  |                  | 3.95  |                |  |  | 333,189 |  |  |   | 3.49  | 
|                  |  |                     |           |                  |  |                  |     |           |  |                  |       |                |  |  |        

At June 30, 2002 and June 30, 2001 there were 38,895 and 713,225 shares,
respectively, of common stock available for future grant under the plan.

Employee Stock Purchase Plan

The Company adopted an employee stock purchase plan on August 9, 2001. Under
the plan, during consecutive six-month offering periods, eligible employees are
allowed to have salary withholdings of up to 15% of their compensation to
purchase shares of common stock at a price equal to 85% of the lower of the
market value of the stock at the beginning of the offering period or at the end
of the purchase period. The initial offering period commenced upon the
effective date of the initial public offering of the Companys common stock.
For the first offering period, shares of common stock were purchased at a price
equal to 85% of the lower of the price per share in the initial public offering
or the market value on the purchase date. The Company initially reserved
705,000 shares of common stock under this plan, and in the year ended June 30,
2002, issued 4,956 shares of common stock under the plan. At June 30, 2002
there were 700,044 shares of common stock available for issuance under the
plan.

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Deferred Stock Compensation

As discussed in Note 1, the Company accounts for its stock-based awards to
employees using the intrinsic value method in accordance with APB No. 25.
Accordingly, the Company records deferred stock compensation equal to the
difference between the grant price and deemed fair value of the Companys
common stock on the date of grant. Deferred stock compensation aggregated
$(84,000) credit for the year ended June 30, 2002 and was comprised of $129,000
of deferred stock compensation on new option grants less $213,000 of deferred
stock compensation credits arising on stock option cancellations in the year.
Deferred stock compensation aggregated $2,714,000, and $0 for the year ended
June 30, 2001, and for the period from October 7, 1999 (inception) through June
30, 2000, respectively. Deferred stock compensation is being amortized to
expense over the vesting period of the options, generally four years, using a
multiple option award valuation approach, which results in accelerated
amortization of the expense resulting in amortization of deferred stock
compensation of $1,223,000, $618,000, and $0 for the years ended June 30, 2002
and 2001, and for the period from October 7, 1999 (inception) through June 30,
2000, respectively.

During the year ended June 30, 2002, the Company granted options to purchase
5,875 shares of common stock to a nonemployee at a weighted average exercise
price of $11.70 per share. These options vested on the date of grant and expire
ten years from the date of grant. The Company expensed the fair value of these
options at grant date which was estimated to be $62,000 using the Black-Scholes
option pricing model with the following assumptions: expected term equal to 10
years; risk-free interest rate of 5.0%; volatility of 95%; and no dividends
during the expected term.

Additional Stock Plan Information

Since the Company continues to account for its stock-based awards to employees
using the intrinsic value method in accordance with APB No. 25, SFAS No. 123
requires the disclosure of pro forma net income (loss) as if the Company had
adopted the fair value method. Under SFAS No. 123, the fair value of
stock-based awards is calculated through the use of option pricing models, even
though such models were developed to estimate the fair value of freely
tradable, fully transferable options without vesting restrictions, which
significantly differ from the Companys stock option awards. The Companys
calculations were made using the Black-Scholes option pricing model, which
requires subjective assumptions, including future stock price volatility and
expected time to exercise, which greatly affects the calculated values. The
following weighted average assumptions were used in the model for the years
ended June 30, 2002 and 2001: expected life, 4 years; weighted average
volatility of 77% and 0% for the years ended June 30, 2002 and 2001,
respectively; risk-free interest rates, 4.6% and 5.9%, for the years ended June
30, 2002 and 2001, respectively; and no dividends during the expected term. The
Companys calculations are based on a multiple option award valuation and
amortization approach, which results in accelerated amortization of the
expense. Forfeitures are recognized as they occur. If the computed fair values
of the employee awards had been amortized to expense over the vesting period of
the awards, the Companys pro forma net loss would have been $16,620,000,
$1,678,000 and $803,000 ($1.75, $1.13 and $0.96 per share, basic and diluted)
for the years ended June 30, 2002 and 2001, and the period from October 7, 1999
(inception) through June 30, 2000, respectively.

