U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-KSB
/X/ ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [Fee Required]
FOR THE FISCAL YEAR ENDED MARCH 31, 1997
/ / TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [No Fee Required]
For the transition period from _____ to _______
COMMISSION FILE NUMBER: 0-20102
CAPITOL MULTIMEDIA, INC.
(Name of small business issuer in its charter)
DELAWARE 52-1283993
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
200 Baker Avenue, Suite 300
Concord, MA 01742
(Address of principal executive offices)
Issuer's telephone number: (508) 287-5888
Securities registered under Section 12(b) of the Exchange Act: NONE
Securities registered under Section 12(g) of the Exchange Act:
COMMON STOCK $.10 PAR VALUE
(Title of Class)
REDEEMABLE SERIES A WARRANTS
(Title of Class)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 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 [ ]
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B in this form and no disclosure will be contained, to the best of
registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB. [X]
Issuer's Revenues for the Fiscal Year Ended March 31, 1997: $ 1,925,913
The aggregate market value of the voting stock held by non-affiliates, computed
issuing the sales price of such stock, as of May 31, 1997 was $7,540,081.
As of May 31, 1997, the number of shares of Common Stock outstanding 6,032,065.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's Definitive Proxy Statement for its 1997 Annual
Meeting of Shareholders to be held August 21, 1997 are incorporated by reference
into Part III hereof. The Definitive Proxy Statement will be filed with the
Commission within 120 days of the registrant's fiscal year ended March 31, 1997.
Transitional Small Business Disclosure Format Yes [ ] No [ X ]
Exhibit Index Located on Page 40 Page 1 of 42
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CAPITOL MULTIMEDIA, INC.
MARCH 31, 1997
FORM 10-KSB
TABLE OF CONTENTS
PART I
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ITEM 1. DESCRIPTION OF BUSINESS 3
ITEM 2. DESCRIPTION OF PROPERTY 12
ITEM 3. LEGAL PROCEEDINGS 12
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 12
PART II
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ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS 12
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS 13
ITEM 7. CONSOLIDATED FINANCIAL STATEMENTS 20
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS 37
PART III
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ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS 37
ITEM 10. EXECUTIVE COMPENSATION 38
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND 38
MANAGEMENT
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 38
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K 38
INDEX OF EXHIBITS 40
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PART I
ITEM 1. DESCRIPTION OF BUSINESS
GENERAL
Capitol Multimedia, Inc. (the "Company") focuses on two software markets,
business software for supply chain management and consumer software for
children's edutainment products. Since its founding in 1982, the Company has
been engaged in the development of software for consumer and business markets.
Since 1995, the Company has been primarily focused on development of children's
edutainment titles. Due to the overproduction of titles in this segment of the
consumer market, the Company decided to diversify into the business software
sector. On March 31, 1997 the Company entered the business software market
through an acquisition of Client Server Technologies Inc. (CSTI), a developer
and integrator of supply chain management software. Supply chain management
encompasses the planning and control of material and resources from order entry
through warehousing and logistics to customer delivery. The Company's strategy
is to provide state-of-the-art, real-time planning and management capabilities
that improve customer cycle time from order receipt to product delivery, and
reduce inventory costs.
On April 16, 1997 the Company sold certain of its multimedia assets to Davidson
& Associates, Inc. (Davidson), a division of CUC International, Inc. The Company
retained all rights to its fourteen (14) multimedia CD-ROM products currently on
the market, three (3) new CD-ROM titles that are near completion, all software
tools and engines, and software development capabilities in the United States
and Russia. The Company's current CD-ROM products are targeted primarily at
children ranging from 3 to 14 years of age and are distributed by Davidson and
Broderbund Software Inc. (Broderbund).
History. The Company was incorporated in Delaware in 1982 and operated a video
post-production business. In 1988, it began developing software for the CD-i
platform. From 1988 to 1995, the Company developed approximately 35 consumer
CD-i titles. In 1991, the Company purchased Philips Media, Inc.'s ("Philips")
partnership interest in a 50/50 joint venture formed by the Company and Philips
to sell CD-i software and hardware to the professional market. In 1993, the
Company sold the assets used by its video post-production operations. In
February 1995, the Company acquired Animation Magic, Inc. ("AMI") and its
wholly-owned subsidiary in St. Petersburg, Russia. With a staff of over 120
people employed by the Russian subsidiary, the transaction more than doubled the
Company's capacity to develop high-end interactive software for the consumer
market on the CD-ROM platform. In August 1995, the Company sold assets
associated with its CD-i professional business to Philips. As a result of this
sale, the Company no longer provided CD-i services to the professional market.
Acquisition of CSTI. On March 31, 1997, the Company acquired CSTI for
approximately $3.9 million through the issuance of 1,200,000 shares of common
stock, the payment of $1.25 million in cash and issuance of non-interest
bearing, convertible, long-term notes totaling $1.9 million to sellers and
discounted to a value of $1.55 million. The transaction was accounted for under
the purchase method of business combinations. The acquisition provided the
Company an entry into the supply chain management sector of the business
software market. CSTI employs approximately 40 people with offices in Dedham,
Massachusetts; Denver, Colorado; and Los Angeles, California. Please refer to
Item 6, Management Discussion and Analysis for further discussion on the
acquisition.
Sale of selected multimedia assets. On April 16, 1997, the Company sold selected
multimedia assets, including assets relating to its art, animation and audio
production
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capabilities in St. Petersburg, Russia and Concord, Massachusetts, to Davidson
for approximately $2.5 million in cash. The gain from this transaction is
approximately $2.0 million. Please refer to Item 6, Management Discussion and
Analysis for further discussion of this transaction. As a result of this sale,
the Company no longer develops its own multimedia software titles for the
consumer market or provides development services for others, but will continue
to sell existing titles through its current distribution channels.
