UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2004

OR

FOR THE TRANSITION PERIOD FROM                     TO                     .

COMMISSION FILE NUMBER: 000-32989

BAM! ENTERTAINMENT, INC.

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

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

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

     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 x No o

     Indicate by check mark whether the registrant (1) is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

THE NUMBER OF SHARES OF COMMON STOCK OUTSTANDING AS OF MAY 21, 2004:
27,834,228

PART I
FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS.

BAM! ENTERTAINMENT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)
(unaudited)

See notes to condensed consolidated financial statements

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BAM! ENTERTAINMENT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)

See notes to condensed consolidated financial statements

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BAM! ENTERTAINMENT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)

See notes to condensed consolidated financial statements

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BAM! ENTERTAINMENT, INC. AND SUBSIDIARIES

1. BASIS OF PRESENTATION

The condensed consolidated financial statements are unaudited. However, in the opinion of management, all adjustments, consisting only of normal recurring adjustments, which, in the opinion of management, are necessary for a fair presentation of the financial position and results of the operations of the interim period, have been included.

These condensed consolidated financial statements include the accounts of Bam! Entertainment, Inc. (“Bam” or “the Company”), located in San Jose, California, and its wholly owned subsidiaries, located in the United Kingdom. All significant intercompany transactions and balances have been eliminated in consolidation. The accompanying interim financial information has been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by accounting principles generally accepted in the United States of America for annual financial statements.

The results of operations for the three and nine months ended March 31, 2004 are not necessarily indicative of the results to be expected for the entire fiscal year, which ends on June 30, 2004.

These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended June 30, 2003, together with management’s discussion and analysis of financial condition and results of operations, contained in Bam’s 2003 Annual Report and Form 10-K.

Reclassifications - Certain 2003 amounts have been reclassified to conform with 2004 presentation. Such reclassifications had no effect on net revenues, net loss or shareholders’ equity.

Going Concern and Liquidity Uncertainties - These condensed consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. As shown in these condensed consolidated financial statements, during the nine months ended March 31, 2004, Bam used cash in operating activities of $6.1 million and incurred a net loss of $11.2 million. As of March 31, 2004, Bam had cash and cash equivalents of $290,000 and its accumulated deficit was $71.0 million. These factors, among others, raise substantial doubt about Bam’s ability to continue as a going concern for a reasonable period of time. The condensed consolidated financial statements do not include any adjustments relating to the recoverability and classification of assets or the amounts and classification of recorded liabilities that might be necessary should Bam be unable to continue as a going concern.

In October 2003, Bam completed the sale of 1,850,000 shares of its common stock and warrants to purchase another 1,665,000 shares of its common stock, resulting in gross proceeds (assuming no exercise of the warrants) of $1.8 million, in a private offering to institutional and accredited investors. The warrants have a five-year term and are immediately exercisable, at $1.87 per share. The placement agents were issued warrants (“placement agent warrants”) to purchase 277,500 shares of Bam’s common stock in connection with placement agent fees under the same terms as the warrants issued to the investors, except that the placement agent warrants are subject to a 180 day lock-up provision. Bam also granted the investors additional investment rights to purchase an additional 1,111,625 shares of its common stock and warrants to purchase another 1,000,462 shares of its common stock. The shares of common stock underlying the additional investment rights are purchasable at $0.96 per share and the warrants underlying the additional investment rights have a five-year term and are exercisable at the greater of (i) $1.87 and (ii) the lesser of (x) the closing bid price of Bam’s common stock on the Nasdaq Stock Market on the business day immediately preceding the exercise date of the additional investment right, and (y) the average of the closing bid price of Bam’s common stock on the Nasdaq Stock Market for the five business days immediately preceding the exercise date of the additional investment right. Between January and March 2004, six of the investors exercised their additional investment rights in full and purchased 1,060,858 shares of Bam’s common stock at $0.96 per share, resulting in gross proceeds (assuming no exercise of the warrants) of $1.0 million. These investors were also issued five-year warrants to purchase 954,772 shares of Bam’s common stock, which are exercisable under the terms of additional investment rights issued in the October private offering of Bam’s securities. The remaining additional investment rights to purchase 50,767 shares of Bam’s common stock and warrants to purchase another 45,690 shares of Bam’s common stock lapsed on March 11, 2004.

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In December 2003, Bam sold a convertible term note and 166,667 warrants, raising gross proceeds of $1.5 million (assuming no exercise of the warrants) to an investment group. The note, which bears interest at a rate of 7% per annum, has a maturity date of December 3, 2004. The warrants have a seven-year term and are immediately exercisable at prices ranging between $1.73 and $2.33 per share. Each month, commencing on April 1, 2004, $166,667 of the principal amount of the note plus accrued and unpaid interest and fees can either be repaid in cash, or converted into Bam’s shares at a fixed conversion price, provided that the closing price of Bam’s shares exceeds 115% of the fixed conversion price for a period of 10 consecutive trading days prior to the date of conversion. If, at any other time, the closing price of Bam’s shares exceeds 115% of the fixed conversion price for a period of 5 consecutive trading days, Bam has the option to, 10 trading days later, convert all or part of the remaining outstanding note, interest and fees, subject to conversion volume limitations based on Bam’s share trading volume and share price in the 10 trading days prior to such conversion. The holder of the note has the right to convert all or any of the outstanding portion of the note, interest and fees at any time at the fixed conversion price. Conversion of the note by either party is subject to there being an effective registration statement in effect and Nasdaq’s confirmation that this transaction is not integrated with the private offering that closed in October 2003. An effective registration statement went into effect on April 22, 2004. Nasdaq has advised Bam that the transaction is not integrated with the private offering that closed in October 2003. The fixed conversion price is subject to an anti dilution adjustment should Bam issue stock at a price below the fixed conversion price prior to repayment of the note. The fixed conversion price was originally set at $1.33 per share, but an issuance of shares in January 2004 triggered the anti-dilution provision, and the fixed conversion price was adjusted to $1.28 per share. Further issuances of shares occurred in May 2004 as set out below, and the fixed conversion price was further adjusted to $1.19 per share. The note is secured by Bam’s North American assets. As of May 21, 2004, none of the note had been repaid or converted into common stock, and accordingly Bam is in default of the terms of the note.

In January 2004, Bam completed the sale of 2,532,522 shares of its common stock and warrants to purchase another 1,519,513 shares of its common stock, resulting in gross proceeds (assuming no exercise of the warrants) of $2.3 million, in a private offering to institutional and accredited investors. The warrants have a five-year term and are exercisable at $1.40 per share. Bam also granted the investors additional investment rights to purchase an additional 2,467,478 shares of its common stock and warrants to purchase another 1,480,487 shares of its common stock. The shares of common stock underlying the additional investment rights are purchasable at $0.92 per share and the warrants underlying the additional investment rights have a five-year term and are exercisable at the greater of (i) $1.40 and (ii) the lesser of (x) the closing bid price of Bam’s common stock on the Nasdaq Stock Market on the business day immediately preceding the exercise date of the additional investment right, and (y) the average of the closing bid price of our common stock on the Nasdaq Stock Market for the five business days immediately preceding the exercise date of the additional investment right. The additional investment rights are exercisable until June 25, 2004.

On February 17, 2004, the management of Bam agreed with the management of VIS entertainment plc (“VIS”), a Scottish developer of interactive entertainment software products, on the terms of an offer (the “VIS Offer”) to acquire all of the Ordinary Shares, A Shares and B Shares of VIS in exchange for the issuance of up to 4.5 million unregistered shares (the “VIS Consideration Shares”) of Bam’s common stock. On May 19, 2004, all the terms of the VIS Offer were either satisfied or waived, and accordingly the VIS Offer was declared unconditional in all respects.

On February 17, 2004, Bam’s management entered into an agreement with the shareholders of State of Emergency Development Corporation (“SOED”) to acquire all of the share capital of SOED (the “SOED Acquisition”) in exchange for the issuance of up to 4.5 million unregistered shares of Bam’s common stock (the “SOED Consideration Shares”). The SOED Acquisition was conditional upon the closing of the acquisition by Bam of all of the VIS shares. On May 19, 2004, the SOED Acquisition was declared unconditional in all respects and Bam issued the 4.5 million unregistered shares of its common stock in exchange for the share capital of SOED.

BAM has received irrevocable acceptances to acquire a controlling interest from shareholders in VIS. As of May 23, 2004, BAM had received irrevocable acceptances to acquire 91.9% of the Ordinary Shares, 95.6% of the A Shares and 100.0% of the B Shares of VIS, respectively. Because Bam has received irrevocable acceptances in excess of 90% of each class of shareholder, Bam can compulsorily acquire the remaining shares held by shareholders who have not accepted the VIS Offer within 14 days of the VIS Offer being declared unconditional. Bam intends to

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enforce the compulsory purchase. Accordingly, Bam will issue 4.5 million unregistered shares of its common stock in exchange for the entire share capital of VIS.

The VIS shareholders and the SOED shareholders have each placed a total of 375,000 of the Bam shares issued in connection with the two transactions in an escrow account for the purpose of indemnifying Bam against any breach by VIS and SOED of the representations and warranties in the purchase agreements. In addition, each of the parties placed 225,000 of the Bam shares to be issued in connection with the transactions in an escrow account to provide security for the additional Purchase Price Adjustments set forth in the agreement. Bam also placed a total of 750,000 of its shares into an escrow account for the purposes of indemnifying the shareholders of VIS and SOED against certain warranties made by Bam to VIS and SOED shareholders. The shares placed in escrow by Bam are in addition to the shares issued by Bam under the acquisition of VIS and SOED. All shares placed in escrow shall remain in escrow until the later of 12 months from closing date and the date of the resolution of any claims that may arise. As of May 21, 2004, no claims had been made.

Bam currently estimates that its direct acquisition costs will be approximately $1.6 million. Of these, $0.5 million is payable in either cash or Bam’s common stock at Bam’s discretion.

The two transactions were conditional upon, among other things, (i) the stockholders of Bam approving the issuance of the 9 million Bam shares in connection with the two transactions; (ii) Bam raising not less than $12.35 million (net of expenses) from the sale of equity capital prior to the closing date expected to be on June 2, 2004; and (iii) Bam using its commercially reasonable efforts to maintain its listing on the NASDAQ Stock Market. The condition for Bam to raise not less than $12.35 million (net of expenses) from the sale of equity capital prior to the closing date was waived by the VIS Board prior to the VIS offer being declared unconditional on May 19, 2004.

Bam, the VIS shareholders, and the SOED shareholders have entered into various agreements affecting the transferability of the SOED Consideration Shares and VIS Consideration Shares. The parties have entered into a registration rights agreement which requires Bam to file, no later than the thirtieth day following the closing date, a registration statement with the Securities and Exchange Commission for the registration of the VIS Consideration Shares and the SOED Consideration Shares. Nevertheless, the parties have also entered into a lock-up agreement which requires the VIS and SOED shareholders to only sell their registered Bam shares in accordance with the following schedule: (i) 25% shall be sold no earlier than the 30^th day following the closing date; (ii) an additional 25% shall be sold no earlier than the 180^th day following the closing date; (iii) an additional 25% shall be sold no earlier than the 270^th day following the closing date; and (iv) the remaining 25% shall be sold no earlier than the first anniversary of the closing date. The closing of transaction takes place 14 days after the offer became unconditional.

On May 19, 2004 Bam entered into an agreement with SOED’s Loanholders whereby, upon close of the SOED transaction, GBP 792,000 (equivalent to $1.4 million) of outstanding loan notes shall be repaid, and GBP 1.7 million (equivalent to $3.0 million) of outstanding loan notes, which were repayable upon the close of the SOED acquisition, will no longer be payable upon the close, but will become payable as follows: the sterling equivalent of $1.0 million plus outstanding interest will become payable by Bam on or before September 30, 2004, and the balance, including outstanding interest, will become payable by Bam on or before the one year anniversary of the closing date. In addition to these amounts, and in consideration of this deferral of payment, Bam will issue upon the closing date 5 year warrants to purchase 1,071,000 shares of its common stock to the Loanholders at the lower of $0.70 and the average mid market price of Bam’s common stock for the five business days prior to exercise of the warrant, and 5 year warrants to purchase 428,500 shares of its common stock to the advisors of the Loanholders at the lower of $0.70 and the average mid market price of Bam’s common stock for the five business days prior to exercise of the warrant. Bam is also

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required to make a cash payment of $210,000 to the advisors of the Loanholders when the loan has been repaid in full.

On May 19, 2004, in accordance with an agreement entered into between Bam and Flextech Television Limited, and upon the VIS Offer becoming unconditional, Bam issued 801,529 shares of its common stock to the Telewest Group of Companies to repay a debt, approximating $393,000, owed by VIS itv Limited to the Telewest Group of Companies. VIS itv Limited is a private limited company incorporated in the United Kingdom, owned as to 50% by Flextech Television Limited, a subsidiary of Telewest Communications plc, and 50% by VIS.

On May 21, 2004 Bam issued 771,715 shares of its common stock, and warrants to purchase another 77,172 shares of its common stock, in exchange for the settlement of debts totaling $463,000 owed to four creditors. The warrants have a five-year term and are exercisable at $0.60 per share.

On May 24, 2004 Bam completed the sale of 282 shares of its Series A Cumulative Convertible Preferred Stock (the “Preference shares”) and warrants to purchase another 2,548,192 shares of its common stock, resulting in gross value (assuming no exercise of the warrants) of $2.8 million, in a private offering to institutional, accredited investors, Bam’s Chief Executive Officer and Vice Chairman of the Board of Directors. Of the total sale, 188 Preference shares and warrants to purchase another 1,698,795 shares of its common stock, resulting in gross proceeds (assuming no exercise of the warrants) of $1.9 million, were sold to institutional and accredited investors, 50 Preference shares and warrants to purchase another 451,807 shares of its common stock, resulting in gross value (assuming no exercise of the warrants) of $500,000 were sold to Bam’s Chief Executive Officer, and 44 Preference shares and warrants to purchase another 397,590 shares of its common stock, resulting in gross value (assuming no exercise of the warrants) of $440,000, were sold in exchange for the settlement of a loan and accrued interest totaling $260,000 from Bam’s Vice Chairman of the Board of Directors and deferred salaries totaling $90,000 each from Bam’s Chief Executive Officer and Vice Chairman of the Board of Directors. All of these warrants have a five-year term and are exercisable at $0.594 per share. Each Preference stockholder receives a 10% dividend per annum, payable quarterly in arrears on the last day of each quarter. The initial dividend payment will be pro-rated from the date of issuance to the end of the first quarter after issuance. Each Preference share is convertible into 12,048 shares of Bam’s common stock at the option of the holder. Bam can require the Preference stockholder to convert the Preference shares into common shares upon the expiration of 30 days notice provided that the following three conditions are all met: (i) there is an effective registration statement in effect, (ii) the daily market price of Bam’s common stock is greater than $1.20 for twenty of the thirty trading days prior to the notice being issued, and (iii) Bam’s common stock is listed on either the Nasdaq SmallCap Market, Nasdaq National Market, American Stock Exchange or the New York Stock Exchange. Each Preference share has a liquidation preference of $10,000. A change of control is not deemed to be a liquidation. Preference stockholders have full voting rights and powers, are treated as the same class as common stock holders at stockholder meetings, and are entitled to vote the number of common stock equivalent votes at each meeting. While at least 10% of the original numbers of Preference shares issued are in issue, Bam may not, without the written consent of the majority of Preferred stockholders (i) repeal or alter the terms under which the Preference shares are issued, (ii)amend or repeal its Certificate of Incorporation or Bylaws, (iii) authorize, offer or issue any stock ranking pari passu or senior to them (iv) redeem or repurchase any shares of the Company in issue, and (v) declare or pay a dividend to any other class of share. Bam is required to redeem all Preference shares and pay the liquidated preference in cash plus all accrued and unpaid dividends if (i) it refuses to convert any Preference shares to common stock having received notice from the holder to convert, or (ii) it breaches any warranty or representation given to the Preference stockholders, or (iii) breaches any covenant given to the Preference stockholders.

On May 24, 2004 Bam completed the sale of a $6.75 million 2% Secured Convertible Debenture (the “Debenture”), due November 24, 2006, and warrants to purchase another 6,549,398 shares of its common stock. The warrants have a five-year term and are exercisable at $0.594 per share. The Debenture is convertible, in whole or in part, into Bam’s common stock, at the option of the Debenture holders, at a conversion price of $0.83 per share. The entire $6.75 million received from the issuance of the Debenture is secured by restricted cash held at an account at a third party custodian. Bam has no access to, or use of the cash, until the Debenture is converted into common stock. If the Debenture is partly converted into common stock, Bam will have access to the cash for the part converted and the remainder of the cash will remain restricted. Interest on the Debenture is payable quarterly in arrears on the last day of each quarter. The initial interest payment will be pro-rated from the date of issuance to the end of the first quarter after issuance. Bam can require the Debenture holder to convert the Debenture into common shares upon the

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expiration of no more than 5 days notice provided that the following two conditions are all met: (i) Bam gives notice to the Debenture holders within 3 days of the daily market price of Bam’s common stock exceeding $1.66 for fifteen consecutive trading days, and (ii) Bam’s common stock’s average daily trading volume over the fifteen consecutive trading days exceeds 100,000 shares. In order to issue the Debenture, Bam was required to obtain the consent of the existing convertible term note holders. The convertible term note holders gave their consent on May 21, 2004 and, as consideration, were issued warrants, with a seven-year term, to purchase 166,667 shares of Bam’s common stock at an exercise price of $0.63 per share.