9.     Cost of Revenues  Royalties, Software Costs, License Costs, and Project
Abandonment

Cost of Revenues Royalties, Software Costs, License Costs, and Project
Abandonment include amortization of non-cash licensed assets of $817,000,
$48,000 and $0 for the years ended June 30, 2002 and 2001 and the period from
October 7, 1999 (inception) through June 30, 2000, respectively. See also Note
8.

10. Income Taxes

Income taxes were $0, $0 and $0 for the years ended June 30, 2002 and 2001 and
the period from October 7, 1999 (inception) through June 30, 2000,
respectively.

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Significant components of the Companys net deferred tax assets consist of the
following as of June 30:

|                          |                                                      |         |        |                |       |      |      |     |     | 
|------------------------- | ---------------------------------------------------- | ------- | ------ | -------------- | ----- | ---- | ---- | --- | --- | 
|                          |                                                      |         |        | 2002           |       | 2001
|                          |                                                      |         |        |                |       |     
|                          |                                                      |         |        | (in thousands)
|Deferred tax assets:      |                                                      |         |        |                |       |      |      |    
|                          | Stock compensation                                   |         | $      | 604            |       |      | $    | 208 |    
|                          | Warrants                                             |         |        | 353            |       |      |      | 20  |    
|                          | Reserves and accruals                                |         |        | 1505           |       |      |      | 312 |    
|                          | Non operating loss carryforwards  Federal and State |         |        | 2,169          |       |      |      | 55  |    
|                          |                                                      | Foreign |        |                | 2,110 |      |      |     | 253 | 
|                          | Other                                                |         |        | 109            |       |      |      | 27  |    
|                          |                                                      |         |        |                |       |      |      |     |    
|Total deferred tax assets |                                                      |         | 6,850  |                |       |      | 875  |    
|Valuation allowance:      |                                                      |         | (6,850 | )              |       |      | (875 | )  
|                          |                                                      |         |        |                |       |      |      |     |    
|Net deferred tax asset    |                                                      | $       |       |                |       | $    |     |    
|                          |                                                      |         |        |                |       |      |      |     |    

The Company established a 100% valuation allowance at June 30, 2002 and 2001
due to the uncertainty of realizing future tax benefits from its net operating
loss carryforwards and other deferred tax assets.

At June 30, 2002, the Company has federal and state net operating loss
carryforwards of approximately $4,206,000 and $12,060,000, respectively,
expiring through 2022 and 2012, respectively. Foreign net operating loss
carryforwards at June 30, 2002 are approximately $7,031,000. During the years
ended June 30, 2002 and 2001, the Company utilized $373,000 and $370,000 of
federal net operating losses, respectively, to offset taxable income.

Current federal and California laws include substantial restrictions on the
utilization of net operating losses and credits in the event of an ownership
change of a corporation. Accordingly, the Companys ability to utilize net
operating loss and tax credit carryforwards may be limited as a result of such
ownership change. Such a limitation could result in the expiration of
carryforwards before they are utilized.

The Companys effective tax rate differs from the federal statutory rate as
follows:

|                                    |  |               |       |                  |  |      |       |    |  |             |       |   
|----------------------------------- |  | ------------- | ----- | ---------------- |  | ---- | ----- | -- |  | ----------- | ----- | --
|                                    |  |               |       |                  |  |      |       |    |  | Period from
|                                    |  | Year ended    |       | October 7, 1999 
|                                    |  | June 30,      |       | (inception)     
|                                    |  |               |       | through June 30,
|                                    |  | 2002          |       | 2001             |  | 2000
|                                    |  |               |       |                  |  |     
|                                    |  | (percentages)
|Income taxes at U.S. statutory rate |  |               | (35.0 | )%               |  |      | (35.0 | )% |  |             | (35.0 | )%
|Meals and entertainment             |  |               |      |                  |  |      | 0.3   |    |  |             | 0.2   |   
|Stock compensation expense          |  |               | 0.6   |                  |  |      | 2.6   |    |  |             |      |   
|Valuation allowances                |  |               | 34.4  |                  |  |      | 32.1  |    |  |             | 34.8  |   
|                                    |  |               |       |                  |  |      |       |    |  |             |       |   
|Effective tax rate                  |  |               |      | %                |  |      |      | %  |  |             |      | % 
|                                    |  |               |       |                  |  |      |       |    |  |             |       |   