INDUSTRY BACKGROUND
Multimedia Market. The consumer software market grew between 25% and 30% during
1996 according to Software Publishers Association's data. The primary area of
growth in that market has been in the sales of CD-ROM products for the Windows
and Macintosh software platforms. As the software market has grown, competition
for retail shelf space has also increased. As a result, the need to
differentiate products on crowded retail shelves highlighted the critical
importance of a brand name. In addition, as a result of significant mergers and
acquisition activity, several companies were able to establish significant
market positions. In this environment, smaller, lesser known software publishers
that do not have either product or company name recognition encountered
difficulty in gaining access to retail distribution outlets and compete. These
trends have led to increased competition for consumer sales, higher development
and distribution costs, lower margins, pricing pressures, and increased
volatility in sales trends, many of which have had an adverse effect on the
Company's operating results and financial condition and affected the Company's
ability to compete in the industry.
Supply Chain Management Software Market. The current business environment has
forced many manufacturing and distribution companies to increase their
efficiency of their operations and improve their responsiveness to the changing
customer requirements and market conditions. In response to these pressures,
companies are transforming their business processes to support order-driven
manufacturing in lieu of mass production. They strive to increase outsourcing
and shorten order-to-delivery times. Software solutions that provide real-time
and accurate information about various elements of the supply chain are becoming
a critical component enabling companies to support this transformation.
The Company believes that the currently employed solutions for supply chain
issues lack the capability to provide customers with:
o accurate and up-to-date information about their supply chains to enable
them to make good decisions
o the ability to optimize performance on an aggregate rather than local basis
o the ability to respond quickly to changes, such as the arrival of new and
important orders
o the ability to consider alternatives based on well-selected relevant data.
The CONTINUUM Solution. Based on a patented approach, the Company believes that
its products provide its customers with software solutions that address many of
the customer needs listed above. The Company's strategy is to provide its
customers with integrated, advanced supply chain planning and management
solutions that are simple to use, install and adjust to a changing business
environment. CONTINUUM is a set of software products designed to help customers
reduce cycle time from order to remittance, improve customer responsiveness,
reduce inventory and thus improve the profitability of the enterprise. The
Company believes that its products are differentiated by the following
capabilities:
Real-time perspective. Allows customers to see changes in their supply chain in
real time. Such capability can help customers to fulfill critical orders in
accordance with their delivery commitments as well as to continuously monitor
and adjust inventory levels to optimize
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operations and reduce inventory carrying costs. All these operations can be done
through a simple, user-friendly interface.
Accurate Information about the Supply Chain. Provides the ability to propagate
changes at all levels in the supply chain immediately after the change is made.
This allows managers to have accurate integrated information that allows them to
make fast strategic and tactical decisions.
Available To Promise. The ability to see the whole supply chain in real time so
customers can determine whether an order can be promised for a certain delivery
date.
Ease Of Installation. Full product integration that utilizes sophisticated tools
to simplify the installation and allow customization in a fast and efficient
manner.
Client Server Infrastructure. Utilize standard architectures and known databases
to simplify the integration on a variety of platforms enabling faster and
simpler integration into customer environments.
Scalability. Allows customers to divide their operations into domains for the
purposes of planning. This capability allows customers to add or delete domains
as the business grows.
Integrated Solution. Fully integrated solution where operational actions are
reflected in the financial data of the business presenting an accurate and
up-to-date picture to a decision-maker.
COMPANY STRATEGY
The Company's strategy is to become a significant provider of supply chain
management software by aggressively pursuing the following growth strategies:
Acquire Complementary Businesses. The Company will look to expand through
acquiring or licensing software products and technologies, including the
acquisition of companies in the market. The Company will be looking to fill
functionality gaps in its product line through integrating capabilities of the
acquired companies. The Company is currently involved in the evaluation of, and
discussions with, one or more acquisition candidates, but the Company has not
reached any agreements with respect to any future acquisitions and can provide
no assurance that any transaction will occur.
Invest in Sales and Marketing. The Company's expenditures in the sales and
marketing category are below the industry average. The Company intends to expand
its sales and marketing efforts. The Company believes that these investments are
necessary and critical to capitalize on the growth in the supply chain
management software market.
Build Alliances and Expand Network of Independent Distributors. The Company's
product is designed in a modular way and allows easy integration with business
software. The Company intends to pursue strategic alliances with Material
Requirements Planning (MRP) and Enterprise Resource Planning (ERP) vendors in
the areas where the Company's modules provide additional flexibility and
functionality to the existing MRP and ERP vendors. In addition, the Company
intends to establish joint marketing and other relationships with complementary
business application software vendors, systems consulting and integration
vendors. The Company is also planning to utilize the multi-currency capabilities
of its "Continuum" product for international sales.
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Develop Advanced Product Functionality. The Company sees many opportunities to
develop advanced product functionality, especially related to the Internet due
to the increasing acceptance of the use of the Internet in business. The Company
intends to develop such functionality for this rapidly evolving market.
Utilize Cost Effective Software Development Capability. The Company intends to
fully utilize its highly sophisticated, cost-effective software development
capability in St. Petersburg, Russia. Such resources have heretofore been
allocated to the development of multimedia products. By increasing resources but
decreasing dollars spent in previous periods by CSTI for integration services
and research and development, the Company intends to free additional cash for
sales and marketing development.