Bam needs to raise additional funds to satisfy its future liquidity requirements. These funds may come from either one or a combination of additional financings, exercise of outstanding warrants and additional investment rights, mergers or acquisitions, or otherwise obtain capital via sale or license of certain of its assets, in order to satisfy its future liquidity requirements. Current market conditions present uncertainty as to Bam’s ability to secure additional financing or effectuate any merger or acquisition, as well as Bam’s ability to reach profitability. There can be no assurances that Bam will be able to secure additional financing or effectuate any such merger or acquisition, or obtain favorable terms on such financing if it is available, or as to Bam’s ability to achieve positive cash flow from operations. Continued negative cash flows create significant uncertainty about Bam’s ability to implement its operating plan and Bam may have to further reduce the scope of its planned operations. If cash and cash equivalents, together with cash generated from operations, are insufficient to satisfy Bam’s liquidity requirements, Bam will not have sufficient resources to continue operations for the next six months.

As of March 31, 2004, Bam had $1.2 million of capitalized development costs and licensed assets, and $291,000 of prepaid royalties. Should Bam be unable to effectuate either a merger or acquisition or to secure sufficient additional financing, part or all of the development projects in progress might have to be abandoned, the related costs might have to be written off, and Bam would be unable to develop or acquire new titles, which would significantly affect its future cash flows from operations.

Stock-Based Compensation - Bam 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 Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation and in accordance with Emerging Issues Task Force (EITF) No. 96-18, Accounting for Equity Instruments That Are Issued To Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services. SFAS No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure requires disclosure in the summary of significant accounting policies of the effects of an entity’s accounting policy with respect to stock-based employee compensation on reported net income and earnings per share in annual and interim financial statements. Bam adopted the disclosure provisions of SFAS No. 148 on January 1, 2003.

Since Bam 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 Bam had adopted the fair value method. Under APB No. 25, stock-based compensation is based on the difference, if any, on the date of grant, between the fair value of Bam’s stock and the exercise price. Unearned compensation is amortized using the multiple option award valuation and amortization approach method and expensed over the vesting period of the respective options.

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The following table illustrates the effect on net loss and net loss per share if Bam had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation. For purposes of SFAS No. 123 pro forma disclosures, the estimated fair value of the options is amortized to expense over the options’ vesting period using the multiple option award valuation and amortization approach method. (in thousands):

Revenue Recognition - Bam 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. Under certain conditions, Bam may allow customers to exchange and return its 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. Bam estimates the amount of future returns, and price protection based upon current known circumstances and historical results.

Fair Values of Financial Instruments - The estimated fair value of Bam’s financial instruments, which include cash and cash equivalents, accounts receivable, convertible term note, loan from director, capital lease obligations, accounts payable and short-term borrowings, approximate their carrying amount, which is due to their short-term maturities. The recorded amount of Bam’s capital lease obligation approximates the estimated fair value.

2.

RESTRUCTURING COSTS (BENEFIT)

Bam accounts for restructuring costs in accordance with SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. For restructuring actions initiated prior to January 1, 2003 Bam accounts for restructuring costs in accordance with EITF 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit on Activity (including Certain Costs Incurred in a Restructuring).

In November 2002, Bam initiated a restructuring of its operations, and accounted for it in accordance with EITF 94-3. As part of the restructuring, upon the sale of its London based studio, Bam granted VIS Entertainment plc a sublease to its London premises through June 2007. VIS had an option to terminate the tenancy of the sublease upon the later of November 30, 2003 and the determination of a porting contract between Bam and VIS. In October 2003, VIS notified Bam that they were terminating the sublease effective November 30, 2003. In April 2004, Bam surrendered the lease to the landlord in consideration for a settlement payment of $225,000, covering arrears of rent and a termination fee. Of the settlement payment, $67,000 relates to costs incurred prior to the termination of the tenancy of the sublease. The remaining $158,000 is accounted for as a restructuring cost.

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Restructuring costs for the three and nine months ended March 31, 2004 comprise Bam’s estimate of its future net expense relating to its former London premises. Management reassesses the estimate on a quarterly basis based on known circumstances and anticipated events and adjusts the reserve as appropriate. In September 2003, December 2003, and March 2004 management revised its estimate of its future net expense. At March 31, 2004, management’s estimate of its future net expense comprised rents payable for the period from the termination of the sublease with VIS to the surrender of the lease with the landlord, the termination fee element of the settlement payment to surrender the London lease, and attributable legal fees.

Restructuring costs (benefit) for the three and nine months ended March 31, 2004 are as follows (in thousands):

Restructuring costs for the three and nine months ended March 31, 2003, which included employee severance payments, write down costs on property and equipment, and legal fees associated with the disposal of the London based studio, were as follows (in thousands):

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3.

INCOME TAXES

Bam accounts for income taxes under an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in Bam’s financial statements or tax returns. In estimating future tax consequences, Bam generally considers all expected future events other than enactments of changes in the tax law or rates. Franchise taxes are classified as general and administrative expense.

4.

NET LOSS PER SHARE

Basic net loss per share is computed using the weighted average number of common stock shares outstanding during the period. Diluted net loss per share is computed using the weighted average number of common stock shares and common stock share equivalents outstanding during the period using the treasury stock method. Potential common stock share equivalents consist of warrants, additional investment rights, a convertible term note, and stock options. Potential common stock share equivalents are excluded from the computation, if their effect is antidilutive, as was the case for the three and nine months ended March 31, 2004 and 2003, respectively.

The following table sets forth the computation of basic and diluted loss per share (in thousands, except per share data):

The following table summarizes common stock share 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:

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5.

COMPREHENSIVE LOSS

SFAS No. 130, Reporting Comprehensive Income, requires that all items recognized under accounting standards as components of comprehensive earnings be reported in an annual statement that is displayed with the same prominence as other annual financial statements. SFAS No. 130 also requires that an entity classify items of other comprehensive earnings by their nature in an annual financial statement. Comprehensive loss, as defined, includes all changes in equity during a period from nonowner sources.

The components of comprehensive loss for the three and nine months ended March 31, 2004 and 2003 were as follows (in thousands):

6.

INVENTORIES

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

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7.

RECEIVABLES

Trade accounts receivable

Accounts receivable, net of allowances, is comprised of the following (in thousands):

If a sales return and price protection allowance for an individual accounts receivable account exceeds the gross accounts receivable balance for the account, Bam accounts for the excess allowance as accrued expenses and other. As of March 31, 2004 and June 30, 2003, Bam had sales return and price protection allowances of $603,000 and $0, respectively, included within accrued expenses and other.

Long-term receivable

On January 22, 2002 Kmart, a customer of Bam, filed voluntary petitions for reorganization under Chapter 11 of the U.S. Bankruptcy Code. On January 22, 2002 Bam had an accounts receivable balance from Kmart of $1.7 million. Bam was an unsecured creditor, and as such was at risk of not recovering in full its accounts receivable balance. Accordingly, in the year ended June 30, 2002 Bam recorded an allowance of $1.1 million against the receivable. As Kmart stated that at earliest it would complete its reorganization in May 2003, Bam classified the receivable, net of allowance, as a long-term asset.

In the three months ended September 30, 2002 management reevaluated and increased the allowance to cover the full accounts receivable balance.

Subsequent to January 22, 2002 Kmart arranged debtor-in-possession financing. Bam sold product to Kmart under this arrangement. Accounts receivables under the debtor-in-possession financing were classified as current assets.

Kmart completed its reorganization and emerged from Chapter 11 on May 6, 2003. Under its plan of reorganization Kmart will distribute Kmart Corporation common stock to the unsecured creditors on a pro-rata basis, at an approximate recovery rate of 9.7% on approved payables. In April 2004, Kmart distributed to Bam 8,086 common stock shares under this plan. Kmart has advised Bam that this distribution approximates 70% of the total distribution payable to Bam, and that the remaining common stock shares will be issued as other claims by other creditors are settled and the total value of all claims firms up.

Bam sold the 8,086 shares in May 2004 for net proceeds of $356,000. Because the 8,086 shares were not issued to Bam until April 2004, Bam had a contingent gain at March 31, 2004. Accordingly, Bam has not adjusted its allowance against the receivable as of March 31, 2004 to take account of the distribution and proceeds of sale.

Although Kmart has advised Bam that it can expect a further distribution of Kmart common stock shares in the future, the final number of shares to be issued and the future value of those shares is not known. Accordingly Bam has not accounted for any potential recoverable sums on those potential future issuances as of March 31 2004 and June 30, 2003, and has continued to classify the receivable as a long-term receivable.

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Concentration of credit risk

As of March 31, 2004, four customers each accounted for between 4% and 27% of Bam’s gross trade accounts receivable, and as of June 30, 2003, four customers each accounted for between 8% and 19% of Bam’s gross trade accounts receivable. Bam has no written agreements or other understandings with any of its customers that relate to future purchases. Therefore, purchases by these customers or any others could be reduced or terminated at any time.

Revenues from the Bam’s four largest customers collectively accounted for 111% and 58% of its net revenues for the three and nine months ended March 31, 2004, respectively, and 74% and 51% of its net revenues for the three and nine months ended March 31, 2003, respectively. Net revenues comprise gross revenues less returns and price protection allowances.

8. OTHER ASSETS

Other assets include prepaid stock issuance costs of $590,000 and $0 as of March 31, 2004 and June 30, 2003, respectively, in connection with Bam’s acquisition of VIS and SOED and the issuance of securities pursuant thereto.

9. SHORT-TERM BORROWINGS

In September 2003, Bam entered into a six month agreement (the “Agreement”) with a finance company, pursuant to which the finance company extended a line of credit facility to fund domestic inventory purchases to Bam. Bam could sell the inventory purchased under the Agreement and was required to remit customer receipts from those sales directly to the finance company up to the amounts funded by them. Bam retained collections in excess of the amounts funded by the finance company, and was responsible for collecting the customer receivables, bearing the risk of loss on all uncollectible accounts. The finance company had a security interest in Bam’s accounts receivable and inventory.

Under the terms of the Agreement, the finance company’s aggregate outstanding funding was limited to $3.2 million. Bam was required to pay the finance company’s expenses under the contract, a facility fee equal to 5.0% of the funds advanced by the finance company, and interest at prime plus 0.5%.

The Agreement terminated on March 31, 2004. Bam had repaid all sums borrowed by that date. Prepayments for products not yet received are included in prepaid expenses.

Prior to entering into the Agreement, Bam had entered into a two year factoring agreement (the “Factoring Agreement”) with a different finance company in February 2002, pursuant to which Bam assigned its North American receivables to the finance company. The finance company was responsible for collecting customer receivables, and upon collection, remitted the funds to Bam, less a service fee. Under the Factoring Agreement, Bam could obtain advances, subject to the finance company’s discretion and Bam’s compliance with certain liquidity covenants, 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, Bam paid a service fee on all receivables assigned, with a minimum annual fee of $150,000, interest at prime plus 1% on all cash sums advanced. All fees were included in interest expense. Bam bore the collection risk on the accounts receivable that were assigned, unless the finance company approved the receivable at the time of assignment, in which case the finance company bore the risk. The finance company had a security interest in Bam’s accounts receivable, inventory, fixed assets and intangible assets.

As of June 30, 2003 Bam did not meet the Factoring Agreement’s liquidity covenants and had no sums advanced under the Factoring Agreement. The Factoring Agreement was mutually terminated in September 2003, and all liabilities settled. Upon the termination of the Factoring Agreement, the minimum annual fee for the second year of the Factoring Agreement was waived, and Bam paid a termination payment of $25,000.

As of March 31, 2004 and June 30, 2003 Bam had no outstanding letters of credit issued on its behalf.

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10. LOAN FROM DIRECTOR

In August 2003, Bam entered into an unsecured Promissory Note with a Director whereby the Director loaned Bam $250,000. The loan, which bears interest at 6% per annum, was repayable on or before April 30, 2004. On May 21, 2004, the loan and accrued interest were repaid in full under a settlement agreement whereby Bam issued 26 Preference shares and five-year warrants to purchase another 234,940 shares of its common stock at an exercise price of $0.594 per share.

11. CONVERTIBLE TERM NOTE

In December 2003, Bam sold a convertible term note and 166,667 warrants, raising gross proceeds of $1.5 million (assuming no exercise of the warrants) to an investment group. The note, which bears interest at a rate of 7% per annum, has a maturity date of December 3, 2004. The warrants have a seven-year term and are immediately exercisable at prices ranging between $1.73 and $2.33 per share.

Each month, commencing on April 1, 2004, $166,667 of the principal amount of the note plus accrued and unpaid interest and fees can either be repaid in cash, or converted into Bam’s shares at a fixed conversion price, provided that the closing price of Bam’s shares exceeds 115% of the fixed conversion price for a period of 10 consecutive trading days prior to the date of conversion. If at any other time the closing price of Bam’s shares exceeds 115% of the fixed conversion price for a period of 5 consecutive trading days, Bam has the option to, 10 trading days later, convert all or part of the remaining outstanding note, interest and fees, subject to conversion volume limitations based on Bam’s share trading volume and share price in the 10 trading days prior to such conversion. The holder of the note has the right to convert all or any of the outstanding portion of the note, interest and fees at any time at the fixed conversion price. Conversion of the note by either party is subject to there being an effective registration statement on file with the Securities and Exchange Commission and Nasdaq’s confirmation that this transaction is not integrated with the private offering that closed in October 2003. An effective registration statement went into effect on April 22, 2004. Nasdaq has advised Bam that the transaction is not integrated with the private offering that closed in October 2003. The fixed conversion price is subject to an anti dilution adjustment should Bam issue stock at a price below the fixed conversion price prior to repayment of the note. The fixed conversion price was originally set at $1.33 per share, but an issuance of shares in January 2004 triggered the anti-dilution provision, and the fixed conversion price was adjusted to $1.28 per share. Further issuances of shares occurred in May 2004 as set out in Note 18, and the fixed conversion price was further adjusted to $1.19 per share. The note is secured by Bam’s North American assets. As of May 21, 2004, none of the note had been repaid or converted into common stock, and accordingly Bam is in default of the terms of the note.

In accordance with EITF No. 00-27, Application of Issue No. 98-5 to Certain Convertible Instruments, Bam allocated $182,000 of the proceeds from the note to the warrants based on the relative fair values of the instruments. Bam also determined that the embedded conversion option within the note has a value of $182,000 and, in accordance with EITF No. 00-27, has reduced the carrying value of the note and increased additional paid in capital by this amount. These amounts are being amortized to interest expense over the life of the note. In calculating the relative fair values of the warrants Bam valued the instrument using the Black-Scholes option pricing model with the following assumptions: expected term equal to seven years; risk-free interest rate of 3.98%; volatility of 174%; and no dividends during the expected term.

Bam incurred finder and other issuance fees of $195,000 upon closing the note. These costs have been offset against the note and are being amortized to interest expense over the life of the note.

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The convertible term note is comprised of the following (in thousands):

As more fully described in Note 18, on May 24, 2004 Bam completed the sale of a $6.75 million 2% Secured Convertible Debenture (the “Debenture”), due November 24, 2006, and warrants to purchase another 6,549,398 shares of its common stock to a different investment group. In order to issue the Debenture, Bam was required to obtain the consent of the existing convertible term note holders. The convertible term note holders gave their consent on May 21, 2004 and, as consideration, were issued warrants, with a seven-year term, to purchase 166,667 shares of Bam’s common stock at an exercise price of $0.63 per share. The cash received on the sale of this note is restricted and cannot be used by Bam until the Debenture has been converted to common stock.

12. COMMON STOCK

In October 2003, Bam completed the sale of 1,850,000 shares of its common stock and warrants to purchase another 1,665,000 shares of its common stock, resulting in gross proceeds (assuming no exercise of the warrants) of $1.8 million, in a private offering to institutional and accredited investors. The warrants have a five-year term and are immediately exercisable, at $1.87 per share. The placement agents were issued warrants to purchase 277,500 shares of Bam’s common stock in connection with placement agent fees under the same terms as the warrants issued to the investors, except that the placement agent warrants are subject to a 180 day lock-up provision. Bam also granted the investors additional investment rights to purchase an additional 1,111,625 shares of its common stock and warrants to purchase another 1,000,462 shares of its common stock. The shares of common stock underlying the additional investment rights are purchasable at $0.96 per share and the warrants underlying the additional investment rights have a five-year term and are exercisable at the greater of (i) $1.87 and (ii) the lesser of (x) the closing bid price of Bam’s common stock on the Nasdaq Stock Market on the business day immediately preceding the exercise date of the additional investment right, and (y) the average of the closing bid price of Bam’s common stock on the Nasdaq Stock Market for the five business days immediately preceding the exercise date of the additional investment right. Bam has allocated the proceeds from the sale of the shares and warrants to the shares, warrants and additional investment rights based on the relative fair values of the instruments. The relative fair value allocation was as follows: common stock $438,000, net of the value of the warrants issued to the placement agent in the amount of $302,000; warrants $755,000; and additional investment rights $281,000. In calculating the relative fair values of the warrants and the placement agent warrants Bam valued the instruments using the Black-Scholes option pricing model with the following assumptions: expected term equal to five years; risk-free interest rate of 2.94%; volatility of 185%; and no dividends during the expected term. In calculating the relative fair values of the additional investment rights Bam valued the instrument using the Black-Scholes option pricing model with the following assumptions: expected term equal to six months; risk-free interest rate of 1.01%; volatility of 185%; and no dividends during the expected term.