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##### Table of Contents



11. Computation of Loss per Share

The following table sets forth the computations of basic and diluted loss per
share:

|                                                  |                                                                                |   |                                       |       |                  |   |        |       |   |   |             |       |  
|------------------------------------------------- | ------------------------------------------------------------------------------ | - | ------------------------------------- | ----- | ---------------- | - | ------ | ----- | - | - | ----------- | ----- | -
|                                                  |                                                                                |   |                                       |       |                  |   |        |       |   |   | Period from
|                                                  |                                                                                |   | Year ended                            |       | October 7, 1999 
|                                                  |                                                                                |   | June 30,                              |       | (inception)     
|                                                  |                                                                                |   |                                       |       | through June 30,
|                                                  |                                                                                |   | 2002                                  |       | 2001             |   | 2000  
|                                                  |                                                                                |   |                                       |       |                  |   |       
|                                                  |                                                                                |   | (in thousands, except per share data)
|Net loss attributable to common stockholders      |                                                                                | $ | (15,673                               | )     |                  | $ | (7,142 | )     |   | $ | (803        | )    
|                                                  |                                                                                |   |                                       |       |                  |   |        |       |   |   |             |      
|Calculation of loss per share, basic and diluted: |                                                                                |   |                                       |       |                  |   |        |       |   |   |             |      
|                                                  | Weighted average number of common stock shares
outstanding  basic and diluted |   |                                       | 9,503 |                  |   |        | 1,482 |   |   |             | 834   |  
|                                                  |                                                                                |   |                                       |       |                  |   |        |       |   |   |             |      
|                                                  | Net loss attributable to common stockholders                                  
|                                                  | per share  basic and diluted                                                  |   | $                                     | (1.65 | )                |   | $      | (4.82 | ) |   | $           | (0.96 | )
|                                                  |                                                                                |   |                                       |       |                  |   |        |       |   |   |             |      

The following table summarizes common stock equivalents that are not included
in the denominator used in the diluted net loss per share calculation because
to do so would be antidilutive for the periods indicated:

|                                                |                                |  |                |       |                  |  |       |       |  |  |             |    | 
|----------------------------------------------- | ------------------------------ |  | -------------- | ----- | ---------------- |  | ----- | ----- |  |  | ----------- | -- | 
|                                                |                                |  |                |       |                  |  |       |       |  |  | Period from
|                                                |                                |  | Year ended     |       | October 7, 1999 
|                                                |                                |  | June 30,       |       | (inception)     
|                                                |                                |  |                |       | through June 30,
|                                                |                                |  | 2002           |       | 2001             |  | 2000 
|                                                |                                |  |                |       |                  |  |      
|                                                |                                |  | (in thousands)
|Options to purchase common stock                |                                |  | 467            |       |                  |  | 292   |       |  |  |            |   
|Warrants to purchase common stock               |                                |  | 442            |       |                  |  | 319   |       |  |  |            |   
|Series A redeemable convertible preferred stock |                                |  | 1,770          |       |                  |  | 4,588 |       |  |  | 17          |   
|Series B redeemable convertible preferred stock |                                |  | 534            |       |                  |  | 707   |       |  |  |            |   
|Series C redeemable convertible preferred stock |                                |  | 446            |       |                  |  | 121   |       |  |  |            |   
|                                                |                                |  |                |       |                  |  |       |       |  |  |             |   
|                                                | Total common stock equivalents |  |                | 3,659 |                  |  |       | 6,027 |  |  |             | 17 | 
|                                                |                                |  |                |       |                  |  |       |       |  |  |             |   

12. Employee Benefit Plan

In January 2000, the Company adopted a 401(k) tax deferred savings plan (the
401(k) Plan) to provide for retirement of its employees. Employee contributions
are limited to a maximum amount subject to IRS guidelines in any calendar year.
The Company may make matching contributions and employer profit sharing
contributions at the Board of Directors discretion. For the years ended June
30, 2002 and 2001, and the period from October 7, 1999 (inception) through June
30, 2000 the Company made employer contributions to the 401(k) Plan of
$125,000, $41,000, and $6,500, respectively.