PRODUCTS
Multimedia Products. From 1994 to 1997, the Company's software development
focused on the children's market within the CD-ROM software industry, developing
titles for the following high-quality animated product families:
Grandpa Tales is a series of six CD-ROM based interactive storybooks designed
for children 3 to 9 years of age. Each title in the series is based on folk
tales from countries around the world. These titles are currently available
nationwide and internationally in major software retail outlets and mail order
catalogs at prices ranging from $20 to $35. Pursuant to a licensing and
distribution agreement, Davidson distributes these titles under its Magic Tales
product line.
Kidventures is a series of two CD-ROM based interactive adventures designed for
children 4 to 8 years of age. The products feature friendly animal characters
who have been designed to promote creativity, discovery, and exploration through
activities that encourage interaction and problem solving. The adventures unfold
with extensive original animation, graphics, sound, and music. Pursuant to a
licensing and distribution agreement, Broderbund is distributing these titles
under its StoryQuests product line.
The Company has also developed three (3) new titles during the year ended March
31, 1997. They include:
Casey Goes to Summer Camp - an animated interactive adventure designed for
children 4 to 8 years of age.
Pearls of Wisdom - an animated interactive adventure board game designed for
children 4 to 8 years of age.
Magic Acorns - an animated interactive adventure board game designed for
children 4 to 8 years of age.
The Company is actively looking for a licenser or purchaser of these titles.
Supply Chain Management Products. The Company's "Continuum" product set provides
software solutions and integration services for logistics, planning,
distribution and financial functions within a business to increase productivity,
reduce inventory and improve planning and control. The software is available in
client/server environment utilizing Microsoft Windows and several widely used
relational database products, including Oracle, Ingress, and Sybase and is fully
Year 2000 compliant. Included in the "Continuum" product line are the following
modules:
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o Distribution Resource Planning - a product based on a patented methodology
that offers true real time continuous planning. It provides a real-time
view of the entire supply chain, coordinates and optimizes all planning
scenarios and allows the planner to execute the chosen scenario. This
module allows regional and enterprise-wide control, is scalable and is
fully integrated with the Company's other modules.
o Sales Order Management - a module that allows order processing in a variety
of ways that are specific to customers. Proprietary tools, such as Order
Type Configurator, allow customization without custom coding.
o Inventory Planning and Control - provides support for multi-warehouse,
multi-location operations and helps customers to identify and execute cost
reduction initiatives across the supply chain.
o Purchase Order Management - allows customers to focus on vendor management
and price negotiations rather than administrative processing by providing
consolidated information. Proprietary tools allow customization with
limited coding requirements.
o Financial Management - allows customers to process accounts receivable,
accounts payable and general ledger activity relative to their business
transactions. A set of financial modules fully integrated with the rest of
the products that reflects changes made throughout the supply chain in an
effective and accurate manner.
All operations in Continuum can be processed in different currencies,
positioning them well for today's global environment. During 1996, the sales
prices for Continuum software packages generally ranged from $100,000 to
approximately $500,000. The price for the individual product package is
determined based on a number of factors, including the number of users, the
number of sites in the customer's business model and the complexity of the
customer's operation.
PRODUCT DEVELOPMENT
Multimedia Products. Prior to the sale of selected multimedia assets in 1997,
the Company's internal product development capabilities for multimedia included:
design, animation, prototyping, software programming, computer graphics design,
sound recording and quality assurance. The divisions responsible for these
capabilities, with the exception of software programming, were based in St.
Petersburg, Russia and Concord, Massachusetts, and were sold to Davidson on
April 16, 1997, significantly reducing the Company's capacity to develop
multimedia products. The Company retained the rights to previously developed
multimedia products, to three (3) new action adventures, as well as to the
software engines and tools. However, the Company will not develop new multimedia
products in the foreseeable future.
Research and Development. Investment in research and development has allowed the
Company to develop state-of-the-art technology for incorporation into its
products. Approximately, $2,031,000 and $2,181,000 was spent on consumer
software research and development activities during fiscal years 1996 and 1997,
respectively. The Company believes that continued significant investments in
research and development are required to remain competitive in the computer
software market.
Production Facilities. The Company sold its subsidiary in St. Petersburg, Russia
to Davidson as part of the sale of assets relating to its art, animation and
audio production capabilities on April 16, 1997. However, the Company retained
its software development
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capabilities in Russia and plans to operate a subsidiary and develop software in
St. Petersburg, Russia. The current political and economic future of Russia is
uncertain. In addition, economic conditions in Russia, including lower wage
rates and lower standards of living, allow the Company to transact business in
St. Petersburg at a relatively low cost structure. Changes in the political,
social, or economic stability, or significant changes in the exchange rate of
the Russian Ruble, could result in increased production costs and significant
delays in the completion of new products. Any such changes could have a material
adverse affect on the Company's operating results and/or financial condition.
Supply Chain Management Products. The Company's supply chain management software
product development process includes design, requirements definition, software
programming, computer graphic design, and quality assurance. On-going product
development efforts are focused on broadening the functionality of Continuum to
leverage the opportunities available through the Internet and on completing the
port to the Windows NT platform, which is to be made available in fiscal year
1998.
Company Products. The Company depends on the successful development of products.
The length of time required to develop the Company's products typically ranges
from six to twelve months. However, the timing and success of software product
development is unpredictable due primarily to changing technological
developments and the technological complexity of software products. If the
Company's new products are not completed and/or introduced when planned,
operating results and the ultimate success of products could be materially
affected, particularly in view of the seasonality of the Company's business (See
"Quarterly Fluctuations and Seasonality" below).
Future Product Development. The Company plans to increase its rate of new
product development for supply chain management software during fiscal year
1998.