Between January and March 2004, six of the investors exercised their additional investment rights in full and purchased 1,060,858 shares of Bam’s common stock at $0.96 per share, resulting in gross proceeds (assuming no exercise of the warrants) of $1.0 million. These six investors were also issued five-year warrants to purchase 954,772 shares of Bam’s common stock, which are exercisable under the terms of additional investment rights issued in the October private offering of Bam’s securities. The placement agents were also issued warrants to

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purchase 159,127 shares of Bam’s common stock in connection with placement agent fees under the same terms as the warrants issued to the investors, except that the placement agent warrants are subject to a 180 day lock-up provision. The remaining additional investment rights to purchase 50,767 shares of Bam’s common stock and warrants to purchase another 45,690 shares of Bam’s common stock lapsed on March 11, 2004. Bam has allocated the proceeds from the sale of the additional investment rights to the additional investment rights, warrants and placement agent warrants based on the relative fair values of the instruments. The relative fair value allocation was as follows: common stock $466,000, net of the value of the warrants issued to the placement agent in the amount of $79,000; warrants $473,000, and placement agent warrants of $79,000. In calculating the relative fair values of the warrants and the placement agent warrants Bam valued the instruments using the Black-Scholes option pricing model with the following assumptions: expected term ranging from four and a half years to four and three-quarters years; risk-free interest rate ranging from 2.72% to 3.16%; volatility ranging from 147% to 150%; and no dividends during the expected term.

As more fully described in Note 16, in September 2002 Bam issued 68,738 shares of common stock pursuant to a license agreement with a production company. Bam capitalized the cost of this issuance at the fair market value of the common stock, equal to $70,000, and amortized this amount to royalties, software costs and license costs over the life of the products after release. Bam previously issued 68,738 shares of common stock pursuant to this license agreement in April 2001. During the three months ended March 31, 2004 and 2003, no sums were amortized to royalties, software costs, and license costs. During the nine months ended March 31, 2004 and 2003, $0 and $70,000, respectively, was amortized to royalties, software costs, and license costs.

In January 2004, Bam completed the sale of 2,532,522 shares of its common stock and warrants to purchase another 1,519,513 shares of its common stock, resulting in gross proceeds (assuming no exercise of the warrants) of $2.3 million, in a private offering to institutional and accredited investors. The warrants have a five-year term and are immediately exercisable, at $1.40 per share. Bam also granted the investors additional investment rights to purchase an additional 2,467,478 shares of its common stock and warrants to purchase another 1,480,487 shares of its common stock. The shares of common stock underlying the additional investment rights are purchasable at $0.92 per share and the warrants underlying the additional investment rights have a five-year term and are exercisable at the greater of (i) $1.40 and (ii) the lesser of (x) the closing bid price of Bam’s common stock on the Nasdaq Stock Market on the business day immediately preceding the exercise date of the additional investment right, and (y) the average of the closing bid price of Bam’s common stock on the Nasdaq Stock Market for the five business days immediately preceding the exercise date of the additional investment right. The additional investment rights are exercisable June 25, 2004. Bam has allocated the proceeds from the sale of the shares and warrants to the shares, warrants and additional investment rights based on the relative fair values of the instruments. The fair value allocation was as follows: common stock $944,000; warrants $712,000; and additional investment rights $673,000. In calculating the relative fair values of the warrants Bam valued the instruments using the Black-Scholes option pricing model with the following assumptions: expected term equal to five years; risk-free interest rate of 3.18%; volatility of 150%; and no dividends during the expected term. In calculating the relative fair values of the additional investment rights Bam valued the instrument using the Black-Scholes option pricing model with the following assumptions: expected term equal to six months; risk-free interest rate of 1.03%; volatility of 164%; and no dividends during the expected term.

13. WARRANTS

There were outstanding warrants to purchase a total of 5,921,029 and 878,450 shares of common stock as of March 31, 2004 and June 30, 2003, respectively.

As more fully described in Note 12, in October 2003, Bam completed the sale of 1,850,000 shares of its common stock and warrants to purchase another 1,665,000 shares of its common stock, in a private offering to institutional and accredited investors. The warrants have a five-year term and are immediately exercisable, at $1.87 per share. The placement agents were also issued warrants to purchase 277,500 shares of Bam’s common stock in connection with placement agent fees under the same terms as the warrants issued to the investors, except that the placement agent warrants are subject to a 180 day lock-up provision. Between January and March 2004, six investors who purchased common stock and warrants in the private placement in October 2003 exercised their additional

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investment rights and purchased an additional 1,060,858 shares of Bam’s common stock and warrants to purchase another 954,772 shares of Bam’s common stock. The warrants have a five-year term and are immediately exercisable, at $1.87 per share. The placement agents were also issued warrants to purchase 159,127 shares of Bam’s common stock in connection with placement agent fees under the same terms as the warrants issued to the investors, except that the placement agent warrants are subject to a 180 day lock-up provision.

As more fully described in Note 12, in January 2004, Bam completed the sale of 2,532,522 shares of its common stock and warrants to purchase another 1,519,513 shares of its common stock, in a private offering to institutional and accredited investors. The warrants have a five-year term and are immediately exercisable, at $1.40 per share.

In connection with an agreement entered into with a third party financial advisor, Europlay Capital Advisors, LLC (“Europlay”), during November 2003, Bam issued a warrant to purchase up to 200,000 shares of common stock. The warrant has a three year term and is immediately exercisable, at $1.44 per share. The fair value of the warrant was estimated to be $240,000 at the grant date, using the Black-Scholes option pricing model with the following assumptions: expected term equal to three years; risk-free interest rate of 2.3%; volatility of 183%; and no dividends during the expected term. The fair value of the warrant was expensed to general and administration during the nine months ended March 31, 2004. Additional compensation is payable to Europlay should Bam consummate a merger, acquisition or business combination arranged or assisted by Europlay. Mark Dyne, a manager and member of Europlay, has served on Bam’s Board of Directors since July 2000.

As more fully described in Note 11, in December 2003, Bam sold a convertible term note and 166,667 warrants to an investment group. The warrants have a seven-year term and are immediately exercisable at prices ranging between $1.73 and $2.33 per share. The relative fair value of the warrants was estimated to be $182,000 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 3.98%; volatility of 174%; and no dividends during the expected term. In accordance with EITF No. 00-27, Application of Issue No. 98-5 to Certain Convertible Instruments, Bam reduced the carrying value of the underlying note by the relative fair value of the warrant and increased additional paid in capital by the same amount.

In connection with an agreement entered into with a production company during January 2002, Bam 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 connection with the agreement, Bam is required to issue 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, such as exercising a right to develop a product. Warrants are issued at the average closing price of Bam’s 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. Through March 31, 2004, Bam has issued warrants to the production company to purchase a total of 35,000 shares of common stock, at an aggregate cost of $97,000, of which $8,000 was amortized to project abandonment in the year ended June, 30, 2003. Bam amortized the remaining licensed asset of $89,000 over the life of the software products on which the warrants are exercisable, estimated at six months, commencing upon release of the products, which occurred in September 2003. During the three and nine months ended March 31, 2004 Bam amortized $17,000 and $97,000 respectively, of this asset. As of March 31, 2004, none of this asset remained unamortized. Bam cannot estimate the aggregate dollar amount of future non-cash charges arising upon the future issuance of warrants as they are based on its share price at future points in time. Each of these future charges will affect the Bam’s gross margins and profitability.

In connection with the issuance of warrants pursuant to a first look agreement with another production company, Bam granted a warrant to purchase up to 200,000 shares of Bam’s 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, Bam incurred a non-cash charge of $29,000. Bam fully amortized the licensed asset of $29,000 to royalties, software costs, and license costs during the year ended June 30, 2003. Bam 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, Bam will amortize the licensed asset over the life of the products, which are expected to be between three and six months. Bam cannot estimate the aggregate dollar amount of these future non-cash charges as they are based on its share price at future points in time. Each of these future charges will affect Bam’s gross margins and profitability.

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In connection with an agreement entered into in March 2004 with a content provider whereby Bam is required to incur, over the life of the agreement, certain minimum levels of advertising expenditures within the content provider’s published magazine, Bam granted a warrant to purchase up to 100,000 shares of Bam’s common stock. The warrant has a two year term and is immediately exercisable, at $0.966 per share. Bam incurred a non cash charge equal to the fair value of the warrant, estimated to be $69,000 at the grant date, using the Black-Scholes option pricing model with the following assumptions: expected term equal to two years; risk-free interest rate of 1.5%; volatility of 171%, and no dividends during the expected term. The fair value of the warrant will be expensed to sales and marketing as the minimum advertising expenditures are incurred. As of March 31, 2004, $3,000 had been amortized and $66,000 remained unamortized.

See Note 18 for additional warrant issuances subsequent to March 31, 2004.

14. BUSINESS SEGMENT AND GEOGRAPHIC INFORMATION

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

Financial information by geographical region is summarized below (in thousands):

15. COMMITMENTS

Bam’s principal commitments at March 31, 2004 comprised operating leases and contractual marketing commitments. As of March 31, 2004, Bam had commitments to spend $871,000 under operating leases and spend

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$763,000 in advertising on the networks and websites of these content providers. Of this sum, $13,000 was due but unpaid at March 31, 2004. Of the total commitments, $1.2 million must be paid no later than March 31, 2005.

16. CONTINGENCIES

As of March 31, 2004, an investment group had a security interest in all of Bam’s North American assets (see Note 11).

As of June 30, 2003, a finance company had a security interest in Bam’s domestic accounts receivable, inventory, fixed assets and intangible assets against advances made under a factoring agreement between the finance company and Bam. This agreement was mutually terminated in September 2003, upon payment by Bam of a termination fee of $25,000. Bam accounted for all cash advances made under the agreement as a current liability and for outstanding letters of credit as a contingent liability.

As of March 31, 2004 and June 30, 2003, other assets included $54,000 of guarantee deposits on facilities leased by Bam.

Bam offers a limited warranty on products sold. Bam does not maintain a general warranty reserve as estimated future warranty costs are accounted for in price protection and return reserves accrued at the time of sale of the Bam’s products.

Under an agreement entered into between Bam and a production company, Bam has a first look right to review screenplays acquired by the production company and to develop products based on films produced from those screenplays. For each film (up to a total of 10 films) that Bam selects, 68,738 fully vested and non-forfeitable shares of common stock will be issued to the production company following the theatrical release of each film for which Bam has developed a product, up to a maximum of 687,375 shares of common stock. As of March 31, 2004 Bam 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 another had its theatrical release during the year ended June 30, 2002. Accordingly, Bam has issued 137,476 shares of common stock to the production company to date, with an aggregate value of $816,000, which has been fully amortized as of June 30, 2003. Bam is not required to issue stock on the remaining film until such time as the film is released, which is anticipated to be in the spring of calendar year 2004.

In connection with an agreement entered into with a separate production company during January 2002, under which Bam may produce software products based on certain properties owned by the production company, Bam 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. As of March 31, 2004, warrants to issue 35,000 shares of common stock have been issued under this agreement, with an aggregate value of $97,000. The issuance of warrants on the remaining 15,000 shares of common stock is contingent upon certain future events occurring, such as exercising a right to develop a product. In December 2003, Bam received notice from the publisher, Aardman Animations Ltd (“Aardman”), that it was terminating with immediate effect its licensing and publishing agreement (the “Agreement”) with Bam for purported breaches of certain terms of the Agreement by Bam. On March 24, 2004, Aardman filed a claim with the High Court of England and Wales asking for a declaration that the Agreement had been validly terminated. Bam disputes the alleged breaches, is contesting the claim for termination, and is seeking equitable protection of its interests. At March 31, 2004, Bam had expensed all prepaid royalties incurred under this Agreement.

In connection with a first look agreement entered into with a production company in May 2002, Bam granted the production company a warrant, with a ten year term from the date of issue, to purchase up to 200,000 shares of Bam’s common stock at an exercise price of $2.60, of which 15,000 shares became immediately exercisable upon the signing of the agreement, at an aggregate cost of $29,000, which has been fully amortized as of June 30, 2003, and the remaining 185,000 shares only become exercisable in multiples of 4,625 shares upon each election by Bam to produce a title based on any films, made for television movies, or television series produced from screenplays to be produced by the production 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 Bam has developed a title. Upon expiration of the

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agreement, any unexercised warrants will cease to be exercisable. Bam’s 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 Bam bases a product, and eight years. The agreement was assigned by the production company to another production company in July 2002.

Legal Proceedings

In December 2003, Bam received notice from a publisher, Aardman Animations Ltd (“Aardman”), that it was terminating with immediate effect its licensing and publishing agreement (the “Agreement”) with Bam for purported breaches of certain terms of the Agreement by Bam. On March 24, 2004, Aardman filed a claim with the High Court of England and Wales asking for a declaration that the Agreement had been validly terminated. Bam disputes the alleged breaches, is contesting the claim for termination, and is seeking equitable protection of its interests. On May 7, 2004, Bam filed its defense and a counterclaim with the High Court. At March 31, 2004, Bam had expensed all prepaid royalties incurred under this Agreement.

In February 2004, Frontier Developments Limited (“Frontier”) filed with the High Court of England and Wales payment claims totaling approximately GBP 335,000 ($600,000) under a development agreement entered into in October 2003 between it and Bam’s UK subsidiary. Under this agreement, certain deliverables were required to be made by Frontier on a weekly and monthly basis. Bam was entitled to withhold payment if the deliverables were either incomplete or not made in accordance with the terms of the Agreement. Bam contended that, for the sums invoiced, the deliverables either had not been received or were incomplete. The parties settled the claim prior to the hearing by the High Court on April 7, 2004, and at the hearing the claim was dismissed. All written documentation has been executed. The terms of the settlement are confidential and did not have a material effect on Bam’s consolidated financial position or results of operations. At March 31, 2004, Bam had accrued and expensed $230,000 within Research and Development costs with respect to services provided by Frontier under this agreement.

17. NEW ACCOUNTING PRONOUNCEMENTS

In January 2003 the FASB issued FIN 46, Consolidation of Variable Interest Entities, and a revised interpretation of FIN 46 (“FIN 46-R”) in December 2003. FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46R clarifies some of the provisions of FIN 46 and exempts certain entities from its requirements. The provisions of FIN 46 are effective immediately for all arrangements entered into after January 31, 2003. Since January 31, 2003, Bam has not invested in any entities it believes are variable interest entities for which Bam is the primary beneficiary. For all arrangements entered into after January 31, 2003, Bam is required to continue to apply FIN 46 through March 31, 2004. Bam is required to adopt the provisions of FIN 46-R for those arrangements entered into subsequent to March 31, 2004. For arrangements entered into prior to February 1, 2003, Bam is required to adopt the provisions of FIN 46-R in financial periods commencing on or after April 1, 2004. Bam does not expect the adoption of FIN 46-R to have an impact on Bam’s consolidated financial position or results of operations.

In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, which requires that certain financial instruments be presented as liabilities that were previously presented as equity or as temporary equity. Such instruments include mandatory redeemable preferred and common stock, and certain options and warrants. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003 and was effective at the beginning of the first interim period beginning after June 15, 2003. In November 2003, the FASB issued FASB FSP No. 150-3, Effective Date, Disclosures, and Transition for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests under SFAS No. 150, which defers the effective date for various provisions of SFAS No. 150. Bam believes that it has properly classified and measured in it balance sheets and disclosed in its interim consolidated financial statements both characteristics of both liabilities and equity appropriately.

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18. SUBSEQUENT EVENTS

As more fully described in Note 2, in April 2004, Bam surrendered the lease on its former London premises back to the landlord in consideration of a settlement payment of $225,000, which included arrears of rents, a termination fee, and attributable legal fees. The payment was made in April 2004.

In February 2004, Frontier Developments Limited (“Frontier”) filed with the High Court of England and Wales payment claims totaling approximately GBP 335,000 ($600,000) under a development agreement entered into in October 2003 between it and Bam’s UK subsidiary. Under this agreement, certain deliverables were required to be made by Frontier on a weekly and monthly basis. Bam was entitled to withhold payment if the deliverables were either incomplete or not made in accordance with the terms of the Agreement. Bam contended that, for the sums invoiced, the deliverables either had not been received or were incomplete. The parties settled the claim prior to the hearing by the High Court on April 7, 2004, and at the hearing the claim was dismissed. All written documentation has been executed. The terms of the settlement are confidential and did not have a material effect on Bam’s consolidated financial position or results of operations. At March 31, 2004, Bam had accrued and expensed $230,000 within Research and Development costs with respect to services provided by Frontier under this agreement.

In December 2003, Bam received notice from a publisher, Aardman Animations Ltd (“Aardman”), that it was terminating with immediate effect its licensing and publishing agreement (the “Agreement”) with Bam for purported breaches of certain terms of the Agreement by Bam. On March 24, 2004, Aardman filed a claim with the High Court of England and Wales asking for a declaration that the Agreement had been validly terminated. Bam disputes the alleged breaches, is contesting the claim for termination, and is seeking equitable protection of its interests. On May 7, 2004, Bam filed its defense and a counterclaim with the High Court.