In March 2001 the Companys UK subsidiary set up a Group Personal Pension
Scheme to provide for retirement of its employees. Employee contributions are
limited to a maximum amount subject to the UK Inland Revenue guidelines. For
participants, the UK subsidiary contributes three percent of basic salary plus
a half percent for each additional one percent contribution in excess of three
percent. For the years ended June 30, 2002 and 2001, and the period from
October 7, 1999 (inception) through June 30, 2000 the Companys UK subsidiary
made employer contributions to the Group Personal Pension Scheme of $84,000,
$22,000, and $0, respectively.

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13. Business Segment and Geographic Information

As defined by the requirements of SFAS No. 131, Disclosures About Segments of
an Enterprise and Related Information,the Company operates in one reportable
segment: the development and publishing of interactive entertainment products.

Financial information by geographical region is summarized below:

|                                          |               |   |                |        |                  |   |        |        |   |   |             |       |  
|----------------------------------------- | ------------- | - | -------------- | ------ | ---------------- | - | ------ | ------ | - | - | ----------- | ----- | -
|                                          |               |   |                |        |                  |   |        |        |   |   | Period from
|                                          |               |   | Year ended     |        | October 7, 1999 
|                                          |               |   | June 30,       |        | (inception)     
|                                          |               |   |                |        | through June 30,
|                                          |               |   | 2002           |        | 2001             |   | 2000  
|                                          |               |   |                |        |                  |   |       
|                                          |               |   | (in thousands)
|Net revenues from unaffiliated customers: |               |   |                |        |                  |   |        |        |   |   |             |      
|                                          | North America |   | $              | 44,965 |                  |   | $      | 22,898 |   |   | $           | 1,377 |  
|                                          | Europe        |   |                | 5,769  |                  |   |        | 2,453  |   |   |             |      |  
|                                          |               |   |                |        |                  |   |        |        |   |   |             |       |  
|Consolidated                              |               | $ | 50,734         |        |                  | $ | 25,351 |        |   | $ | 1,377       |      
|                                          |               |   |                |        |                  |   |        |        |   |   |             |       |  
|Income (loss) from operations:            |               |   |                |        |                  |   |        |        |   |   |             |      
|                                          | North America |   | $              | (7,413 | )                |   | $      | 469    |   |   | $           | (781  | )
|                                          | Europe        |   |                | (5,925 | )                |   |        | (822   | ) |   |             |      |  
|                                          |               |   |                |        |                  |   |        |        |   |   |             |       |  
|Consolidated                              |               | $ | (13,394        | )      |                  | $ | (353   | )      |   | $ | (781        | )    
|                                          |               |   |                |        |                  |   |        |        |   |   |             |       |  

|                     |                                     |   |                |         |      |   |        |        |  
|-------------------- | ----------------------------------- | - | -------------- | ------- | ---- | - | ------ | ------ | -
|                     |                                     |   | June 30,      
|                     |                                     |   |               
|                     |                                     |   | 2002           |         | 2001
|                     |                                     |   |                |         |     
|                     |                                     |   | (in thousands)
|Identifiable assets: |                                     |   |                |         |      |   |        |       
|                     | North America                       |   | $              | 53,313  |      |   | $      | 19,741 |  
|                     | Europe                              |   |                | 15,648  |      |   |        | 7,789  |  
|                     | Intercompany items and eliminations |   |                | (19,494 | )    |   |        | (6,538 | )
|                     |                                     |   |                |         |      |   |        |        |  
|Total                |                                     | $ | 49,467         |         |      | $ | 20,992 |       
|                     |                                     |   |                |         |      |   |        |        |  
|Long-Lived assets:   |                                     |   |                |         |      |   |        |       
|                     | North America                       |   | $              | 3,668   |      |   | $      | 3,170  |  
|                     | Europe                              |   |                | 3,363   |      |   |        | 500    |  
|                     |                                     |   |                |         |      |   |        |        |  
|Total                |                                     | $ | 7,031          |         |      | $ | 3,670  |       
|                     |                                     |   |                |         |      |   |        |        |  