The Company will continue to evaluate the need to adapt the Company's products
to emerging hardware and software platforms and technologies. Technological
advances provide opportunities for improvement in the sophistication, technical
capabilities, and performance of software products. As a result of the emergence
of new platforms, environments, and technologies, and increased competition, the
Company expects to increase resources allocated to product development. There
can be no assurance that the Company will be able to anticipate, evaluate, and
adapt to changes in platforms and evolving technologies, or to do so in a timely
or cost-effective manner.
The Company is not dependent on the sources and availability of any new
materials needed to produce its products. The Company does not believe that it
will experience any adverse effect from existing or probable government
regulations. Further, the Company is not currently planning to seek any
government approval for principle products or services. Lastly, the Company is
not effected by any current or pending environmental laws.
CUSTOMER INTEGRATION SERVICES
Due to the complexity of customer hardware and software environments, it is
often necessary to develop interfaces between the Company's supply chain
management products and the existing software in the customer's environment. If
a customer has needs that are specific to their business, it is often necessary
to develop additional functionality to satisfy these needs and make Company's
products be more effective in this customer's environment. The Company believes
that providing such technical support and project management to its supply chain
management customers is critical for a rapid product implementation and
instrumental in continued license sales and revenue growth. The Company intends
to expand such services in the future.
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SALES, DISTRIBUTION AND MARKETING
Multimedia. Distribution channels through which consumer software products are
sold are characterized by rapid change, including consolidations and financial
difficulties of certain distributors and retailers, and the emergence of new
retailers such as mass merchandisers as a principal channel for this
distribution of consumer software. In addition, there are an increasing number
of companies and products competing for access to these channels. Due to these
factors and the Company's relatively small size and limited resources, it does
not currently view the publication and self-distribution of its products as an
appropriate means to achieve its objectives. Accordingly, the Company has chosen
to license its titles to leading distributors of children's software products.
In 1995 and 1996, the Company entered into worldwide licensing and distribution
agreements for its Grandpa Tales and Kidventures series (See "Products" above)
with Davidson and Broderbund, respectively, two leading distributors of
children's software products. Under these agreements, the Company creates,
develops, produces, and retains ownership of the original interactive software
titles, and Davidson and Broderbund test, replicate, manufacture, package, sell,
market, distribute, supply customer support, and maintain warranty obligations
for the products. After recovery of certain out-of-pocket expenses, the Company
shares in product net revenues with the distributors.
Supply Chain Management. The Company sells its supply chain management software
and services primarily through its direct sales organization. As of March 31,
1997, the Company conducted sales through three offices in the United States.
The Company has over 75 customers in the U.S. and over 30 customers in Europe in
the middle market (companies ranging in size from $50 million to $1 billion) of
manufacturing, distribution and retail business. The sales process usually
consists of prospect identification, prospect validation, sales presentations
and product demonstrations, proposals and system design studies. The system
design studies are consulting projects which are small in scope and result in
providing customers a more definitive project plan, timetable and cost estimate.
The Company plans to expand its sales and marketing organization in fiscal 1998.
Currently the Company has two, third-party marketing and sales alliances. The
Company has a joint marketing agreement with Computer Associates, Inc. for the
marketing of Continuum to the Computer Associates' customer base. The Company
also has a non-exclusive distribution agreement with The Orion Group, which
allows Orion to market, sell and implement the Continuum products to its
customers primarily in the Mid-West. The Company is actively seeking additional
third-party alliances to expand its sales and marketing capability, as well as
to supplement its product offerings. By using these sales channels, the Company
intends to capitalize on the installed base of other software vendors and
increase its market presence.
COMPETITION
Multimedia. The consumer software industry is intensely competitive. The
Company's consumer software products compete with a broad range of entities from
small companies with limited resources to large companies with vast financial,
technical, distribution and marketing resources. Competitors include, but are
not limited to, The Learning Company, Broderbund Software Inc., Davidson &
Associates, Inc., IBM, The Walt Disney Company, CUC Software, Electronic Arts,
and Microsoft.
The Company believes that existing competitors are likely to broaden their
product lines and that new competitors, including large hardware and software
companies, media companies,
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and educational publishers, may enter the consumer software market, resulting in
increased competition.
An increasing number of high-quality competitive products are being offered by a
growing number of companies -- all of which are battling for limited retail
shelf space. The increasing number of children's software titles may limit the
Company's ability to sell or distribute products, increase marketing and
distribution costs, and create additional pricing pressures, any of which could
have a material adverse effect on the Company's operating results and financial
condition.
Only a small percentage of products introduced to the consumer market ever
achieve any degree of market acceptance. Competitive factors in the software
industry include access to distribution, brand name recognition, quality,
features, ease-of-use and pricing of products. The Company believes its products
compete favorably with respect to quality, features, and ease-of-use and it
plans to continue to work with its distributors to achieve greater market
acceptance of the Company's products in the consumer market.
Supply Chain Management. The Company's products are addressing the needs of the
growing market for supply chain management software solutions. The Company's
competitors include small and large companies which offer various solutions in
different segments of the supply chain. Many of the Company's competitors, such
as SAP, Manugistics, BAAN, and Oracle, have longer operating histories, larger
customer bases, better name recognition, significantly greater financial,
technical, marketing and distribution resources than the Company. The Company is
currently focused on the middle market of manufacturers and distributors with
revenue over $100 million. The Company offers an integrated solution with some
superior capabilities that are advantageous to customers in this market. To the
extent larger competitors either acquire or develop products with functionality
comparable to the Company's products and are able to offer them to the middle
market at competitive prices, their integrated solutions will provide a
significant competitive advantage over the Company. There can be no assurance
that the Company will be able to compete successfully with existing or new
competitors or that competition will not have a material adverse effect on the
Company's business, operating results and financial condition.