On January 22, 2002 Kmart, a customer of Bam, filed voluntary petitions for reorganization under Chapter 11 of the U.S. Bankruptcy Code. Bam, an unsecured creditor, recorded a 100% allowance against the accounts receivable balance due from Kmart. Kmart completed its reorganization and emerged from Chapter 11 on May 6, 2003. Under its plan of reorganization Kmart distributed 8,086 shares of Kmart Corporation’s common stock to Bam in April 2004. Bam sold the 8,086 shares in May 2004 for net proceeds of $356,000.

On February 17, 2004, the management of Bam agreed with the management of VIS entertainment plc (“VIS”), a Scottish developer of interactive entertainment software products, on the terms of an offer (the “VIS Offer”) to acquire all of the Ordinary Shares, A Shares and B Shares of VIS in exchange for the issuance of up to 4.5 million unregistered shares (the “VIS Consideration Shares”) of Bam’s common stock. On May 19, 2004, all the terms of the VIS Offer were either satisfied or waived, and accordingly the VIS Offer was declared unconditional in all respects.

On February 17, 2004, Bam’s management entered into an agreement with the shareholders of State of Emergency Development Corporation (“SOED”) to acquire all of the share capital of SOED (the “SOED Acquisition”) in exchange for the issuance of up to 4.5 million unregistered shares of Bam’s common stock (the “SOED Consideration Shares”). The SOED Acquisition was conditional upon the closing of the acquisition by Bam of all of the VIS shares. On May 19, 2004, the SOED Acquisition was declared unconditional in all respects and Bam issued the 4.5 million unregistered shares of its common stock in exchange for the share capital of SOED.

BAM has received irrevocable acceptances to acquire a controlling interest from shareholders in VIS. As of May 23, 2004, BAM had received irrevocable acceptances to acquire 91.9% of the Ordinary Shares, 95.6% of the A Shares and 100.0% of the B Shares of VIS, respectively. Because Bam has received irrevocable acceptances in excess of 90% of each class of shareholder, Bam can compulsorily acquire the remaining shares held by shareholders who have not accepted the VIS Offer within 14 days of the VIS Offer being declared unconditional. Bam intends to enforce the compulsory purchase. Accordingly, Bam will issue 4.5 million unregistered shares of its common stock in exchange for the entire share capital of VIS.

The VIS shareholders and the SOED shareholders have placed a total of 750,000 of the Bam shares issued in connection with the two transactions in an escrow account for the purpose of indemnifying Bam against any breach

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by VIS and SOED of the representations and warranties in the purchase agreements. In addition, the parties placed 450,000 of the Bam shares to be issued in connection with the transactions in an escrow account to provide security for the additional Purchase Price Adjustments set forth in the agreement. Bam also placed a total of 750,000 of its shares into an escrow account for the purposes of indemnifying the shareholders of VIS and SOED against certain warranties made by Bam to VIS and SOED shareholders. The shares placed in escrow by Bam are in addition to the shares issued by Bam under the acquisition of VIS and SOED. All shares placed in escrow shall remain in escrow until the later of 12 months from closing date and the date of the resolution of any claims that may arise. As of May 21, 2004, no claims had been made.

Bam currently estimates that its direct acquisition costs will be approximately $1.6 million. Of these, $0.5 million is payable in either cash or Bam’s common stock at Bam’s discretion.

The two transactions were conditional upon, among other things, (i) the stockholders of Bam approving the issuance of the 9 million Bam shares in connection with the two transactions; (ii) Bam raising not less than $12.35 million (net of expenses) from the sale of equity capital prior to the closing date expected to be on June 2, 2004; and (iii) Bam using its commercially reasonable efforts to maintain its listing on the NASDAQ Stock Market. The condition for Bam to raise not less than $12.35 million (net of expenses) from the sale of equity capital prior to the closing date was waived by the VIS Board prior to the VIS offer being declared unconditional on May 19, 2004.

Bam, the VIS shareholders, and the SOED shareholders have entered into various agreements affecting the transferability of the SOED Consideration Shares and VIS Consideration Shares. The parties have entered into a registration rights agreement which requires Bam to file, no later than the thirtieth day following the closing date, a registration statement with the Securities and Exchange Commission for the registration of the VIS Consideration Shares and the SOED Consideration Shares. Nevertheless, the parties have also entered into a lock-up agreement which requires the VIS and SOED shareholders to only sell their registered Bam shares in accordance with the following schedule: (i) 25% shall be sold no earlier than the 30th day following the closing date; (ii) an additional 25% shall be sold no earlier than the 180th day following the closing date; (iii) an additional 25% shall be sold no earlier than the 270th day following the closing date; and (iv) the remaining 25% shall be sold no earlier than the first anniversary of the closing date. The closing of transaction takes place 14 days after the offer became unconditional.

On May 19, 2004 Bam entered into an agreement with SOED’s Loanholders whereby GBP 1.7 million (equivalent to $3.0 million) of outstanding loan notes, which were repayable upon the close of the SOED acquisition, will no longer be payable upon the close, but will become payable as follows: the sterling equivalent of $1.0 million plus outstanding interest will become payable by Bam on or before September 30, 2004, and the balance, including outstanding interest, will become payable by Bam on or before the one year anniversary of the closing date. In addition to these amounts and in consideration of this deferral of payment, Bam will issue upon the closing date 5 year warrants to purchase 1,071,000 shares of its common stock to the Loanholders at the lower of $0.70 and the average mid market price of Bam’s common stock for the five business days prior to exercise of the warrant, and 5 year warrants to purchase 428,500 shares of its common stock to the advisors of the Loanholders at the lower of $0.70 and the average mid market price of Bam’s common stock for the five business days prior to exercise of the warrant. Bam is also required to make a cash payment of $210,000 to the advisors of the Loanholders when the loan has been repaid in full.

On May 19, 2004, in accordance with an agreement entered into between Bam and Flextech Television Limited, and upon the VIS Offer becoming unconditional, Bam issued 801,529 shares of its common stock to the Telewest Group

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of Companies to repay a debt, approximating $393,000, owed by VIS itv Limited to the Telewest Group of Companies. VIS itv Limited is a private limited company incorporated in the United Kingdom, owned as to 50% by Flextech Television Limited, a subsidiary of Telewest Communications plc, and 50% by VIS.

On May 21, 2004 Bam issued 771,715 shares of its common stock, and warrants to purchase another 77,172 shares of its common stock, in exchange for the settlement of debts totaling $463,000 owed to four creditors. The warrants have a five-year term and are exercisable at $0.60 per share.

On May 24, 2004 Bam completed the sale of 282 shares of its Series A Cumulative Convertible Preferred Stock (the “Preference shares”) and warrants to purchase another 2,548,192 shares of its common stock, resulting in gross value (assuming no exercise of the warrants) of $2.8 million, in a private offering to institutional, accredited investors, Bam’s Chief Executive Officer and Vice Chairman of the Board of Directors. Of the total sale, 188 Preference shares and warrants to purchase another 1,698,795 shares of its common stock, resulting in gross proceeds (assuming no exercise of the warrants) of $1.9 million, were sold to institutional and accredited investors, 50 Preference shares and warrants to purchase another 451,807 shares of its common stock, resulting in gross value (assuming no exercise of the warrants) of $500,000 were sold to Bam’s Chief Executive Officer, and 44 Preference shares and warrants to purchase another 397,590 shares of its common stock, resulting in gross value (assuming no exercise of the warrants) of $440,000, were sold in exchange for the settlement of a loan and accrued interest totaling $260,000 from Bam’s Vice Chairman of the Board of Directors and deferred salaries totaling $90,000 each from Bam’s Chief Executive Officer and Vice Chairman of the Board of Directors. All of these warrants have a five-year term and are exercisable at $0.594 per share. Each Preference stockholder receives a 10% dividend per annum, payable quarterly in arrears on the last day of each quarter. The initial dividend payment will be pro-rated from the date of issuance to the end of the first quarter after issuance. Each Preference share is convertible into 12,048 shares of Bam’s common stock at the option of the holder. Bam can require the Preference stockholder to convert the Preference shares into common shares upon the expiration of 30 days notice provided that the following three conditions are all met: (i) there is an effective registration statement in effect, (ii) the daily market price of Bam’s common stock is greater than $1.20 for twenty of the thirty trading days prior to the notice being issued, and (iii) Bam’s common stock is listed on either the Nasdaq SmallCap Market, Nasdaq National Market, American Stock Exchange or the New York Stock Exchange. Each Preference share has a liquidation preference of $10,000. Preference stockholders have full voting rights and powers, are treated as the same class as common stock holders at stockholder meetings, and are entitled to vote the number of common stock equivalent votes at each meeting. While at least 10% of the original numbers of Preference shares issued are in issue, Bam may not, without the written consent of the majority of Preferred stockholders (i) repeal or alter the terms under which the Preference shares are issued, (ii)amend or repeal its Certificate of Incorporation or Bylaws, (iii) authorize, offer or issue any stock ranking pari passu or senior to them (iv) redeem or repurchase any shares of the Company in issue, and (v) declare or pay a dividend to any other class of share. Bam is required to redeem all Preference shares and pay the liquidated preference in cash plus all accrued and unpaid dividends if (i) it refuses to convert any Preference shares to common stock having received notice from the holder to convert, or (ii) it breaches any warranty or representation given to the Preference stockholders, or (iii) breaches any covenant given to the Preference stockholders.

On May 24, 2004 Bam completed the sale of a $6.75 million 2% Secured Convertible Debenture (the “Debenture”), due November 24, 2006, and warrants to purchase another 6,549,398 shares of its common stock. The warrants have a five-year term and are exercisable at $0.594 per share. The Debenture is convertible, in whole or in part, into Bam’s common stock, at the option of the Debenture holders, at a conversion price of $0.83 per share. The entire $6.75 million received from the issuance of the Debenture is secured by restricted cash held at an account at a third party custodian. Bam has no access to, or use of the cash, until the Debenture is converted into common stock. If the Debenture is partly converted into common stock, Bam will have access to the cash for the part converted and the remainder of the cash will remain restricted. Interest on the Debenture is payable quarterly in arrears on the last day of each quarter. The initial interest payment will be pro-rated from the date of issuance to the end of the first quarter after issuance. Bam can require the Debenture holder to convert the Debenture into common shares upon the expiration of no more than 5 days notice provided that the following two conditions are all met: (i) Bam gives notice to the Debenture holders within 3 days of the daily market price of Bam’s common stock exceeding $1.66 for fifteen consecutive trading days, and (ii) Bam’s common stock’s average daily trading volume over the fifteen consecutive trading days exceeds 100,000 shares. In order to issue the Debenture, Bam was required to obtain the consent of the existing convertible term note holders. The convertible term note holders gave their consent on May 21, 2004 and,

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as consideration, were issued warrants, with a seven-year term, to purchase 166,667 shares of Bam’s common stock at an exercise price of $0.63 per share.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis should be read in conjunction with the condensed consolidated financial statements and notes thereto appearing elsewhere in this Report on Form 10-Q.

This Form 10-Q 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. When used in this Form 10-Q, the words “anticipate,” “believe,” “estimate,” “will,” “plan,” “intend” and “expect” and similar expressions identify forward-looking statements. Although we believe that our plans, intensions and expectations reflected in those forward-looking statements are reasonable, we cannot assure you that these plans, intentions or expectations will be achieved. Actual results, performance or achievements could differ materially from those contemplated, expressed or implied by the forward-looking statements contained in this Form 10-Q. Important factors that could cause actual results to differ materially from our forward-looking statements include but are not limited to those set forth below under the heading “Risk Factors” and elsewhere in this Report. Our actual results could differ materially from those predicated in these forward-looking statements, and the events anticipated in the forward-looking statements may not actually occur. All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements set forth in the above prospectus. Other than as required by federal securities law, we are under no obligation to update any forward-looking statement, whether as a result of new information, future events or otherwise.

OVERVIEW

We develop and publish interactive entertainment software products. We currently publish titles for the most popular interactive entertainment hardware platforms, such as Sony’s PlayStation and PlayStation 2, Nintendo’s GameCube, N64, Game Boy Color and Game Boy Advance, Microsoft’s Xbox, portable handheld devices manufactured by Palm and Handspring, and for personal computers or PCs. 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 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 have offices in both the United States and Europe. International operations outside of North America are conducted through our office in England, where we perform international sales and marketing activities and manage local third-party developers.

Domestically, 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.

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In July 2003, we entered into a distribution agreement with Acclaim Entertainment Ltd (“Acclaim”) whereby Acclaim exclusively distribute certain current and forthcoming products of ours in PAL territories. PAL is the television standard for the United Kingdom, continental Europe and Australia. Acclaim are responsible for the manufacture, sale, distribution and marketing of the products and are required to pay us based on net receipts from the sales made by them. The agreement obligates Acclaim to pay us minimum guarantee advances both before and after product release dates, but such payments are reduced upon late delivery of a product, and fully repayable upon cancellation of the product.

We have experienced recurring net losses from inception (October 7, 1999) through March 31, 2004. During the nine months ended March 31, 2004, we used cash in operating activities of $6.1 million and incurred a net loss of $11.2 million. As of March 31, 2004, we had cash and cash equivalents of $290,000 and an accumulated deficit of $71.0 million. These factors, among others, raise substantial doubt about our ability to continue as a going concern for a reasonable period of time. The consolidated financial statements do not include any adjustments relating to the recoverability and classification of assets or the amounts and classification of recorded liabilities that might be necessary should we be unable to continue as a going concern.

In October 2003, we completed the sale of 1,850,000 shares of our common stock and warrants to purchase another 1,665,000 shares of our common stock, resulting in gross proceeds (assuming no exercise of the warrants) of $1.8 million, in a private offering to institutional and accredited investors. The warrants have a five-year term and are exercisable at $1.87 per share. The placement agents were issued warrants to purchase 277,500 shares of our common stock in connection with placement agent fees under the same terms as the warrants issued to the investors, except that the placement agent warrants are subject to a 180 day lock-up provision. We also granted the investors additional investment rights to purchase an additional 1,111,625 shares of our common stock and warrants to purchase another 1,000,462 shares of our common stock. The shares of common stock underlying the additional investment rights are purchasable at $0.96 per share and the warrants underlying the additional investment rights have a five-year term and are exercisable at the greater of (i) $1.87 and (ii) the lesser of (x) the closing bid price of our common stock on the Nasdaq Stock Market on the business day immediately preceding the exercise date of the additional investment right, and (y) the average of the closing bid price of our common stock on the Nasdaq Stock Market for the five business days immediately preceding the exercise date of the additional investment right. Between January and March 2004, six of the investors exercised their additional investment rights in full and purchased 1,060,858 shares of our common stock at $0.96 per share, resulting in gross proceeds (assuming no exercise of the warrants) of $1.0 million. These six investors were also issued five-year warrants to purchase 954,772 shares of our common stock, which are exercisable under the terms of additional investment rights issued in the October private offering of our securities. The remaining additional investment rights to purchase 50,767 shares of our common stock and warrants to purchase another 45,690 shares of our common stock, lapsed on March 11, 2004.

In December 2003, we sold a convertible term note and 166,667 warrants, raising gross proceeds of $1.5 million (assuming no exercise of the warrants) to an investment group. The note, which bears interest at a rate of 7% per annum, has a maturity date of December 3, 2004. The warrants have a seven-year term and are immediately exercisable at prices ranging between $1.73 and $2.33 per share. Each month, commencing on April 1, 2004, $166,667 of the principal amount of the note plus accrued and unpaid interest and fees can either be repaid in cash, or converted into our shares of our common stock at a fixed conversion price, provided that the closing price of shares of our common stock exceeds 115% of the fixed conversion price for a period of 10 consecutive trading days prior to the date of conversion. If, at any other time, the closing price of our shares exceeds 115% of the fixed conversion price for a period of 5 consecutive trading days, we have the option to, 10 trading days later, convert all or part of the remaining outstanding note, interest and fees, subject to conversion volume limitations based on our share trading volume and share price in the 10 trading days prior to such conversion. The holder of the note has the right to convert all or any of the outstanding portion of the note, interest and fees at any time at the fixed conversion price. Conversion of the note by either party is subject to there being an effective registration statement in effect and Nasdaq’s confirmation that this transaction is not integrated with the private offering that closed in October 2003. An effective registration statement went into effect on April 22, 2004. Nasdaq has advised us that the transaction is not integrated with the private offering that closed in October 2003. The fixed conversion price is subject to an anti dilution adjustment should we issue stock at a price below the fixed conversion price prior to repayment of the note. The fixed conversion price was originally set at $1.33 per share, but an issuance of shares in January 2004 triggered the anti-dilution provision, and the fixed conversion price was adjusted to $1.28 per share. Further issuances of

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shares occurred in May 2004 as set out below, and the fixed conversion price was further adjusted to $1.19 per share. The note is secured by our North American assets. As of May 21, 2004, none of the note had been repaid or converted into common stock, and accordingly we are in default of the terms of the note.

In January 2004, we completed the sale of 2,532,522 shares of our common stock and warrants to purchase another 1,519,513 shares of our common stock, resulting in gross proceeds (assuming no exercise of the warrants) of $2.3 million, in a private offering to institutional and accredited investors. The warrants have a five-year term and are exercisable at $1.40 per share. We also granted the investors additional investment rights to purchase an additional 2,467,478 shares of our common stock and warrants to purchase another 1,480,487 shares of our common stock. The shares of common stock underlying the additional investment rights are purchasable at $0.92 per share and the warrants underlying the additional investment rights have a five-year term and are exercisable at the greater of (i) $1.40 and (ii) the lesser of (x) the closing bid price of our common stock on the Nasdaq Stock Market on the business day immediately preceding the exercise date of the additional investment right, and (y) the average of the closing bid price of our common stock on the Nasdaq Stock Market for the five business days immediately preceding the exercise date of the additional investment right. The additional investment rights are exercisable until June 25, 2004.