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14. Customer Concentrations

The following table summarizes net revenues and accounts receivable for
customers which accounted for 10% or more of net revenues or accounts
receivable:

|           |   |  |                     |    |                     |  |                 |    |      |  |              |    |                  |  |   |    |  |  |   |    | 
|---------- | - |  | ------------------- | -- | ------------------- |  | --------------- | -- | ---- |  | ------------ | -- | ---------------- |  | - | -- |  |  | - | -- | 
|           |   |  |                     |    |                     |  |                 |    |      |  | Net revenues
|           |   |  |                     |    |                     |  |                 |    |      |  |             
|           |   |  | Accounts receivable |    | Year ended June 30, |  | Period from    
|           |   |  |                     |    |                     |  | October 7, 1999
|           |   |  | June 30,            |    |                     |  |                 |    |      |  |              |    | (inception)     
|           |   |  |                     |    |                     |  |                 |    |      |  |              |    | through June 30,
|           |   |  | 2002                |    | 2001                |  | 2002            |    | 2001 |  | 2000        
|           |   |  |                     |    |                     |  |                 |    |      |  |             
|           |   |  | (percentages)      
|Customer
A |   |  | 16                  | %  |                     |  |                | %  |      |  |             | %  |                  |  |  | %  |  |  |  | % 
|           | B |  |                     | 14 |                     |  |                 | 12 |      |  |              |   |                  |  |   |   |  |  |   |   | 
|           | C |  |                     | 13 |                     |  |                 | 13 |      |  |              | 22 |                  |  |   | 17 |  |  |   |   | 
|           | D |  |                     | 10 |                     |  |                 |   |      |  |              |   |                  |  |   | 14 |  |  |   | 16 | 
|           | E |  |                     | 10 |                     |  |                 |   |      |  |              | 11 |                  |  |   |   |  |  |   |   | 
|           | F |  |                     |   |                     |  |                 | 27 |      |  |              |   |                  |  |   |   |  |  |   |   | 
|           | G |  |                     |   |                     |  |                 | 11 |      |  |              |   |                  |  |   | 12 |  |  |   |   | 
|           | H |  |                     |   |                     |  |                 |   |      |  |              |   |                  |  |   |   |  |  |   | 49 | 
|           | I |  |                     |   |                     |  |                 |   |      |  |              |   |                  |  |   |   |  |  |   | 10 | 

15. Commitments and Contingencies

Under an agreement entered into between the Company and a production company,
the Company has a first look right to review screenplays acquired by the
production company and to develop products based on films produced from those
screenplays. In exchange for these rights, the Company will have to pay
royalties to the production company calculated as a percentage of sales of the
developed products. For each film (up to a total of ten films) that the Company
selects, 68,738 fully vested and non-forfeitable shares of common stock will be
issued following the theatrical release of each film for which the Company has
developed a product, up to a maximum of 687,375 shares of common stock. As the
shares contingently issuable under this arrangement are dependent upon the
theatrical release of the film for which the Company has elected to develop
products, the Company will only measure the value of these shares in accordance
with EITF 96-18 Accounting for Equity Instruments That Are Issued To Other Than
Employees for Acquiring, or in Conjunction with Selling, Goods or Servicesif
and when this contingency is satisfied. If the software product is released
after the release of the film, the Company will amortize the non-cash charge
over the life of the product, which is expected to be between three and six
months. If the software product is released prior to the release of the film,
the Company will at each interim period assess whether it is probable that the
value of the shares issuable is recoverable through future sales of the product
to which it relates. If this is probable, the non-cash charge will be amortized
to licensed costs over the life of the product, while the Company will expense
the non-cash charge at the time of the issuance of the shares if it is not
probable that the value of the shares issued is recoverable through future
sales of the product to which these shares relate. The Company cannot estimate
the aggregate dollar amount of these future non-cash charges as they are based
on the Companys share price at a future point in time. As of June 30, 2001 and
2002 the Company has elected to produce software products for three films
pursuant to this agreement. One of these films had its theatrical release
during the year ended June 30, 2001 and accordingly the Company issued 68,738
shares of common stock. The Company will not be required to issue stock on the
remaining two films until such time as the films are released.