PROPRIETARY RIGHTS
The Company regards the software it develops and owns as proprietary and relies
primarily on a combination of copyrights, trademarks, trade secret laws,
employee and third-party nondisclosure agreements and other methods to protect
its proprietary rights. The Company has registered trademarks in the United
States for certain of its product names and has pending trademark applications
for certain additional product names. The Company believes that trademarks and
copyrights are important, but less significant to the Company's success than
factors such as the knowledge, ability, and experience of the Company's
personnel, research and development, brand name recognition, and product
loyalty.
Most of the Company's products do not include any mechanisms to prevent or
inhibit unauthorized copying, nor does the Company rely on shrink-wrap licenses
which restrict copying and use of the products. The Company is aware that
unauthorized copying occurs within the software industry; however, policing
unauthorized use of the Company's products is difficult. While the Company is
unable to determine the extent to which software piracy of its products exists,
software piracy, is expected to be a persistent problem.
The Company believes that its products, trademarks, and other proprietary rights
do not infringe on the proprietary rights of third parties. As the number of
software products increases and the functionality of these products further
overlaps, software developers may
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become increasingly subject to infringement claims. There can be no assurances
that third parties will not assert infringement claims against the Company with
respect to current or future products, or that any such assertion may not
require the Company to enter into royalty arrangements or result in costly
litigation.
QUARTERLY FLUCTUATIONS AND SEASONALITY
The level of net sales realized by the Company in any quarter is principally
dependent on the number of sold new Continuum software licenses and the number
of titles shipped for published consumer software titles. The purchase of supply
chain management solutions requires a significant commitment of capital and
resources on the part of the customer, the sales cycles are long and average
from six to nine months. As a result, revenue recognition is subject to many
risks such as budgetary cycles, changes in the business of a customer and
overall economic trends that are not controllable by the Company. Quarterly
results have varied significantly in the past and are likely to fluctuate in the
future as a result of new orders timing, product development expenditures, the
number and timing of new product completions, and multimedia product shipments
and returns. A significant portion of the Company's operating expenses are fixed
and planned expenditures in any given quarter are based on sales and revenue
forecasts. Accordingly, if net sales do not meet the Company's expectations in
any given quarter, operating results and financial condition could be adversely
and disproportionately affected because a significant portion of the Company's
expenses do not vary with revenues. As a result of these and other factors, the
Company's results of operations and financial condition for any period are
inherently difficult to predict. Any significant change from levels expected by
securities analysts or shareholders could result in substantial volatility in
the trading price of the Company's common stock.
In addition, net sales derived from the Company's published multimedia products
are typically highest in the Company's second and third quarters ending in
September and December each year due primarily to the increased demand for
products for the calendar year-end holiday selling season. There can be no
assurance, however, that any quarterly fluctuations based on seasonality will
continue.
EMPLOYEES
As of May 31, 1997, the Company employed 46 people on a full-time basis. None of
the Company's employees are represented by a labor union or bound by a
collective bargaining agreement. The Company has never suffered a work stoppage.
The Company believes its future success will depend, in part, upon continued
service of a small number of key technical and senior management personnel and
on its continued ability to recruit and retain highly-skilled management and
technical personnel. Competition for such employees is intense and the loss of
services of key personnel could have a material adverse effect on the Company's
operating results and financial condition. There can be no assurance that the
Company will retain its key managerial and technical employees or that it will
be successful in attracting and retaining other highly-skilled managerial and
technical resources.
COMPLEXITY OF SOFTWARE PRODUCTS
The market for the Company's software products requires continuous upgrades due
to technological advances, introductions of new hardware platforms and operating
systems, changes in customer requirements and frequent new product
introductions. The Company's future success will depend on its ability to
continue to upgrade its products taking these changes into consideration. There
can be no assurance that the Company will be successful in
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developing and marketing such new products on a timely and cost-effective basis.
The Company's failure to successfully develop and market new products and
enhancement that keep pace with the advances of the market could have a material
adverse effect on the Company' business, operating results and financial
condition.
The Company's supply chain management products are very complex due to its
client/server architecture, depth of the functionality and the number of modules
and interdependencies between them. Given such product complexity, the Company's
new products may have undetected errors that would not have been found until the
installation of the product at a customer's site despite rigorous testing of the
product by the Company. Even though such infrequent occurrences have not had a
material adverse impact on the Company's business in the past, there can be no
assurance that delays related to error correction will not have a material
adverse impact on the Company's financial condition in the future.
ITEM 2. DESCRIPTION OF PROPERTY
The Company leases approximately 15,000 square feet of office space in Bethesda,
Maryland, pursuant to a non-cancelable lease expiring in April, 2004 with an
option to renew for one additional five-year term. Of the 15,000 square feet,
the Company currently has sublet approximately 7,000 square feet through March,
2000. On April 24, 1997, the Company entered into a sublease for approximately
8,000 square feet in Bethesda, Maryland through the remainder of the lease term
(March, 2004). In 1996, the Company decided to relocate its headquarters from
Bethesda, Maryland to Concord, Massachusetts. The Company entered into a
three-year, non-cancelable lease for approximately 5,400 square feet in Concord,
expiring October, 1999. The Company's subsidiary located in St. Petersburg,
Russia leases approximately 7,000 square feet pursuant to a lease expiring in
March, 1998. On March 31, 1997, the Company acquired CSTI. CSTI has offices in
three (3) locations: Dedham, Massachusetts (approximately 8,000 square feet on a
three-year, non-cancelable lease expiring December, 1999); Denver, Colorado
(approximately 100 square feet on a six [6] month continuous lease) and Los
Angeles, California (approximately 3,000 square feet on a lease expiring June,
1998).