On February 17, 2004, our management agreed with the management of VIS entertainment plc (“VIS”), a Scottish developer of interactive entertainment software products, on the terms of an offer (the “VIS Offer”) to acquire all of the Ordinary Shares, A Shares and B Shares of VIS in exchange for the issuance of up to 4.5 million unregistered shares (the “VIS Consideration Shares”) of our common stock. On May 19, 2004, all the terms of the VIS Offer were either satisfied or waived, and accordingly the VIS Offer was declared unconditional in all respects.

On February 17, 2004, our management entered into an agreement with the shareholders of State of Emergency Development Corporation (“SOED”) to acquire all of the share capital of SOED (the “SOED Acquisition”) in exchange for the issuance of up to 4.5 million unregistered shares of our common stock (the “SOED Consideration Shares”). The SOED Acquisition was conditional upon the closing of the acquisition by us of all of the VIS shares. On May 19, 2004, the SOED Acquisition was declared unconditional in all respects and we issued the 4.5 million unregistered shares of our common stock in exchange for the share capital of SOED.

We have received irrevocable acceptances to acquire a controlling interest from shareholders in VIS. As of May 23, 2004, we had received irrevocable acceptances to acquire 91.9% of the Ordinary Shares, 95.6% of the A Shares and 100.0% of the B Shares of VIS, respectively. Because we have received irrevocable acceptances in excess of 90% of each class of shareholder, we can compulsorily acquire the remaining shares held by shareholders who have not accepted the VIS Offer within 14 days of the VIS Offer being declared unconditional. We intend to enforce the compulsory purchase. Accordingly, we will issue 4.5 million unregistered shares of our common stock in exchange for the entire share capital of VIS.

The VIS shareholders and the SOED shareholders have placed a total of 750,000 of our shares issued in connection with the two transactions in an escrow account for the purpose of indemnifying us against any breach by VIS and SOED of the representations and warranties in the purchase agreements. In addition, the parties placed 450,000 of the our shares to be issued in connection with the transactions in an escrow account to provide security for the additional Purchase Price Adjustments set forth in the agreement. We also placed a total of 750,000 of our shares into an escrow account for the purposes of indemnifying the shareholders of VIS and SOED against certain warranties made by Bam to VIS and SOED shareholders. The shares placed in escrow by us are in addition to the shares issued by us under the acquisition of VIS and SOED. All shares placed in escrow shall remain in escrow until the later of 12 months from closing date and the date of the resolution of any claims that may arise. As of May 21, 2004, no claims had been made.

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We currently estimate that our direct acquisition costs will be approximately $1.6 million. Of these, $0.5 million is payable in either cash or our common stock at our discretion.

The two transactions were conditional upon, among other things, (i) our stockholders approving the issuance of the 9 million shares in connection with the two transactions; (ii) our raising not less than $12.35 million (net of expenses) from the sale of equity capital prior to the closing date expected to be on June 2, 2004; and (iii) our using commercially reasonable efforts to maintain our listing on the NASDAQ Stock Market. The condition for us to raise not less than $12.35 million (net of expenses) from the sale of equity capital prior to the closing date was waived by the VIS Board prior to the VIS offer being declared unconditional on May 19, 2004.

Our shareholders, the VIS shareholders, and the SOED shareholders have entered into various agreements affecting the transferability of the SOED Consideration Shares and VIS Consideration Shares. The parties have entered into a registration rights agreement which requires us to file, no later than the thirtieth day following the closing date, a registration statement with the Securities and Exchange Commission for the registration of the VIS Consideration Shares and the SOED Consideration Shares. Nevertheless, the parties have also entered into a lock-up agreement which requires the VIS and SOED shareholders to only sell their registered shares in us in accordance with the following schedule: (i) 25% shall be sold no earlier than the 30^th day following the closing date; (ii) an additional 25% shall be sold no earlier than the 180^th day following the closing date; (iii) an additional 25% shall be sold no earlier than the 270^th day following the closing date; and (iv) the remaining 25% shall be sold no earlier than the first anniversary of the closing date. The closing of transaction takes place 14 days after the offer became unconditional.

On May 19, 2004 we entered into an agreement with SOED’s Loanholders whereby, upon close of the SOED transaction, GBP 792,000 (equivalent to $1.4 million) of outstanding loan notes shall be repaid, and GBP 1.7 million (equivalent to $3.0 million) of outstanding loan notes, which were repayable upon the close of the SOED acquisition, will no longer be payable upon the close, but will become payable as follows: the sterling equivalent of $1.0 million plus outstanding interest will become payable by us on or before September 30, 2004, and the balance, including outstanding interest, will become payable by us on or before the one year anniversary of the closing date. In addition to these amounts, and in consideration of this deferral of payment, we will issue upon the closing date 5 year warrants to purchase 1,071,000 shares of our common stock to the Loanholders at the lower of $0.70 and the average mid market price of our common stock for the five business days prior to exercise of the warrant, and 5 year warrants to purchase 428,500 shares of our common stock to the advisors of the Loanholders at the lower of $0.70 and the average mid market price of our common stock for the five business days prior to exercise of the warrant. We are also required to make a cash payment of $210,000 to the advisors of the Loanholders when the loan has been repaid in full.

On May 19, 2004, in accordance with an agreement entered into between us and Flextech Television Limited, and upon the VIS Offer becoming unconditional, we issued 801,529 shares of our common stock to the Telewest Group of Companies to repay a debt, approximating $393,000, owed by VIS itv Limited to the Telewest Group of Companies. VIS itv Limited is a private limited company incorporated in the United Kingdom, owned as to 50% by Flextech Television Limited, a subsidiary of Telewest Communications plc, and 50% by VIS.

On May 21, 2004 we issued of 771,715 shares of our common stock, and warrants to purchase another 77,172 shares of our common stock, in exchange for the settlement of debts totaling $463,000 owed to four creditors. The warrants have a five-year term and are exercisable at $0.60 per share.

On May 24, 2004 we completed the sale of 347 shares of our Series A Cumulative Convertible Preferred Stock (the “Preference shares”) and warrants to purchase another 3,135,542 shares of our common stock, resulting in gross value (assuming no exercise of the warrants) of $3.4 million, in a private offering to institutional, accredited investors, Bam’s Chief Executive Officer and Vice Chairman of the Board of Directors. Of the total sale, 253 Preference shares and warrants to purchase another 2,286,145 shares of our common stock, resulting in gross proceeds (assuming no exercise of the warrants) of $2.5 million, were sold to institutional and accredited investors, 50 Preference shares and warrants to purchase another 451,807 shares of our common stock, resulting in gross value (assuming no exercise of the warrants) of $500,000 were sold to our Chief Executive Officer, and 44

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Preference shares and warrants to purchase another 397,590 shares of our common stock, resulting in gross value (assuming no exercise of the warrants) of $440,000, were sold in exchange for the settlement of a loan and accrued interest totaling $260,000 from our Vice Chairman of the Board of Directors and deferred salaries totaling $90,000 each from our Chief Executive Officer and Vice Chairman of the Board of Directors. All of these warrants have a five-year term and are exercisable at $0.594 per share. Each Preference stockholder receives a 10% dividend per annum, payable quarterly in arrears on the last day of each quarter. The initial dividend payment will be pro-rated from the date of issuance to the end of the first quarter after issuance. Each Preference share is convertible into 12,048 shares of our common stock at the option of the holder. We can require the Preference stockholder to convert the Preference shares into common shares upon the expiration of 30 days notice provided that the following three conditions are all met: (i) there is an effective registration statement in effect, (ii) the daily market price of our common stock is greater than $1.20 for twenty of the thirty trading days prior to the notice being issued, and (iii) our common stock is listed on either the Nasdaq SmallCap Market, Nasdaq National Market, American Stock Exchange or the New York Stock Exchange. Each Preference share has a liquidation preference of $10,000. Preference stockholders have full voting rights and powers, are treated as the same class as common stock holders at stockholder meetings, and are entitled to vote the number of common stock equivalent votes at each meeting. While at least 10% of the original numbers of Preference shares issued are in issue, we may not, without the written consent of the majority of Preferred stockholders (i) repeal or alter the terms under which the Preference shares are issued, (ii)amend or repeal its Certificate of Incorporation or Bylaws, (iii) authorize, offer or issue any stock ranking pari passu or senior to them (iv) redeem or repurchase any shares of the Company in issue, and (v) declare or pay a dividend to any other class of share. We are required to redeem all Preference shares and pay the liquidated preference in cash plus all accrued and unpaid dividends if (i) we refuse to convert any Preference shares to common stock having received notice from the holder to convert, or (ii) we breach any warranty or representation given to the Preference stockholders, or (iii) we breach any covenant given to the Preference stockholders.

On May 24, 2004 we completed the sale of a $6.75 million 2% Secured Convertible Debenture (the “Debenture”), due November 24, 2006, and warrants to purchase another 6,549,398 shares of our common stock. The warrants have a five-year term and are exercisable at $0.594 per share. The Debenture is convertible, in whole or in part, into our common stock, at the option of the Debenture holders, at a conversion price of $0.83 per share. The entire $6.75 million received from the issuance of the Debenture is secured by restricted cash held at an account at a third party custodian. We have no access to, or use of the cash, until the Debenture is converted into common stock. If the Debenture is partly converted into common stock, we will have access to the cash for the part converted and the remainder of the cash will remain restricted. Interest on the Debenture is payable quarterly in arrears on the last day of each quarter. The initial interest payment will be pro-rated from the date of issuance to the end of the first quarter after issuance. We can require the Debenture holder to convert the Debenture into common shares upon the expiration of no more than 5 days notice provided that the following two conditions are all met: (i) We gives notice to the Debenture holders within 3 days of the daily market price of our common stock exceeding $1.66 for fifteen consecutive trading days, and (ii) our common stock’s average daily trading volume over the fifteen consecutive trading days exceeds 100,000 shares. In order to issue the Debenture, we were required to obtain the consent of the existing convertible term note holders. The convertible term note holders gave their consent on May 21, 2004 and, as consideration, were issued warrants, with a seven-year term, to purchase 166,667 shares of our common stock at an exercise price of $0.63 per share.

We need to raise additional funds to satisfy our future liquidity requirements. These funds may come from either one or a combination of additional financings, exercise of outstanding warrants and additional investment rights, mergers or acquisitions, or otherwise obtain capital via sale or license of certain of our assets, in order to satisfy our future liquidity requirements. Current market conditions present uncertainty as to our ability to secure additional financing or effectuate any merger or acquisition, as well as our ability to reach profitability. There can be no assurances that we will be able to secure additional financing or effectuate any such merger or acquisition, or obtain favorable terms on such financing if it is available, or as to our ability to achieve positive cash flow from operations. Continued negative cash flows create significant uncertainty about our ability to implement our operating plan and we may have to further reduce the scope of our planned operations. If cash and cash equivalents, together with cash generated from operations, are insufficient to satisfy our liquidity requirements, we will not have sufficient resources to continue operations for the next six months.

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As of March 31, 2004, we had $1.2 million of capitalized development costs and licensed assets, and $291,000 of prepaid royalties. If we are unable to effectuate either a merger or acquisition or to secure sufficient additional financing, part or all of the development projects in progress might have to be abandoned, the related costs might have to be written off, and we would be unable to develop or acquire new titles, which would significantly affect our future cash flows from operations.

CRITICAL ACCOUNTING POLICIES

Financial Reporting Release No. 60 requires all companies to include a discussion of critical accounting policies or methods used in the preparation of 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 requires all companies to 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, future costs to be incurred associated with restructuring activities, carrying values of inventories, the future recoverability of prepaid royalties, capitalized software costs and licensed assets, and foreign currency translation.

Net revenues

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.

We derive our revenues from either the shipment of packaged or licensed products to our customers.

Packaged products: Our sales of packaged product are typically made on credit, with terms that vary depending upon the customer and other factors. Under certain conditions, we may allow customers to exchange and return packaged 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.

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 collectibility 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 allowances against receivables. We also estimate cooperative marketing costs on the sale and account for these costs as a marketing expense and as an allowance 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

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allowances will affect the reported amounts of revenues and expenses during the reporting periods the adjustments are made.

Licensed products: Our licensed product sales are typically made on terms requiring either an upfront minimum prepayment or payment upon delivery of the product, followed by subsequent payments based upon a percentage of monies received by the licensee, in excess of the prepayment, from products distributed by them. These subsequent payments are made at the time the licensee reports products distributed by them, normally on a quarterly basis. If our sale is made requiring an upfront prepayment or payment at the time of delivery, and that sum is non-refundable, we will recognize revenue equal to that sum at the time we deliver the product, provided we have no future deliverables, which is normally the case. We will only recognize subsequent revenue when we receive the licensee report of products distributed by them and of monies due by them, provided the revenue is considered collectible. We bear the risk of the inability of a customer to pay our receivables and of any delay in payment. If the collectibility of a receivable becomes uncertain after revenue has been recognized, we will record an allowance for doubtful accounts against our accounts receivable. We continually monitor, reassess and adjust the adequacy of the allowance for doubtful accounts, based on known circumstances, historical results, commitments made, anticipated events and anticipated commitments. Adjustments to this allowance will affect the reported amounts of expenses during the reporting periods the adjustments are made.

General: 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.

We have experienced, and are likely to continue to experience, quarterly fluctuations in net revenues. We believe the factors which influence these fluctuations include (i) the timing of our introduction of new products, (ii) the level of consumer acceptance of new and existing products, (iii) general economic and industry conditions that affect consumer spending and retail purchasing, (iv) the timing of the placement, cancellation or pickup of customer orders, (v) the timing of expenditures in anticipation of increased sales, (vi) actions by competitors, (vii) location of product releases, and (viii) the number of titles released in the period and the hardware platforms on which they are released. The timing of our introduction of new products is affected by uncertainties associated with software development, lengthy manufacturing lead times, production delays and the approval process for products by hardware manufacturers and other licensors. 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. Due to these and other factors, the operating results for any particular quarter are not necessarily indicative of the results for the entire fiscal year.

Cost of revenues

Cost of revenues consists of cost of goods sold, royalties, software costs and 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, and license costs. Royalties, software costs, and license costs include 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.

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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 begin to 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 are 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.

Project abandonment costs. If we terminate a development project prior to completion, we expense the capitalized software development costs and licensed assets costs to project abandonment.

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. 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.

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RESULTS OF OPERATIONS

The following table sets forth the unaudited condensed consolidated results of operations as a percentage of net revenues for the three and nine months ended March 31, 2004 and 2003.

Net revenues

Net revenues were $599,000 and $7.9 million for the three and nine months ended March 31, 2004, respectively, compared to $2.9 million and $33.6 million for the comparable periods in 2003, respectively. Revenues declined because we released fewer products in the three and nine months ended March 31, 2004 compared to the comparable periods in 2003.

During the three months ended March 31, 2004 we released no new titles in North America. During the nine months ended March 31, 2004, we released four new titles in North America. In both periods we also sold products first released in prior quarters. New products released in North America during the nine months ended March 31, 2004 were Wallace & Gromit in Project Zoo for the Sony PlayStation 2, the Microsoft Xbox, the Nintendo GameCube and the PC and The Powerpuff Girls Relish Rampage for the Nintendo GameCube.

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During the three and nine months ended March 31, 2004, under an exclusive distribution agreement with Acclaim for PAL territories, we shipped four and ten products, respectively. PAL is the television standard for the United Kingdom, continental Europe and Australia. With the exception of revenue from Acclaim, all revenue outside of North America was derived from direct packaged product sales. Revenue from distribution performed by Acclaim is recognized as licensed product revenue. For a description of revenue recognition accounting policies, see Critical Accounting Policies – net revenues. The products delivered to Acclaim for distribution, in the three months ended March 31, 2004, were The Powerpuff Girls Relish Rampage and Carmen Sandiego for the Nintendo GameCube, and Ice Nine and A Sound of Thunder for the Nintendo Game Boy Advance.

During the three and nine months ended March 31, 2003 we released three and 19 new products, respectively, worldwide.

We anticipate that, during the three months ended June 30, 2004, net revenues will increase in absolute dollars, compared to the three months ended March 31, 2004, as we intend to release new titles in the period.

Net revenues by geographical region for the three and nine months ended March 31, 2004 and 2003 are summarized below (in thousands):

The following table sets forth our net revenues by customer representing more than 10% of each period’s net revenues for the three and nine months ended March 31, 2004 and 2003 (percentages):

Net revenues to Kmart in the three and nine months ended March 31, 2003 were made under Kmart’s debtor-in-possession financing arrangement.

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Cost of revenues

Cost of goods sold was $429,000, or 72% of net revenues, for the three months ended March 31, 2004 as compared to $2.0 million, or 68% of net revenues, for the comparable period in 2003, and $4.8 million, or 61% of net revenues, for the nine months ended March 31, 2004 as compared to $20.7 million, or 62% of net revenues, for the comparable period in 2003. The decrease in absolute dollars was due to decreased sales of products in the current period compared to the comparable periods in 2003. There were no cost of goods sold on products licensed to Acclaim as they were responsible for all manufacturing costs. Excluding net revenue arising from products licensed to Acclaim, the percentage of cost of goods sold compared to net revenues deteriorated when compared to the comparable period in 2003, and this was due to a number of factors, including selling products at low margins for inclusion in holiday promotions by retailers, inventory write-downs, increased price protection allowances and returns reserved against sales. In absolute dollars, cost of goods sold decreased compared to the comparable periods in 2003 as fewer new products were released and less product was sold. We anticipate that, during the three months ended June 30, 2004, costs of goods sold expense will increase in absolute dollars, compared to the three months ended March 31, 2004, as we intend to release new titles in the period.