In connection with an agreement entered into with a production company during
January 2002, the Company obtained the exclusive right of first refusal, for a
period of five years, to develop products based on certain properties owned by
the production company and to distribute them worldwide. In exchange for these
rights, the Company will have to pay royalties to the production company
calculated as a percentage of sales of the developed products. Also,

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in connection with the agreement, the Company is required to issue to the
production company warrants to purchase up to 50,000 shares of common stock, in
pre-determined multiples of either 5,000 or 10,000 shares, upon the occurrence
of certain pre-determined events. Warrants will be issued at the average
closing price of the Companys stock for the five days immediately prior to the
date of issuance, have a five year term from date of issuance, are fully vested
and are immediately exercisable upon issuance. In January 2002, the Company
issued warrants to purchase 10,000 shares of common stock under this agreement,
and in March 2002 the Company issued a warrant to purchase an additional 10,000
shares of common stock under the agreement. As the remaining 30,000 warrants
contingently issuable under this arrangement are dependent upon the occurrence
of certain pre-determined events, the Company will only measure the value of
these warrants in accordance with EITF 96-18 Accounting for Equity Instruments
That Are Issued To Other Than Employees for Acquiring, or in Conjunction with
Selling, Goods or Servicesif and when the warrants are issued. When the
software product is released, the Company will amortize the non-cash charge
over the life of the product, which is expected to be between three and six
months. The Company cannot estimate the aggregate dollar amount of these future
non-cash charges as they are based on the Companys share price at a future
point in time.

In May 2002, in connection with a licensing and publishing agreement entered
into with a publishing company, we granted to the production company a warrant,
with a ten year term from the date of issue, to purchase up to 200,000 shares
of our common stock at an exercise price of $2.60, of which 15,000 became
immediately exercisable upon the signing of the agreement, and the remaining
185,000 only become exercisable in multiples of 4,625 shares upon each election
by us to produce a title based on any films, made for television movies, or
television series produced from screenplays to be produced by the publishing
company, up to a maximum ten titles, and multiples of 13,875 shares upon the
theatrical release or television air-date of each film for which we have
developed a title. Upon expiration of the agreement, any unexercised warrants
will cease to be exercisable. Our agreement expires upon the later of five
years, and the earlier of either the theatrical release or television air-date
of the tenth film or television series on which we base a product, and eight
years. The fair value of the remaining 185,000 shares will be calculated as and
when shares become exercisable and will be capitalized to prepaid royalties,
capitalized software costs and licensed assets. As the warrants contingently
exercisable under this arrangement are dependent upon the occurrence of certain
pre-determined events, the Company will only measure the value of these
warrants in accordance with EITF 96-18 Accounting for Equity Instruments That
Are Issued To Other Than Employees for Acquiring, or in Conjunction with
Selling, Goods or Servicesif and when the warrants become exercisable. When
the software product is released, the Company will amortize the non-cash charge
over the life of the product, which is expected to be between three and six
months. The Company cannot estimate the aggregate dollar amount of these future
non-cash charges as they are based on the Companys share price at a future
point in time.

Under various licensing agreements entered into between the Company and content
providers, the Company has contractual marketing commitments to spend
$6,150,000 and $5,250,000 in advertising on the content providers networks and
online mediums as of June 30, 2002 and 2001, respectively. As of June 30, 2002
and 2001, the Company has made payments totaling $3,202,000 and $1,150,000,
respectively, under these agreements. Future minimum annual advertising
payments under these contractual marketing commitments are as follows:

|                    |                 |   |                |       | 
|------------------- | --------------- | - | -------------- | ----- | 
|                    |                 |   | June 30, 2002 
|                    |                 |   |               
|                    |                 |   | (in thousands)
|Fiscal year ending: |                 |   |                |      
|                    | 2003            |   | $              | 1,400 | 
|                    | 2004            |   |                | 1,098 | 
|                    | 2005            |   |                |      | 
|                    | 2006            |   |                | 450   | 
|                    | 2007 and beyond |   |                |      | 
|                    |                 |   |                |       | 
|Total               |                 | $ | 2,948          |      
|                    |                 |   |                |       | 