On April 16, 1997, the Company sold selected multimedia assets to Davidson. As
part of this transaction, the leased office space in Concord, Massachusetts was
assigned to Davidson and a small amount of space in these premises has been
sublet by the Company from Davidson. The space located in St. Petersburg, Russia
was transferred to Davidson.
ITEM 3. LEGAL PROCEEDINGS
The Company is not party to, nor is it aware of, any threatened litigation of a
material nature.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during the quarter
ended March 31, 1997.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The Company's Common Stock and Series A Warrants are traded on the NASDAQ
Small-Cap Market System under the symbols CDIM and CDIMW, respectively. The
following table
12
<PAGE>
sets forth, for the periods indicated, the high and low sales prices for the
Company's Common Stock as reported by NASDAQ:
HIGH LOW
---- ---
Fiscal Year Ended March 31, 1997
First Quarter $5.00 $3.50
Second Quarter $3.875 $1.75
Third Quarter $2.125 $1.125
Fourth Quarter $1.313 $ .719
Fiscal Year Ended March 31, 1996
First Quarter $4.25 $2.50
Second Quarter $4.75 $2.75
Third Quarter $6.00 $3.69
Fourth Quarter $4.75 $3.13
The above over-the-counter market quotations reflect inter-dealer prices,
without retail mark-ups, mark-downs, or commissions and may not represent actual
transactions.
The Company has not paid cash dividends on its common stock since its
organization and does not intend to pay any cash dividends in the foreseeable
future. As of May 31, 1997, the Company had approximately 132 shareholders of
record excluding shareholders whose stock is held in nominee or street name by
brokers.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS
Business Developments
During the quarter ended June 1996, the Company entered into an agreement with
Davidson to develop an animated CD-ROM game for the adult market. The title is
based upon Blizzard Entertainment's (a division of Davidson) WarCraft software
series. Under the agreement, the Company retains ownership of the underlying
software engine and receives a residual royalty interest in the product after a
certain level of sales is achieved.
In July 1996, the Company announced the release of Gregory and the Hot Air
Balloon and Darby The Dragon, two of its interactive animated adventures, by
Broderbund, a leading publisher and distributor of interactive children's
entertainment and educational software for both the home and school markets.
These titles are part of a Broderbund line of products known as StoryQuests(TM).
In September 1996, three of the Company's international folk tale titles -- Liam
Finds a Story, an Irish folk tale; Sleeping Cub's Test of Courage, a Native
American folk tale; and The Princess and the Crab, an Italian folk tale, were
released for distribution by Davidson under its Magic Tales(TM) product line.
The Company consolidated its Bethesda, Maryland headquarters with its operations
in Massachusetts in November of 1996. Robert I. Bogin, the Company's President
and Chief Executive Officer, chose not to relocate, resigning as an officer of
the Company effective September 12, 1996. He remained employed by the Company
through December 1996 however, and continues to serve as a director of the
Company. The Company's Board of Directors selected Igor R. Razboff, previously
Vice President of Production and one of the Company's largest shareholders, as
Chairman of the Board and Chief Executive Officer. The Board of Directors also
selected Luda Kopeikina, most recently Vice President of GE Information
Services, as President. Ms. Kopeikina is married to Mr. Razboff. Catherine K.
Hoopes, the Company's Chief Financial Officer and Secretary/Treasurer also chose
not to
13
<PAGE>
relocate to Massachusetts. The Board of Directors selected Edward Terino to
replace Ms. Hoopes as Chief Financial Officer and Secretary/Treasurer effective
December 16, 1996.
On March 31, 1997, the Company announced the acquisition of CSTI, a developer
and integrator of supply chain management software based in Dedham,
Massachusetts for approximately $3.9 million, consisting of $1.25 million in
cash, 1.2 million shares of Capitol unregistered common stock and issuance of
non-interest bearing, convertible, long-term notes totaling $1.95 million to
sellers and discounted to a value of $1.55 million. Re-payment of the notes
begins in fiscal 1999. Note holders have the right to convert a portion ($1
million) of the interest and principal owed under the notes into shares of the
Company's common stock at a $3.00 per share conversion price. This transaction
was accounted for under the purchase method of business combinations. For
additional information on this acquisition, see Footnote 5 and 7 in Item 7
Financial Statements.
On April 16, 1997 after the Company's fiscal 1997 year end, the Company sold
certain of its multimedia assets to Davidson for approximately $2.5 million in
cash . The assets sold included the machinery and capital equipment utilized in
art, animation and audio production in St. Petersburg, Russia and Concord,
Massachusetts. The net asset value transferred was $258 thousand. The gain on
the sale resulting from this transaction was approximately $2 million. In
addition, the Company sold the stock of its Russian subsidiary, ZOA AMI, and the
right to use the name Animation Magic. As part of the transaction, the Company
amended its software development contract with Blizzard Entertainment. In
addition, the Company entered into a work-for-hire agreement with Davidson &
Associates, Inc. related to software engineering services for the Warcraft
Series, and assigned present Concord, Massachusetts offices lease to Davidson &
Associates, Inc. Most of the staff in St. Petersburg, Russia and Concord,
Massachusetts office were transferred to Davidson. Included in this transaction
was Mr. Igor Razboff, Chairman of the Board and CEO of Capitol Multimedia, Inc.,
who resigned his CEO position to accept a position at CUC International, Inc.