Royalties, software costs, and license costs were $2.4 million, or 396% of net revenues, for the three months ended March 31, 2004 as compared to $1.9 million, or 65% of net revenues, for the comparable period in 2003. The increase in absolute dollars was primarily due to the amortization of titles with higher development costs in the period compared to the comparative period. The increase in the percentage of net revenues was due to decreased sales of products in the period compared to the comparable period. We anticipate that, during the three months ended June 30, 2004, royalties, software costs, and license costs will decrease in absolute dollars, compared to the three months ended March 31, 2004, as new titles released and amortized in the period will have been developed at a lower cost than those amortized in the comparable period.

Royalties, software costs, and license costs were $6.3 million, or 80% of net revenues, for the nine months ended March 31, 2004 as compared to $15.5 million, or 46% of net revenues, for the comparable period in 2003. The decrease in absolute dollars was due to fewer releases of new products in the period and decreased sales of product. The increase in the percentage of net revenues was due to decreased sales of product in the period compared to the comparable period, combined with higher development costs on those products released in the period compared to those released in the comparable period of 2003.

There were no project abandonment costs for the three months ended March 31, 2004. Project abandonment costs were $1.0 million, or 36% of net revenues, for the comparable period in 2003, and $105,000, or 1% of net revenues, for the nine months ended March 31, 2003 as compared to $6.6 million, or 20% of net revenues for the comparable period in 2003. During the nine months ended March 31, 2004 we abandoned one project, while during the three and nine months ended March 31, 2003 we abandoned three and ten projects respectively, including a number late in the development cycle, resulting in higher amounts being expensed.

Research and development

Research and development expenses were $300,000, or 50% of net revenues, for the three months ended March 31, 2004, as compared to $527,000, or 18% of net revenues, for the comparable period in 2003, and $1.5 million, or 19% of net revenues, for the nine months ended March 31, 2004, as compared to $2.6 million, or 8% of net revenues, for the comparable period in 2003. The decrease in absolute dollars was primarily as a result of reduced headcount and development activity. The increase in the percentage of net revenues was due to reduced sales volumes in the current periods compared to the comparable periods of 2003. We anticipate, in absolute dollar terms, that research and development expenses will increase during the three months ended June 30, 2004.

Sales and marketing

Sales and marketing expenses were $303,000, or 51% of net revenues, for the three months ended March 31, 2004, as compared to $1.2 million, or 41% of net revenues, for the comparable period in 2003. The decrease in absolute dollars was primarily as a result of reduced marketing and selling expenses incurred by us for each product sold in the period as compared to a year ago, and no releases of new products in the period. In the comparable period of 2003 we released three new products. In addition we had reduced headcount compared to the comparable period in

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2003. The increase in the percentage of net revenues was due to reduced sales volumes in the current period compared to the comparable period of 2003. We anticipate that, during the three months ended June 30, 2004, sales and marketing expenses will increase in absolute dollars, compared to the three months ended March 31, 2004 as we anticipate releasing new titles in the period.

Sales and marketing expenses were $1.9 million, or 24% of net revenues, for the nine months ended March 31, 2004, as compared to $8.2 million, or 24% of net revenues, for the comparable period in 2003. The decrease in absolute dollars was primarily a result of reduced headcount, fewer releases of new products in North America during the period, and limited cash resources resulting in limited marketing and selling activities in the period as compared the comparable period in 2003.

General and administrative

General and administrative expenses were $1.4 million, or 235% of net revenues, for the three months ended March 31, 2004, as compared to $1.4 million, or 48% of net revenues, for the comparable period in 2003. The increase in the percentage of net revenues was due to reduced sales volumes. We anticipate that general and administrative expenses will, in absolute dollar terms, increase during the three months ended June 30, 2004.

General and administrative expenses were $4.2 million, or 53% of net revenues, for the nine months ended March 31, 2004, as compared to $5.8 million, or 17% of net revenues, for the comparable period in 2003. During the nine months ended March 31, 2004 we incurred a non cash charge of $240,000 on a warrant issued to a financial consultant. During the nine months ended March 31, 2003 we incurred $900,000 of credit insurance on sales made to Kmart, and increased our bad debt allowance against our Kmart long-term receivable by $547,000. Excluding these costs, general and administrative expenses decreased and this was due to lower headcount and facilities costs during the nine months ended March 31, 2004.

Amortization of deferred stock compensation

Amortization of deferred stock compensation was $23,000, or 4% of net revenues, for the three months ended March 31, 2004, as compared to $44,000, or 2% of net revenues, for the comparable period in 2003, and $132,000, or 2% of net revenues, for the nine months ended March 31, 2004 as compared to $338,000, or 1% of net revenues, for the comparable period in 2003. Amortization of deferred stock compensation resulted from varying terms of stock option grants previously made, and by using the multiple option award valuation and amortization approach, which is an accelerated amortization method to account for compensatory stock options granted to employees and directors during the six months ended September 30, 2001. We expect to amortize $18,000 during the remainder of fiscal 2004 and $24,000 during fiscal 2005.

Litigation settlement

Litigation settlement was $0 for both the three months ended March 31, 2004 and March 31, 2003, and $650,000 credit, or 8% of net revenues, for the nine months ended March 31, 2004 as compared to $0 for the comparable period in 2003, and comprises sums receivable from the settlement of a legal dispute with Amaze Entertainment, Inc.

Restructuring costs

Restructuring costs were $87,000 credit, or 15% of net revenues, for the three months ended March 31, 2004, as compared to $8,000 for the comparable period in 2003, and $158,000, or 2% of net revenues, for the nine months ended March 31, 2004 as compared to $459,000, or 1% of net revenues, for the comparable period in 2003. Restructuring costs in the three and nine months ended March 31, 2004 comprise our estimate of our future net expense relating to our former London premises. Restructuring costs in the three months ended March 31, 2003 comprise a revision of employee severance cost estimates and property and equipment write-downs. Restructuring costs in the nine months ended March 31, 2003 comprise employee severance costs of $276,000, and costs of $183,000 incurred upon the disposal of our London development studio. As part of this restructuring, during the

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nine months ended March 31, 2003 we wrote off $1.3 million of capitalized development costs and included such costs in Cost of Revenues – Project abandonment costs.

Interest income

There was no interest income during the three months ended March 31, 2004, as compared to $3,000 for the comparable period in 2003. Interest income was $2,000 for the nine months ended March 31, 2004 as compared to $146,000 for the comparable period in 2003. Interest income in each period relates to interest earned on funds deposited in money market accounts and decreased as a result of lower money market account balances and decreased interest rates. Interest income will increase in the three months ended June 30, 2004 as additional funds will be held on deposit.

Interest expense

Interest expenses were $278,000, or 46% of net revenues, for the three months ended March 31, 2004, as compared to $50,000, or 2% of net revenues, for the comparable period in 2003, and $627,000, or 8% of net revenues, for the nine months ended March 31, 2004, as compared to $576,000, or 2% of net revenues, for the comparable period in 2003. Interest expense increased as a result of our borrowing under a more expensive short-term line of credit in 2004, new additional borrowings under a convertible term note, new borrowing from a director, and the cost of amortizing the intrinsic value of the conversion option of the convertible note and fair value of warrants, along with amortized note issuance costs. For the three months ended March 31, 2004, interest expense includes $68,000 of amortized intrinsic value of the conversion option of the convertible term note, $68,000 of amortized fair value of the warrants to the note, and $74,000 of amortized issuance costs incurred under the note. For the nine months ended March 31, 2004, interest expense includes $91,000 of amortized intrinsic value of the conversion option of the convertible term note, $91,000 of amortized fair value of the warrants to the note, and $98,000 of amortized issuance costs incurred under the note. We anticipate that, during the three months ended June 30, 2004, interest expense will increase in absolute dollars, compared to the three months ended March 31, 2004, as more short-term borrowing will be necessary to fund new titles being released in the period.

Other income (expense)

Other income (expense) was $7,000 expense, or 1% of net revenues, for the three months ended March 31, 2004, as compared to $72,000 income, or 3% of net revenues, for the comparable period in 2003, and $47,000 expense, or 1% of net revenues, for the nine months ended March 31, 2004 as compared to $48,000 income for the comparable period in 2003. Other income (expense) comprised mostly foreign exchange gains and losses on UK receivables and payables.

LIQUIDITY AND CAPITAL RESOURCES

In October 2003, we completed the sale of 1,850,000 shares of our common stock and warrants to purchase another 1,665,000 shares of our common stock, resulting in gross proceeds (assuming no exercise of the warrants) of $1.8 million, in a private offering to institutional and accredited investors. Between January and March 2004, six of the investors exercised additional investment rights granted in the private offering, and we completed the sale of 1,060,858 shares of our common stock and warrants to purchase another 954,772 shares of our common stock, resulting in gross proceeds (assuming no exercise of the warrants) of $1.0 million, under the terms of the additional investment rights.

In December 2003, we sold a convertible term note and 166,667 warrants, raising gross proceeds of $1.5 million (assuming no exercise of the warrants) to an investment group. The note, which bears interest at a rate of 7% per annum, has a maturity date of December 3, 2004. The warrants have a seven-year term and are immediately exercisable at prices ranging between $1.73 and $2.33 per share. Each month, commencing on April 1, 2004, $166,667 of the principal amount of the note plus accrued and unpaid interest and fees can either be repaid in cash, or converted into our shares at a fixed conversion price, provided that the closing price of our shares exceeds 115%

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of the fixed conversion price for a period of 10 consecutive trading days prior to the date of conversion. If, at any other time, the closing price of our shares exceeds 115% of the fixed conversion price for a period of 5 consecutive trading days, we have the option to, 10 trading days later, convert all or part of the remaining outstanding note, interest and fees, subject to conversion volume limitations based on our share trading volume and share price in the 10 trading days prior to such conversion. The holder of the note has the right to convert all or any of the outstanding portion of the note, interest and fees at any time at the fixed conversion price. Conversion of the note by either party is subject to there being an effective registration statement in effect and Nasdaq’s confirmation that this transaction is not integrated with the private offering that closed in October 2003. An effective registration statement went into effect on April 22, 2004. Nasdaq has advised us that the transaction is not integrated with the private offering that closed in October 2003. The fixed conversion price is subject to an anti dilution adjustment should we issue stock at a price below the fixed conversion price prior to repayment of the note. The fixed conversion price was originally set at $1.33 per share, but an issuance of shares in January 2004 triggered the anti-dilution provision, and the fixed conversion price was adjusted to $1.28 per share. Further issuances of shares occurred in May 2004 as set out below, and the fixed conversion price was further adjusted to $1.19 per share. The note is secured by our North American assets. As of May 21, 2004, none of the note had been repaid or converted into common stock, and accordingly we are in default of the terms of the note.

In January 2004, we completed the sale of 2,532,522 shares of our common stock and warrants to purchase another 1,519,513 shares of our common stock, resulting in gross proceeds (assuming no exercise of the warrants) of $2.3 million, in a private offering to institutional and accredited investors.

On February 17, 2004, our management agreed with the management of VIS entertainment plc (“VIS”), a Scottish developer of interactive entertainment software products, on the terms of an offer (the “VIS Offer”) to acquire all of the Ordinary Shares, A Shares and B Shares of VIS in exchange for the issuance of up to 4.5 million unregistered shares (the “VIS Consideration Shares”) of our common stock. On May 19, 2004, all the terms of the VIS Offer were either satisfied or waived, and accordingly the VIS Offer was declared unconditional in all respects.

On February 17, 2004, our management entered into an agreement with the shareholders of State of Emergency Development Corporation (“SOED”) to acquire all of the share capital of SOED (the “SOED Acquisition”) in exchange for the issuance of up to 4.5 million unregistered shares of our common stock (the “SOED Consideration Shares”). The SOED Acquisition was conditional upon the closing of the acquisition by us of all of the VIS shares. On May 19, 2004, the SOED Acquisition was declared unconditional in all respects.

On May 19, 2004 we entered into an agreement with SOED’s Loanholders whereby, upon close of the SOED transaction, GBP 792,000 (equivalent to $1.4 million) of outstanding loan notes shall be repaid and GBP 1.7 million (equivalent to $3.0 million) of outstanding loan notes, which were repayable upon the close of the SOED acquisition, will no longer be payable upon the close, but will become payable as follows: the sterling equivalent of $1.0 million plus outstanding interest will become payable by us on or before September 30, 2004, and the balance, including outstanding interest, will become payable by us on or before the one year anniversary of the closing date. In consideration of this deferral of payment, we will issue upon the closing date 5 year warrants to purchase 1,071,000 shares of our common stock to the Loanholders at the lower of $0.70 and the average mid market price of our common stock for the five business days prior to exercise of the warrant, and 5 year warrants to purchase 428,500 shares of our common stock to the advisors of the Loanholders at the lower of $0.70 and the average mid market price of our common stock for the five business days prior to exercise of the warrant. We are also required to make a cash payment of $210,000 to the advisors of the Loanholders when the loan has been repaid in full.

On May 19, 2004, in accordance with an agreement entered into between us and Flextech Television Limited, and upon the VIS Offer becoming unconditional, we issued 801,529 shares of our common stock to the Telewest Group of Companies to repay a debt, approximating $393,000, owed by VIS itv Limited to the Telewest Group of Companies. VIS itv Limited is a private limited company incorporated in the United Kingdom, owned as to 50% by Flextech Television Limited, a subsidiary of Telewest Communications plc, and 50% by VIS.

On May 21, 2004 we issued of 771,715 shares of our common stock, and warrants to purchase another 77,172 shares of our common stock, in exchange for the settlement of debts totaling $463,000 owed to four creditors. The warrants have a five-year term and are exercisable at $0.60 per share.

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On May 24, 2004 we completed the sale of 282 shares of our Series A Cumulative Convertible Preferred Stock (the “Preference shares”) and warrants to purchase another 2,548,192 shares of our common stock, resulting in gross value (assuming no exercise of the warrants) of $2.8 million, in a private offering to institutional, accredited investors, Bam’s Chief Executive Officer and Vice Chairman of the Board of Directors. Of the total sale, 188 Preference shares and warrants to purchase another 1,698,795 shares of our common stock, resulting in gross proceeds (assuming no exercise of the warrants) of $1.9 million, were sold to institutional and accredited investors, 50 Preference shares and warrants to purchase another 451,807 shares of our common stock, resulting in gross value (assuming no exercise of the warrants) of $500,000 were sold to our Chief Executive Officer, and 44 Preference shares and warrants to purchase another 397,590 shares of our common stock, resulting in gross value (assuming no exercise of the warrants) of $440,000, were sold in exchange for the settlement of a loan and accrued interest totaling $260,000 from our Vice Chairman of the Board of Directors and deferred salaries totaling $90,000 each from our Chief Executive Officer and Vice Chairman of the Board of Directors. All of these warrants have a five-year term and are exercisable at $0.594 per share. Each Preference stockholder receives a 10% dividend per annum, payable quarterly in arrears on the last day of each quarter. The initial dividend payment will be pro-rated from the date of issuance to the end of the first quarter after issuance. Each Preference share is convertible into 12,048 shares of our common stock at the option of the holder. We can require the Preference stockholder to convert the Preference shares into common shares upon the expiration of 30 days notice provided that the following three conditions are all met: (i) there is an effective registration statement in effect, (ii) the daily market price of our common stock is greater than $1.20 for twenty of the thirty trading days prior to the notice being issued, and (iii) our common stock is listed on either the Nasdaq SmallCap Market, Nasdaq National Market, American Stock Exchange or the New York Stock Exchange. Each Preference share has a liquidation preference of $10,000. Preference stockholders have full voting rights and powers, are treated as the same class as common stock holders at stockholder meetings, and are entitled to vote the number of common stock equivalent votes at each meeting. While at least 10% of the original numbers of Preference shares issued are in issue, we may not, without the written consent of the majority of Preferred stockholders (i) repeal or alter the terms under which the Preference shares are issued, (ii)amend or repeal its Certificate of Incorporation or Bylaws, (iii) authorize, offer or issue any stock ranking pari passu or senior to them (iv) redeem or repurchase any shares of the Company in issue, and (v) declare or pay a dividend to any other class of share. We are required to redeem all Preference shares and pay the liquidated preference in cash plus all accrued and unpaid dividends if (i) we refuse to convert any Preference shares to common stock having received notice from the holder to convert, or (ii) we breach any warranty or representation given to the Preference stockholders, or (iii) we breach any covenant given to the Preference stockholders.