In connection with a number of licensing and developing agreements, the Company
is required to pay guaranteed minimum royalties with respect to these
agreements. As of June 30, 2002 and 2001, the Company has capitalized payments
totaling $4,422,000 and $2,025,000 respectively under these agreements. These
guaranteed amounts will

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be applied against future royalties that may become payable to the respective
licensors under the agreement. Future minimum annual royalty payments under
these contractual licensing and developing commitments are as follows:

|                    |                 |   |                |       | 
|------------------- | --------------- | - | -------------- | ----- | 
|                    |                 |   | June 30, 2002 
|                    |                 |   |               
|                    |                 |   | (in thousands)
|Fiscal year ending: |                 |   |                |      
|                    | 2003            |   | $              | 1,728 | 
|                    | 2004            |   |                | 800   | 
|                    | 2005 and beyond |   |                |      | 
|                    |                 |   |                |       | 
|Total               |                 | $ | 2,528          |      
|                    |                 |   |                |       | 

Under a two year factoring agreement as described in Note 7, which commenced in
February 2002, a minimum annual service fee of $150,000 is payable to the
factoring company. The fee becomes payable based on the volume of receivables
factored. As of June 30, 2002 the first years minimum fee had been exceeded.

Under a finance agreement as described in Note 7, a commitment fee of
$1,125,000 was payable to a finance company. A portion of the commitment fee
was waived based on the Companys usage of the financing agreement and on
amounts advanced to the Company. The agreement terminated in February 2002, and
the Company had utilized advances available under the finance agreement such
the full commitment fee had been waived.

The Company leases facilities under various noncancelable operating leases.
Future minimum annual rental payments under the lease agreements are as
follows:

|                    |                 |   |                |     | 
|------------------- | --------------- | - | -------------- | --- | 
|                    |                 |   | June 30, 2002 
|                    |                 |   |               
|                    |                 |   | (in thousands)
|Fiscal year ending: |                 |   |                |    
|                    | 2003            |   | $              | 557 | 
|                    | 2004            |   |                | 567 | 
|                    | 2005            |   |                | 475 | 
|                    | 2006            |   |                | 161 | 
|                    | 2007            |   |                | 148 | 
|                    | 2008 and beyond |   |                |    | 
|                    |                 |   |                |     | 
|Total               |                 | $ | 1,908          |    
|                    |                 |   |                |     | 

Rent expense for the years ended June 30, 2002 and 2001 and the period from
October 7, 1999 (inception) through June 30, 2000 was $389,000, $135,000, and
$35,000, respectively.

From time to time we may be involved in litigation relating to claims arising
out of our operations in the ordinary course of business. As of June 30, 2002,
we are not a party to any material legal proceedings.

16. Related Party Transactions

In October 1999, the Company issued 580,962 shares of common stock to an
officer in exchange for a note receivable from the officer. The note was repaid
in April 2001.

In each of November 1999 and January 2000, the Company issued an officer a
convertible promissory note each in the principal amount of $500,000, and in
May 2000 issued the officer an additional convertible promissory note in the
principal amount of $47,000. Each note bore interest at 7.0% per annum with
principal and accrued interest due on demand after one year from the date of
issuance. Each note was automatically convertible into shares of Series A

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Redeemable Convertible Preferred Stock upon the initial closing of the
Companys Series A Redeemable Convertible Preferred Stock financing. In May
2000, the notes were converted and the officer was issued 482,625 shares of
Series A Redeemable Convertible Preferred Stock at $2.17 per share.

In November 1999 the Company entered into an agreement to lease its principal
facilities under a noncancelable operating lease. As a condition of this
agreement, an officer of the Company entered into a separate agreement with the
lessor to guarantee the Companys obligations under the agreement. The
guarantee was terminated in April 2002.

In February 2000, the Company entered into an agreement with a financing
company to finance the purchase of materials required to produce products. As a
condition of this agreement, an officer of the Company entered into a separate
agreement with the financing company to guarantee the Companys obligations
under the agreement. The guarantee lapsed in February 2002.