Mr. Razboff will remain as Chairman of the Company's Board of Directors.
Presentation
Since the Company's August 1995 sale of assets relating to its CD-i professional
business, it has focused solely on the creation and development of consumer
multimedia software products. Accordingly, the discussion and analysis of the
Company's results of operations compares results for the twelve months ended
March 31, 1997 to pro forma results for the twelve months ended March 31, 1996.
See Footnote 4 of the Financial Statements in Item 7 for proforma results. In
addition, the acquisition of CSTI occurred on the last day of fiscal 1997, and
therefore, fiscal 1997 results from operations do not include any results from
the supply chain management software business. The Company believes such
comparison provides a more meaningful analysis of current and prior fiscal year
results.
14
<PAGE>
Net Sales
The composition of net sales for the twelve months ended March 31, 1997 and 1996
is as follows:
<TABLE>
<CAPTION>
Twelve Months Ended
March 31
Pro-Forma
% $
1997 1996 Change Change
------------------------------------------------- ------------
<S> <C> <C> <C> <C>
Software development
revenue $ 1,286,203 $ 2,332,463 (45%) ($1,046,260)
Consumer software sales and
royalties 639,710 1,403,156 (54%) (763,446)
Licensing and distribution
fees 232,616 (100%) (232,616)
------------------------------------------------- ------------
Total net sales $ 1,925,913 $ 3,968,235 (51%) ($2,042,322)
================================================= ============
</TABLE>
Software development revenue decreased $1,046,260 or 45% for the twelve months
ended March 31, 1997 due a decrease of $1,675,000 in software development
revenue from Philips Media, Inc. ("Philips") offset by increases in
work-for-hire revenues from other customers, including Simon & Schuster
Interactive and Davidson & Associates, Inc. During fiscal year 1996, the Company
developed titles for Philips on a work-for-hire basis. The Company however, did
not perform any development services for Philips during fiscal year 1997. As a
result of the sale of multimedia assets (art, animation and production) to
Davidson & Associates, Inc. on April 16, 1997, the Company expects to generate
no new software development revenues for multimedia products beyond fiscal 1997.
During the quarter ended September 1996, two of the Company's interactive
animated adventures were released by Broderbund and three of the Company's
international folk tale titles were released by Davidson. Due to intensified
competition in the children's multimedia market, however, the Company
experienced lower orders and higher return rates, and as a result, consumer
software sales and royalties decreased $763,446 or 54% for the twelve months
ended March 31, 1997. The Company ended fiscal 1997 with three interactive
animated adventures developed and not yet in distribution. Further, the Company
entered into a distribution agreement in April, 1997 with Davidson to distribute
its Magic Tales(TM) series under the Fisher Price label. Both of these events
are expected to generate increased software sales and royalties in fiscal 1998
over fiscal 1997.
Although the Company completed the purchase of CSTI on March 31, 1997, there are
no sales from CSTI included in the Company's fiscal 1997 financial statements.
CSTI had unaudited sales of $3.7 million and $4.0 million in calendar year 1996
and 1995, respectively. Please see Footnote 5 in Item 7 - Financial Statements
for pro-forma results assuming the acquisition of CSTI had occurred prior to
April 1, 1995.
The level of multimedia sales realized in any quarter is principally dependent
on the number of titles shipped and/or sold for published products. As a result
of the intense competition for sales of children's animated and story adventure
titles, the Company cannot currently
15
<PAGE>
predict any seasonal consumer software sales fluctuations. Quarterly results may
fluctuate as a result of product mix, the number and timing of new product
completions, and product returns.
The level of sales from supply chain management in any quarter is dependent on
the timing of integration services and installation of software. Since both of
these events are dependent on the lead time associated with the sale (which can
take 6 to 9 months to close) and customer's participation in the project, the
Company cannot currently predict any seasonal business software sales
fluctuations. Quarterly results may fluctuate as a result of contracts signed,
the amount of integration service billed to customers and the installation of
software licenses.
Research and Development
Research and development costs increased by $151,000 or 7.4% for the twelve
months ended March 31, 1997. The twelve month increase is due to a liquidation
of $94,000 of inventory associated with CD-ROM and Sega CD products no longer
distributed by the Company and $195,000 associated with expansion of the
Company's development and production capabilities in the early part of fiscal
1997, offset by a decrease of $115,000 in third party royalties relating to CD-i
titles and a general decrease of $23,000.
In April, 1997, the Company sold selected multimedia assets to Davidson. The
assets that were sold include art, animation and audio production capabilities
located in St. Petersburg, Russia and Concord, Massachusetts. As a result, the
Company expects research and development costs to be substantially reduced in
fiscal 1998. Since the remaining resources located in Russia are materially
less, the Company is less vulnerable to changes in the political and economic
uncertainties associated with Russia.
Depreciation and Amortization
Depreciation and amortization increased $69,000 or 52% for the twelve months
ended March 31, 1997, as a result of expansion of its development and production
capabilities earlier in the fiscal year. The acquisition of CSTI will increase
the amortization of goodwill in fiscal 1998, as well as, the amortization of
capitalized software. The total amortization costs for fiscal 1998 are expected
to be approximately $150,000.
General and Administrative
General and Administrative expenses increased $129,700 or 7.3% for the twelve
months ended March 31, 1997 due to one-time charges relating to the
consolidation of the Company's Bethesda, Maryland headquarters with operations
in Massachusetts completed in December, 1996. The Company expects to incur an
additional $50,000 in charges relating to the consolidation of offices, the
majority of which is expected to be recognized during fiscal year 1998.