On May 24, 2004 we completed the sale of a $6.75 million 2% Secured Convertible Debenture (the “Debenture”), due November 24, 2006, and warrants to purchase another 6,549,398 shares of our common stock. The warrants have a five-year term and are exercisable at $0.594 per share. The Debenture is convertible, in whole or in part, into our common stock, at the option of the Debenture holders, at a conversion price of $0.83 per share. The entire $6.75 million received from the issuance of the Debenture is secured by restricted cash held at an account at a third party custodian. We have no access to, or use of the cash, until the Debenture is converted into common stock. If the Debenture is partly converted into common stock, we will have access to the cash for the part converted and the remainder of the cash will remain restricted. Interest on the Debenture is payable quarterly in arrears on the last day of each quarter. The initial interest payment will be pro-rated from the date of issuance to the end of the first quarter after issuance. We can require the Debenture holder to convert the Debenture into common shares upon the expiration of no more than 5 days notice provided that the following two conditions are all met: (i) We gives notice to the Debenture holders within 3 days of the daily market price of our common stock exceeding $1.66 for fifteen consecutive trading days, and (ii) our common stock’s average daily trading volume over the fifteen consecutive trading days exceeds 100,000 shares. In order to issue the Debenture, we were required to obtain the consent of the existing convertible term note holders. The convertible term note holders gave their consent on May 21, 2004 and, as consideration, were issued warrants, with a seven-year term, to purchase 166,667 shares of our common stock at an exercise price of $0.63 per share.

We need to raise additional funds to satisfy our future liquidity requirements. These funds may come from either one or a combination of additional financings, exercise of outstanding warrants and additional investment rights, mergers or acquisitions, or otherwise obtain capital via sale or license of certain of our assets, in order to satisfy our future liquidity requirements. Current market conditions present uncertainty as to our ability to secure additional financing or effectuate any merger or acquisition, as well as our ability to reach profitability. There can be no assurances that we will be able to secure additional financing or effectuate any such merger or acquisition, or obtain

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favorable terms on such financing if it is available, or as to our ability to achieve positive cash flow from operations. Continued negative cash flows create significant uncertainty about our ability to implement our operating plan and we may have to further reduce the scope of our planned operations. If cash and cash equivalents, together with cash generated from operations, are insufficient to satisfy our liquidity requirements, we will not have sufficient resources to continue operations for the next six months.

Since September 30, 2003, we have not met the listing maintenance standards of The Nasdaq SmallCap Market. On November 24, 2003, we received a notification letter from Nasdaq that our common stock failed to meet these required listing standards. We provided Nasdaq with a plan setting forth how we expect to regain compliance with the required listing standards. On February 10, 2004, we received a staff determination letter of delisting from Nasdaq. The letter provided that our plan was not accepted by Nasdaq and that our common stock would be delisted on February 19, 2004, pending our right to appeal Nasdaq’s decision. We requested an oral hearing before the Nasdaq Listing Qualification Panel to appeal Nasdaq’s determination to delist our common stock, which under applicable rules stays the delisting of our common stock, pending a decision by the Nasdaq Panel. At a hearing on March 11, 2004, we presented a plan, which required the completion of the VIS and SOED acquisitions, to the Nasdaq Panel for achieving and sustaining compliance with the required listing standards. On April 13, 2004, we received a letter from the Nasdaq Panel which provided that we had been granted a temporary exception to the required listing standards and the listing of our common stock has been continued until May 17, 2004. On or before May 17, 2004, we were required to file our quarterly report on Form 10-Q for the three months ended March 31, 2004; the filing to include a balance sheet with pro-forma adjustments evidencing the completion of the VIS and SOED acquisitions and the private placement of our common stock in connection therewith subsequent to March 31, 2004, resulting in a minimum of $18 million is stockholders’ equity. On May 5, 2004, we received a notification of additional concern from the Nasdaq Panel indicating that our common stock was not in compliance with Nasdaq’s minimum $1.00 bid price per share requirement for continued listing on The Nasdaq SmallCap Market, and that we must present a plan evidencing our ability to regain compliance with the minimum bid price requirement for at least ten consecutive days prior to November 1, 2004. On May 10, 2004, we filed a Form NT 10-Q allowing us to obtain a five day extension through May 24, 2004 to file our Form 10-Q. As a result of the completion of the VIS and SOED acquisitions, our stockholders’ equity will exceed the minimum stockholders’ equity requirement of $2.5 million required by Nasdaq’s standards for continued listing on The Nasdaq SmallCap Market, but will not exceed the $18 million requirement as set out in the April 13, 2004 letter. Management estimates that its shareholders’ equity will approximate $14.1 million as of March 31, 2004 on a pro-forma basis, after taking account of the financial effects of the VIS and SOED acquisitions, and our sale of equity in May 2004. Neither management nor the independent auditors have completed a full analysis of the accounting for the transactions, and this estimate of pro-forma shareholders’ equity could change upon completion of the analysis. Management is hopeful that the Nasdaq Panel will reconsider the terms of the exception set out in the April 13, 2004 letter. In order to fully comply with the terms of the exception, we must be able to demonstrate compliance with all requirements for continued listing on The Nasdaq SmallCap Market. In the event that we fail to comply with any term of this exception, our common stock may be immediately delisted from The Nasdaq SmallCap Market. If our common stock should be delisted from The Nasdaq SmallCap Market, it may continue to be listed on the OTC Bulletin Board. Effective with the opening of business on April 15, 2004 and for the duration of the exception, our Nasda q symbol will be “BFUNC” The “C” will be removed from the symbol when the Nasdaq Listing Qualifications Panel has confirmed compliance with the terms of the exception and all other criteria necessary for continued listing.

Net cash used in operating activities was $6.1 million for the nine months ended March 31, 2004, as compared to $9.8 million for the comparable period in 2003. For the nine months ended March 31, 2004 and 2003, net cash used in operating activities was the result of net losses, net of depreciation, amortization, provision for price protection and cooperative advertising.

Net cash used in investing activities was $6,000 for the nine months ended March 31, 2004, as compared to net cash provided by investing activities of $8.0 million for the comparable period in 2003. Net cash used in investing activities during the nine months ended March 31, 2004, consisted of the purchase of property and equipment. For the comparative period, net cash provided by investing activities consisted of the sale of short-term investments offset by the purchase of property and equipment.

Net cash provided by financing activities was $5.3 million for the nine months ended March 31, 2004, as compared to net cash used in financing activities of $1.3 million for the comparable period in 2003. Net cash provided by

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financing activities during the nine months ended March 31, 2004 consisted mostly of funds received from private placements, net of issuance costs, funds received from the sale of a convertible term note, a loan from a director and the exercise of stock options. For the comparable period, net cash used in financing activities consisted mostly of net repayments under a finance agreement.

In September 2003, we entered into a six month agreement (the “Agreement”) with a finance company, pursuant to which the finance company extended a line of credit facility to fund domestic inventory purchases to us. We could sell the inventory purchased under the Agreement and we were required to remit customer receipts from those sales directly to the finance company up to the amounts funded by them. We retained collections in excess of the amounts funded by the finance company, and we were responsible for collecting the customer receivables, bearing the risk of loss on all uncollectible accounts. The finance company had a security interest in our accounts receivable and inventory.

Under the terms of the Agreement, the finance company’s aggregate outstanding funding was limited to $3.2 million. We were required to pay the finance company’s expenses under the contract, a facility fee equal to 5.0% of the funds advanced by the finance company, and interest at prime plus 0.5%.

The Agreement terminated on March 31, 2004. We had repaid all sums borrowed by that date. We accounted for all cash advances made under this Agreement as a current liability. Prepayments for products not yet received were included in prepaid expenses.

Prior to entering into the Agreement, we had entered into a two year factoring agreement (the “Factoring Agreement”) with a different finance company in February 2002, pursuant to which we assigned our North American receivables to the finance company. The finance company was responsible for collecting customer receivables, and upon collection, remitted the funds to us, less a service fee. Under the Factoring Agreement, we could obtain advances, subject to the finance company’s discretion and our compliance with certain liquidity covenants, 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 paid a service fee on all receivables assigned, with a minimum annual fee of $150,000, interest at prime plus 1% on all cash sums advanced. All fees were included in interest expense. We bore the collection risk on the accounts receivable that were assigned, unless the finance company approved the receivable at the time of assignment, in which case the finance company bore the risk. The finance company had a security interest in our accounts receivable, inventory, fixed assets and intangible assets.

As of June 30, 2003 we did not meet the Factoring Agreement’s liquidity covenants and we had no sums advanced under the Factoring Agreement. The Factoring Agreement was mutually terminated in September 2003, and all liabilities settled. Upon the termination of the Factoring Agreement, the minimum annual fee for the second year of the Factoring Agreement was waived, and we paid a termination payment of $25,000.

As of March 31, 2004 and June 30, 2003 we had no outstanding letters of credit issued on our behalf.

As of March 31, 2004, we had cash and cash equivalents of $290,000 and an accumulated deficit of $71.0 million. As of June 30, 2003, we had cash and cash equivalents of $1.1 million.

Capital expenditures were $6,000 and $338,000 for the nine months ended March 31, 2004 and 2003, respectively. We did not have any material commitments for capital expenditures at either of those dates.

Our principal commitments at March 31, 2004 comprised operating leases and contractual marketing commitments. As of March 31, 2004, we had commitments to spend $871,000 under operating leases and spend $763,000 in advertising on the networks and websites of these content providers. Of this sum, $13,000 was due but unpaid at March 31, 2004. Of the total commitments, $1.2 million must be paid no later than March 31, 2005.

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ADDITIONAL FINANCIAL INFORMATION

The following table details, on a pro-forma basis, the approximate effect of the following transactions on our total shareholders’ equity (deficit) as if they had occurred on March 31, 2004:

(1) the VIS and SOED acquisitions

(2) the issuance of (a) preferred stock, (b) common stock and (c) warrants, all between May 19, 2004 and May 24, 2004

(3) the settlement of certain debts through issuance of common stock and warrants on May 21, 2004 and

(4) the sales of Secured Convertible Debentures

Management has not completed a full analysis and review of the accounting for the transactions. This estimate of pro-forma shareholders’ equity could change materially upon completion of the analysis. In addition, our independent auditors have not audited or reviewed this information.

Accordingly, the final accounts allocation may materially change some or all of the amounts included within the table. This table is for illustrative purposes only (in millions):

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RISK FACTORS

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

RISKS RELATED TO OUR FINANCIAL RESULTS

If we are unable to successfully obtain additional financing or enter into a merger or acquisition, we may not have sufficient cash to continue operations for the next six months.

Although we raised gross proceeds of approximately $1.8 million through the sale of our common stock, warrants and additional investment rights in October 2003, $1.5 million through the sale of a convertible term note and warrants in December 2003, $1.0 million between January and March 2004 through the exercise of additional investment rights that were sold in October 2003, $2.3 million through the sale of our common stock, warrants and additional investment rights in January 2004, $2.8 million through the sale of preferred stock and warrants in May 2004, and $6.75 million through the sale of a convertible debenture and warrants in May 2004, we will need to raise additional funds. These funds may come from either one or a combination of additional financings, exercise of outstanding warrants and additional investment rights, mergers or acquisitions, or otherwise obtain capital via sale or license of certain of our assets, in order to satisfy our future liquidity requirements. Current market conditions present uncertainty as to our ability to secure additional financing or effectuate any merger or acquisition, as well as our ability to reach profitability. There can be no assurances that we will be able to secure additional financing or effectuate any such merger or acquisition, or obtain favorable terms on such financing if it is available, or as to our ability to achieve positive cash flow from operations. Continued negative cash flows create significant uncertainty about our ability to implement our operating plan and we may have to further reduce the scope of our planned operations. If cash and cash equivalents, together with cash generated from operations, are insufficient to satisfy our liquidity requirements, we will not have sufficient resources to continue operations for the next six months.

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

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

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

•		secure additional financing and fund purchases of inventory;
•		expand our domestic and international 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;

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•		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 $11.2 million for the nine months ended March 31, 2004, $36.2 million for the year ended June 30, 2003, $15.7 million for the year ended June 30, 2002, and $1.6 million for the year ended June 30, 2001. We will need to generate significant revenues and control expenses 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 we fail to achieve profitability, or sustain or increase profitability if we achieve it, this will have a negative impact on our operating results.

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, and historically have, harmed our business and operating results.

Our operating results would be, and historically have been, harmed by a decrease in sales, price erosions, and 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.

These and other factors could harm our business and have a material adverse effect on our operating results.

Product development schedules are frequently unpredictable, which may result in revenues and earnings not meeting analysts’ expectations.

Product development schedules for software products, particularly for new hardware platforms such as Sony’s PlayStation 2, Nintendo’s GameCube and Microsoft’s Xbox, are difficult to predict because they involve creative processes, use of new development tools for new platforms and the learning process, research and development, and experimentation associated with development for new technologies. Our revenues and earnings are dependent on our ability to meet our product release schedules, and our failure to meet those schedules have resulted in, and may again result in, revenues and earnings that fall short of analysts’ expectations for any individual quarter and the fiscal year.

Our earnings will be affected upon the issuance of shares of our common stock pursuant to third-party entertainment property license agreements.

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 137,476 shares under this agreement for an aggregate value of $816,000. We are required to issue these shares when the films are released and will then incur a non-cash charge. We cannot estimate the aggregate dollar amount of these future non-cash charges as they will be based on our share price at a future point in time, but they may be substantial. All of the non-cash charges on the shares issued to date under the agreement had been amortized as of March 31, 2004.

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In connection with the issuance of warrants pursuant to a separate license agreement with another production company, we incurred a non-cash charge of $97,000, of which $8,000 was amortized to project abandonment in the year ended June, 30, 2003, and $89,000 was amortized to royalties, software costs and licensed assets in the nine months ended March 31, 2004. Under the agreement, additional warrants to purchase up to an additional 15,000 shares may be issued, contingent upon certain future events occurring, such as exercising the right to develop a product. Upon issuance of the warrants we will incur an additional non-cash charge. 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 future charges will affect our gross margins and profitability. In December 2003, we received notice from the publisher, Aardman Animations Ltd (“Aardman”), that it was terminating with immediate effect its licensing and publishing agreement (the “Agreement”) with us for purported breaches of certain terms of the Agreement by us. On March 24, 2004, Aardman filed a claim with the High Court of England and Wales asking for a declaration that the Agreement had been validly terminated. We dispute the alleged breaches, we are contesting the claim for termination, and we are seeking equitable protection of our interests. At March 31, 2004, we had expensed all prepaid royalties incurred under this Agreement. On May 7, 2004, we filed our defense and a counterclaim with the High Court.

In connection with the issuance of warrants pursuant to a first look 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 had been fully amortized as of June 30, 2003. 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 will be based on our share price at future points in time. Each of these future charges will affect our gross margins and profitability.

RISKS RELATED TO OUR BUSINESS

Our ability to effectuate additional financing transactions to fund our operations could impair the value of your investment.

Although we raised gross proceeds of approximately $1.8 million through the sale of our common stock, warrants and additional investment rights in October 2003, $1.5 million through the sale of a convertible term note and warrants in December 2003, $1.0 million between January and March 2004 through the exercise of additional investment rights that were sold in October 2003, $2.3 million through the sale of our common stock, warrants and additional investment rights in January 2004, $2.8 million through the sale of our preferred stock and warrants in May 2004 and $6.75 million through the sale of a convertible debenture and warrants in May 2004, if we are not acquired by or merge with another entity or if we are not able to raise additional capital via sale or license of certain of our assets, we will need to consummate additional financing transactions pursuant to which we receive additional liquidity. These additional financings will likely take the form of us raising additional capital through either one or a combination of public or private equity offerings or debt financings and the exercise of outstanding warrants and additional investment rights. To the extent we raise additional capital by issuing equity securities, our stockholders will likely experience substantial dilution. Also, any new equity securities may have greater rights, preferences or privileges than our existing common stock.

We cannot assure you that we will be able to meet our future capital requirements.

If we are not acquired by or merge with another entity or if we are not able to raise additional capital via sale or license of certain of our assets, we will need to consummate additional financing transactions pursuant to which we receive additional liquidity. We cannot be certain that additional capital will be available to us on favorable terms, or at all. If we cannot effectuate financing transactions to raise needed funds on acceptable terms, we will 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 will require us to take drastic steps such as reducing our level of operations, disposing of selected assets or seeking protection under federal bankruptcy laws.

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We depend on a relatively limited number of products for a significant portion of our revenues.

A significant portion of our revenues is derived each quarter from a relatively limited number of products that were released in that quarter or the or in the immediately preceding quarter. During the nine months ended March 31, 2004, sales of four products each accounted for between 9% and 36% of our net revenues. During the nine months ended March 31, 2003, sales of four products each accounted for between 9% and 14% of our net revenues. We expect that a limited number of products will continue to produce a disproportionately large amount of our net revenues. Due to this dependence on a limited number of brands, the failure of one or more products to achieve anticipated results could, and in the past has, significantly harmed our business and operating results.

We cannot assure you that new products introduced by us will achieve significant market acceptance and be sufficient in order for us to achieve profitability.

The interactive entertainment software market is characterized by short product life cycles, continually changing consumer preferences that are difficult to predict and frequent introduction of new products. 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, and sales price erosion. Even the most successful titles remain popular for only limited periods of time, often less than six months. 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 in order for us to achieve profitability.

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, and historically have, granted 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 and have harmed 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 occurred with Microsoft’s Xbox and Nintendo’s GameCube and 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.

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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 achieve profitability.

The technological advancements of the most popular 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.

The costs of developing and marketing products for existing and anticipated interactive entertainment hardware platforms can be substantial and could negatively impact our results of operations.

The costs associated with the introduction of products for new hardware platforms, such as Sony’s PlayStation 2, Nintendo’s GameCube and Microsoft’s Xbox, could harm our business as we believe the costs of developing and publishing titles for these hardware platforms 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 interactive entertainment hardware platforms fail to achieve significant market acceptance, it may negatively impact our sales and results of operations.