In November 2000, the Company entered into a revolving note agreement with a
bank. The note was secured by a personal guarantee from an officer of the
Company and by a security interest in a money market account maintained at the
bank in the name of a director of the Company. The guarantee and security
interest lapsed in December 2000.

The Company incurred legal services of $290,000, $195,000 and $9,000 for the
years ended June 30, 2002 and 2001 and for period from October 7, 1999
(inception) through June 30, 2000, respectively, to a law firm whose partner is
also a director of the Company.

18. Subsequent events

In August 2002, the Board of Directors approved an increase to 3,500,000 shares
of common stock available under the 2000 Stock Incentive Plan. The increase is
subject to shareholder approval at the 2002 Annual Meeting of Shareholders.

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SCHEDULE II  VALUATION AND QUALIFYING ACCOUNTS

|                                                              |  |                |       |           |  |            |        |        |  |   |        |            |  |   |       | 
|------------------------------------------------------------- |  | -------------- | ----- | --------- |  | ---------- | ------ | ------ |  | - | ------ | ---------- |  | - | ----- | 
|                                                              |  | Balance -     |       |           |  |            |        |        |  |   |        | Balance -
|                                                              |  | Beginning      |       |           |  |            |        |        |  |   |        | End of    
|Description                                                   |  | of Period      |       | Additions |  | Deductions |        | Period
|                                                              |  |                |       |           |  |            |        |       
|                                                              |  | (in thousands)
|Year ended June 30, 2002                                      |  |                |       |           |  |            |        |        |  |   |        |            |  |   |       | 
|Allowance for doubtful accounts                               |  | $              | 70    |           |  | $          | 1,529  |        |  | $ | 86     |            |  | $ | 1,513 | 
|Allowance for sales return and price protection               |  | $              | 650   |           |  | $          | 10,648 |        |  | $ | 8,591  |            |  | $ | 2,707 | 
|Allowance for cooperative advertising                         |  | $              | 443   |           |  | $          | 2,483  |        |  | $ | 2,346  |            |  | $ | 580   | 
|                                                              |  |                |       |           |  |            |        |        |  |   |        |            |  |   |       | 
|                                                              |  | $              | 1,163 |           |  | $          | 14,660 |        |  | $ | 11,023 |            |  | $ | 4,800 | 
|                                                              |  |                |       |           |  |            |        |        |  |   |        |            |  |   |       | 
|Year ended June 30, 2001                                      |  |                |       |           |  |            |        |        |  |   |        |            |  |   |       | 
|Allowance for doubtful accounts                               |  | $              | 77    |           |  | $          | 143    |        |  | $ | 150    |            |  | $ | 70    | 
|Allowance for sales return and price protection               |  | $              |      |           |  | $          | 893    |        |  | $ | 243    |            |  | $ | 650   | 
|Allowance for cooperative advertising                         |  | $              |      |           |  | $          | 953    |        |  | $ | 510    |            |  | $ | 443   | 
|                                                              |  |                |       |           |  |            |        |        |  |   |        |            |  |   |       | 
|                                                              |  | $              | 77    |           |  | $          | 1,989  |        |  | $ | 903    |            |  | $ | 1,163 | 
|                                                              |  |                |       |           |  |            |        |        |  |   |        |            |  |   |       | 
|Period from October 7, 1999 (inception)
through June 30, 2000 |  |                |       |           |  |            |        |        |  |   |        |            |  |   |       | 
|Allowance for doubtful accounts                               |  | $              |      |           |  | $          | 77     |        |  | $ |       |            |  | $ | 77    | 
|Allowance for sales return and price protection               |  | $              |      |           |  | $          |       |        |  | $ |       |            |  | $ |      | 
|Allowance for cooperative advertising                         |  | $              |      |           |  | $          |       |        |  | $ |       |            |  | $ |      | 
|                                                              |  |                |       |           |  |            |        |        |  |   |        |            |  |   |       | 
|                                                              |  | $              |      |           |  | $          | 77     |        |  | $ |       |            |  | $ | 77    | 
|                                                              |  |                |       |           |  |            |        |        |  |   |        |            |  |   |       | 

S-1