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, such as occurred with Microsoft’s Xbox and Nintendo’s GameCube and Game Boy Advance, can and have significantly harmed 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.

Over 58% of our net revenues are derived from sales to our four 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 four largest customers collectively accounted for 58% of our net revenues for the nine months ended March 31, 2004, as compared to 51% of our net revenues for the nine months ended March 31, 2003. As of March 31, 2004, four customers each accounted for between 4% and 27% of our gross trade accounts receivable, and as of June 30, 2003, four customers each accounted for between 8% and 19% of our gross trade 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 negatively impact us.

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

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 negatively impact us, as could a business failure by any of our distributors or other retailers.

Product returns and markdown allowances could negatively impact 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 also allow distributors and retailers to return defective and damaged products in accordance with negotiated terms. Product returns and markdown allowances that exceed our expectations could negatively impact our business.

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.

We depend to a significant extent on the contributions and industry experience of our key personnel, in particular our Chief Executive Officer, Raymond C. Musci, and our Vice Chairman, Anthony R. Williams. If we fail to retain the services of our key personnel, our ability to secure additional licenses and develop and sell new products might be 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

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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 Wallace & Gromit series, Powerpuff Girls series, and Dexter’s Laboratory series are based upon entertainment properties licensed from third parties. We cannot assure you that we will be able to obtain new licenses, or renew existing ones, on reasonable terms, if at all. If we are unable to obtain licenses for the properties which we believe offer significant consumer appeal, we would be required to obtain licenses for less popular properties or would have to develop all of our titles based upon internally developed concepts.

In December 2003, we received notice from the publisher of Wallace & Gromit, Aardman Animations Ltd (“Aardman”), that it was terminating with immediate effect its licensing and publishing agreement (the “Agreement”) with us for purported breaches of certain terms of the Agreement by us. On March 24, 2004, Aardman filed a claim with the High Court of England and Wales asking for a declaration that the Agreement had been validly terminated. We dispute the alleged breaches, we are contesting the claim for termination, and we are seeking equitable protection of our interests. At March 31, 2004, we had expensed all prepaid royalties incurred under this Agreement. On May 7, 2004, we filed our defense and a counterclaim with the High Court.

To the extent a licensed property is less popular than we anticipate, or is unsuccessful, sales of titles based on that property may be negatively impacted.

We have in the past experienced unsuccessful releases of titles based on properties that we licensed from third parties. 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 our titles.

We rely on third-party interactive entertainment software developers for the development 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 future 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.

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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 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.

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

We intend to increase our international revenues. We cannot assure you that we will be able to generate international market demand for our products. International sales and operations are subject to a number of risks, including:

•		international consumer acceptance of existing and proposed titles;
•		the impact of possible recessions in foreign economies;
•		our ability to protect our intellectual property;
•		the time and costs associated with translating and localizing products for foreign markets;
•		foreign currency fluctuations;
•		unexpected changes in regulatory requirements;
•		difficulties and costs of staffing and managing foreign operations, or licensing to foreign entities; and
•		political and economic instability.

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A significant downturn in general economic condition which results in a reduction in discretionary spending has reduced, and may continue to reduce, demand for our products and could 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 terrorist attacks on September 11, 2001. 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.

RISKS RELATED TO OUR INDUSTRY

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

The interactive entertainment industry is intensely competitive. Many of our competitors have greater name recognition among consumers and licensors of entertainment properties, broader product lines and greater financial, marketing and other resources than us. Accordingly, these competitors may be able to market their products more effectively, make larger offers or guarantees in connection with the acquisition of licensed entertainment properties, adopt more aggressive pricing policies or pay more to third-party developers. We believe that other technology, entertainment and media companies are increasing their focus on the interactive entertainment software market, which might result in greater competition for us. In addition, many of our competitors are developing online 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;
•		we might not be able to achieve full distribution of our products with our customers;
•		as competition for retail shelf space becomes more intense, we may need to increase our marketing expenditures to maintain sales of our interactive entertainment software titles; and
•		we could be required to reduce the wholesale unit prices of our titles.

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

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

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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.

RISKS RELATED TO THE ACQUISITIONS OF VIS AND SOED

Difficulties encountered in integrating our operations with those of VIS may prevent the companies from realizing benefits from the acquisitions.

A portion of the combined company’s long-term strategic plan depends upon the successful development and introduction of products. In order for the combined company to succeed in such efforts, it must align strategies and successfully integrate our business operations with those of VIS.

The challenges involved in this integration include the following:

•		coordinating research and development operations in a rapid and efficient manner to ensure timely release of products to market;
•		diversion of management resources in order to facilitate the integration;
•		increased difficulty of integrating operations and business cultures;
•		ability to, and costs and delays involved in, implementing compatible information communication systems, common operating procedures, compatible financial controls and comparable human resources practices;

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•		impairment of relationships with employees and consultants or strategic partners as a result of any integration of new personnel; and
•		retaining key alliances.

Our failure to successfully integrate our operations with those of VIS could significantly harm the business of the combined company and could prevent it from realizing the anticipated benefits of the merger.

The market price of our common stock may decline as a result of the acquisitions of VIS and SOED.

The market price of our common stock may decline as a result of the acquisitions for a number of reasons, including if:

•		the integration of our company and VIS is not completed in a timely and efficient manner;
•		the combined company does not achieve the perceived benefits of the acquisitions as rapidly or to the extent anticipated by financial or industry analysts;
•		the effect of the acquisitions on the combined company’s financial results is not consistent with the expectations of financial or industry analysts; or
•		significant, our stockholders decide to dispose of their shares following the acquisitions.

The acquisitions of VIS and SOED may result in loss of key employees.

Despite VIS’s efforts to retain key employees, the combined company might lose some key employees following the acquisitions. Competition for qualified technical and management employees is intense. Competitors and other companies may recruit employees prior to the acquisitions and during the integration process following the closing of the acquisitions, which has become a common practice. In addition, any real or perceived differences in the policies, career prospects, compensation levels or cultures between our company and VIS may cause key employees to leave. As a result, employees could leave with little or no prior notice, which could cause delays and disruptions in the effort to integrate the two companies and result in expenses associated with finding replacement employees.

There may be sales of substantial amounts of our common stock after the acquisitions of VIS and SOED, which could cause our stock price to fall.

A substantially large number of shares of our common stock may be sold into the public market within short periods of time at various dates following the closing of the acquisitions of VIS and SOED. As a result, our stock price could fall.

RISKS RELATED TO OUR COMMON STOCK

Our stock price has been volatile and we expect it to continue 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, irrespective of our actual performance or prospects, could result in a further decline in the market price of our common stock.

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If our common stock is delisted from The Nasdaq SmallCap Market, the liquidity and price of our common stock may be adversely affected.

Since September 30, 2003, we have not met the listing maintenance standards of The Nasdaq SmallCap Market. On November 24, 2003, we received a notification letter from Nasdaq that our common stock failed to meet these required listing standards. We provided Nasdaq with a plan setting forth how we expect to regain compliance with the required listing standards. On February 10, 2004, we received a staff determination letter of delisting from Nasdaq. The letter provided that our plan was not accepted by Nasdaq and that our common stock would be delisted on February 19, 2004, pending our right to appeal Nasdaq’s decision. We requested an oral hearing before the Nasdaq Listing Qualification Panel to appeal Nasdaq’s determination to delist our common stock, which under applicable rules stays the delisting of our common stock, pending a decision by the Nasdaq Panel. At a hearing on March 11, 2004, we presented a plan, which required the completion of the VIS and SOED acquisitions, to the Nasdaq Panel for achieving and sustaining compliance with the required listing standards. On April 13, 2004, we received a letter from the Nasdaq Panel which provided that we had been granted a temporary exception to the required listing standards and the listing of our common stock has been continued until May 17, 2004. On or before May 17, 2004, we were required to file our quarterly report on Form 10-Q for the three months ended March 31, 2004; the filing to include a balance sheet with pro-forma adjustments evidencing the completion of the VIS and SOED acquisitions and the private placement of our common stock in connection therewith subsequent to March 31, 2004, resulting in a minimum of $18 million is stockholders’ equity. On May 5, 2004, we received a notification of additional concern from the Nasdaq Panel indicating that our common stock was not in compliance with Nasdaq’s minimum $1.00 bid price per share requirement for continued listing on The Nasdaq SmallCap Market, and that we must present a plan evidencing our ability to regain compliance with the minimum bid price requirement for at least ten consecutive days prior to November 1, 2004. On May 10, 2004, we filed a Form NT 10-Q allowing us to obtain a five day extension through May 24, 2004 to file our Form 10-Q. As a result of the completion of the VIS and SOED acquisitions, our stockholders’ equity will exceed the minimum stockholders’ equity requirement of $2.5 million required by Nasdaq’s standards for continued listing on The Nasdaq SmallCap Market, but will not exceed the $18 million requirement as set out in the April 13, 2004 letter. Management estimates that its shareholders’ equity will approximate $14.1 million as of March 31, 2004 on a pro-forma basis, after taking account of the financial effects of the VIS and SOED acquisitions, and our sale of equity in May 2004. Neither management nor the independent auditors have completed a full analysis of the accounting for the transactions and this estimate of pro-forma shareholders’ equity could change upon completion of the analysis. Management is hopeful that the Nasdaq Panel will reconsider the terms of the exception set out in the April 13, 2004 letter. In order to fully comply with the terms of the exception, we must be able to demonstrate compliance with all requirements for continued listing on The Nasdaq SmallCap Market. In the event that we fail to comply with any term of this exception, our common stock may be immediately delisted from The Nasdaq SmallCap Market. If our common stock should be delisted from The Nasdaq SmallCap Market, it may continue to be listed on the OTC Bulletin Board. Effective with the opening of business on April 15, 2004 and for the duration of the exception, our Nasdaq symbol will be “BFUNC” The “C” will be removed from the symbol when the Nasdaq Listing Qualifications Panel has confirmed compliance with the terms of the exception and all other criteria necessary for continued listing.

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

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		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.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT 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.

FOREIGN CURRENCY EXCHANGE RATE RISK

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 income, 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.

INTEREST RATE RISK

We do not consider our cash and cash equivalents to be subject to interest rate risk due to the short maturities of the instruments in which we have invested. We are exposed to interest rate risk on our 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 $30,000 for the nine months ended March 31, 2004.

INFLATION

Inflation has not had a material adverse effect on our results of operations; however, our results of operations may be materially and adversely affected by inflation in the future.

ITEM 4. CONTROLS AND PROCEDURES

(a) Evaluation of disclosure controls and procedures

The term “disclosure controls and procedures” refers to the controls and procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files under Rule 13a – 14 of the Securities Exchange Act of 1934 (the “Exchange Act”) is recorded, processed, summarized and reported within required time periods. As of the end of the period covered by this Quarterly Report on Form 10-Q (the “Evaluation Date”), we carried out an evaluation under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer of the effectiveness of our disclosure controls and procedures. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of the Evaluation Date, such controls and procedures were effective in ensuring that required information

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will be disclosed on a timely basis in our periodic reports filed with the Securities and Exchange Commission under the Exchange Act.

(b) Changes in internal controls

There were no significant changes to our internal controls or in other factors that could significantly affect our internal controls subsequent to the Evaluation Date.

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PART II
OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

The Registrant occasionally becomes involved in litigation arising from the normal course of business. The Registrant believes that any liability with respect to pending legal actions, individually or in the aggregate, will not have a material adverse effect on our business, financial condition or results of operations.

ITEM 2. CHANGE IN SECURITIES AND USE OF PROCEEDS

In October 2003, the Registrant completed the sale of 1,850,000 shares of its common stock and warrants to purchase another 1,665,000 shares of its common stock, resulting in gross proceeds (assuming no exercise of the warrants) of $1.8 million, in a private offering to institutional and accredited investors. Expenses incurred in connection with the sale totaled approximately $0.3 million.

These proceeds had been fully utilized as of March 31, 2004 as follows:

•		$0.7 million for product development and prepaid royalties
•		$0.8 million for additional working capital.

Between January and March 2004, the Registrant completed the sale of 1,060,858 shares of its common stock and warrants to purchase another 954,772 shares of its common stock, resulting in gross proceeds (assuming no exercise of the warrants) of $1.0 million, in the exercise of additional investment rights sold in the private offering to institutional and accredited investors in October 2003. Expenses incurred in connection with the sale totaled approximately $0.2 million.

These proceeds had been fully utilized as of March 31, 2004 as follows:

•

$0.8 million for additional working capital

In January 2004, the Registrant completed the sale of 2,532,522 shares of its common stock and warrants to purchase another 1,519,513 shares of its common stock, resulting in gross proceeds (assuming no exercise of the warrants) of $2.3 million, in a private offering to institutional and accredited investors. Expenses incurred in connection with the sale totaled approximately $0.5 million.

These proceeds had been fully utilized as of March 31, 2004 as follows:

•		$0.4 million for product development
•		$1.4 million for additional working capital.

ITEM 3. DEFAULTS UPON SENIOR NOTES

In December 2003, the Registrant sold a convertible term note and 166,667 warrants, raising gross proceeds of $1.5 million (assuming no exercise of the warrants) to an investment group. The note, which bears interest at a rate of 7% per annum, has a maturity date of December 3, 2004. The warrants have a seven-year term and are immediately exercisable at prices ranging between $1.73 and $2.33 per share.

Each month, commencing on April 1, 2004, $166,667 of the principal amount of the note plus accrued and unpaid interest and fees can either be repaid in cash, or converted into the Registrant’s shares at a fixed conversion price, provided that the closing price of the Registrant’s shares exceeds 115% of the fixed conversion price for a period of

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10 consecutive trading days prior to the date of conversion. If at any other time the closing price of the Registrant’s shares exceeds 115% of the fixed conversion price for a period of 5 consecutive trading days, the Registrant has the option to, 10 trading days later, convert all or part of the remaining outstanding note, interest and fees, subject to conversion volume limitations based on the Registrant’s share trading volume and share price in the 10 trading days prior to such conversion. The holder of the note has the right to convert all or any of the outstanding portion of the note, interest and fees at any time at the fixed conversion price. Conversion of the note by either party is subject to there being an effective registration statement on file with the Securities and Exchange Commission and Nasdaq’s confirmation that this transaction is not integrated with the private offering that closed in October 2003. An effective registration statement went into effect on April 22, 2004. Nasdaq has advised the Registrant that the transaction is not integrated with the private offering that closed in October 2003. The fixed conversion price is subject to an anti dilution adjustment should the Registrant issue stock at a price below the fixed conversion price prior to repayment of the note. The fixed conversion price was originally set at $1.33 per share, but an issuance of shares in January 2004 triggered the anti-dilution provision, and the fixed conversion price was adjusted to $1.28 per share. Further issuances of shares occurred in May 2004, and the fixed conversion price was further adjusted to $1.19 per share. The note is secured by the Registrant’s North American assets. As of May 21, 2004, none of the note had been repaid or converted into common stock, and accordingly the Registrant is in default of the terms of the note.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

On March 30, 2004, the Registrant held a special meeting of stockholders. Of 20,340,822 shares eligible to vote, 12,781,494 votes were returned, or 62.8%, formulating a quorum. At the stockholders meeting, the following matter was submitted to stockholders for vote: Proposal No. 1 – To approve the issuance or potential issuance of up to 44,750,000 shares of the Registrant’s Common Stock.

The result of voting on this proposal was as follows:

Proposal No. 1 – To approve the issuance or potential issuance of up to 44,750,000 shares of the Registrant’s Common Stock.

     Proposal No. 1 was approved with 10,117,047 shares voted for, 235,786 voted against, and 2,428,661 abstained from voting, thereby approving the issuance or potential issuance of up to 44,750,000 shares of the Registrant’s Common Stock.

ITEM 5. OTHER INFORMATION – Not Applicable

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

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(b) Reports on Form 8-K

On February 2, 2004, under Item 5 – Other events. Regarding the Registrant’s announcement on January 30, 2004 that it had agreed to sell 2,532,522 shares of its common stock and warrants to purchase another 1,519,513 shares of its common stock, resulting in gross proceeds (assuming no exercise of the warrants) of $2,330,000, in a private offering to institutional and accredited investors. A copy of the press release announcing the private offering was furnished as Exhibit 99.1 to the Form 8-K.

On February 11, 2004, under Item 5 – Other events. Regarding the Registrant’s announcement that it had received a letter from the Nasdaq Listing Qualification Department indicating that the Registrant was subject to delisting because of its failure to comply with certain Nasdaq Marketplace Rules. A copy of the press release was furnished as Exhibit 99.1 to the Form 8-K.

On February 23, 2004, under Item 12 – Results of Operation and Financial Condition. Regarding the Registrant’s announcement on February 18, 2004 of its financial results for the quarter and six months ended December 31, 2004. A copy of the press release was furnished as Exhibit 99.1 to the Form 8-K.

On March 29, 2004, under Item 5 – Other events and Item 7 – Regulation FD Disclosure. The Registrant advised that on March 24, 2004 Aardman Animations Limited had filed a claim with the High Court of England and Wales seeking a declaration that an agreement between them and the Registrant had been validly terminated, and that Frontier Developments Limited had filed with the High Court of England and Wales payment claims totaling $600,000 under a development agreement. The Registrant also announced that its Board of Directors had reached an agreement with the board of directors of VIS entertainment plc (VIS) and SOE Development Limited (SOED) on the terms of an offer by the Registrant for the entire issued share capital of both VIS and SOED. A copy of the press release was furnished as Exhibit 99.1 to the Form 8-K.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

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