A significant portion of the Company's operating expenses are fixed, and planned
expenditures in any given quarter are based on sales and revenue forecasts.
Accordingly, if products are not completed and/or shipped on schedule and net
sales do not meet the Company's expectations in any given quarter, operating
results and financial condition could be adversely affected. Given the Company's
recent acquisition and sale of certain assets, as well as, the consolidation of
operations in November, 1996, general and administrative expenses will increase
in absolute dollars, however, they will decrease as a percent of sales in fiscal
1998.
16
<PAGE>
In-Process Research and Development
On March 31, 1997, the Company acquired the stock of Client Server Technologies,
Inc. (CSTI) for approximately $3.9 million in cash, restricted common stock of
the Company and notes. In order to determine the purchase price accounting for
the CSTI stock acquired by the Company, an independent third party was engaged
to complete a valuation of the intangible assets of CSTI acquired by the
Company. The results of this independent valuation attributed $2,200,000 to
In-Process Research and Development costs. The Company's accounting practice, in
accordance with GAAP, is to expense research and development costs, therefore,
the Company recorded a write-off of $2,200,000 related to in-process research
and development acquired in the purchase of CSTI stock. The Company estimates
that products under development will be completed in fiscal 1998 and cost an
additional $1 million to complete.
Consolidation Charges
During the quarter ended September 1996, the Company recognized $462,500 in
one-time consolidation charges consisting of severance benefits and fees
relating to subleasing its facilities in Maryland. As of March 31, 1997,
approximately $84,000 of the total charge remained in the balance sheet, and
relates directly to future payments for the Maryland facility. The Company
expects to realize benefits from the consolidation in several areas, including
lower research and development costs attributed to reduced labor costs and lower
facilities costs, and lower general and administrative costs attributed to
reduced salaries. The sale of selected multimedia assets to Davidson &
Associates, Inc. on April 16, 1997, including the transfer of research and
development staff and assignment of the Company's Concord, Massachusetts office
lease will eliminate a significant portion of research and development expenses
in fiscal 1998, thus decreasing the realization of consolidation benefits.
However, the Company still expects to realize benefits from these actions of
approximately $150,000 in general and administrative costs in fiscal 1998.
Loss on the Sale of Assets
The Company recognized a loss of the disposition of assets associated with the
CD-i business, which was sold to Philips in fiscal 1995 and the consolidation of
operations in the fiscal third quarter of 1997.
Income Taxes
The Company did not incur any tax liabilities for fiscal year 1997 as a result
of the current year net loss. Please refer to Footnote 12 in the Financial
Statements for additional information on deferred tax assets and liabilities.
Liquidity and Capital Resources
The Company's primary sources of liquidity are its cash, cash equivalents, and
short-term investments. During the twelve months ended March 31, 1997, cash,
cash equivalents, and investments decreased $2,567,000 or 59% to $1,751,000.
This decrease relates to $1,250,000 for the purchase of CSTI, $207,000 in
capital expenditures and $1,415,000 used to fund operating activities offset by
the $155,000 cash on CSTI's books at the date of the closing.
Accounts receivable increased $524,000 or 104% to $1,027,000 at March 31, 1997
due to the accounts receivable balance on CSTI's books as of March 31, 1997.
17
<PAGE>
Notes and guaranteed royalties receivable decreased $250,000 or 50% to $250,000
as a result of the receipt of a $500,000 royalty payment, offset by $250,000 in
guaranteed royalties receivable which were reclassified from long to short term.
Prepaid expenses and other current assets decreased $98,000 or 56% to $77,000
primarily due to the liquidation of $94,000 in inventory associated with CD-ROM
and Sega CD products no longer distributed by the Company.
Accounts payable and accrued liabilities increased $258,000 or 149% due to the
recording of CSTI's accounts payable and royalty payable of $156,000 and the
accrual of $100,000 in closing costs associated with the acquisition of CSTI.
Unearned revenue and deferred rent increased by $329,222 or 500% to $395,000 due
to the inclusion of CSTI's unearned revenues of $291,000 on the Company's books
as of March 31, 1997.
On April 16, 1997 the Company consummated a sale of certain multimedia assets
which had a significant impact on the its liquidity and capital resources.
Summary proforma balance sheet information is presented below, alongside actual
March 31, 1997 information for comparison purposes, assuming that the
transaction had occurred on March 31, 1997.
March 31, 1997
--------------
Actual Proforma
------ --------
Current Assets $3,111,010 $5,463,312
---------- ----------
Total Assets 5,911,039 7,976,930
---------- ----------
Current Liabilities 826,150 846,149
---------- ----------
Total Liabilities 2,461,547 2,481,545
---------- ----------
Total Shareholders Equity 3,449,492 5,495,383
---------- ----------
Total Liabilities and Shareholders Equity $5,911,039 $7,976,930
---------- ----------
18
<PAGE>
The Company believes that existing cash and cash equivalent balances, short-term
investment balances and potential cash flow from operations will satisfy the
Company's working capital and capital expenditure requirements for at least the
next 12 months. However, any material acquisitions of complementary business,
products or technologies could require the Company to obtain additional sources
of financing.
At March 31, 1997, the Company had outstanding Series A Warrants to purchase
492,700 shares of Common Stock at $4.37 per share. These warrants expire March
31, 1998, subject to extension by the Company. Pursuant to the redemption
provision in the Warrant Agreement, the Company has the option of redeeming the
warrants on an "all or nothing basis," and, given favorable market conditions,
may do so. Exercise of these warrants would generate approximately $2,153,000 in
cash.
The Company intends to pursue acquisition candidates with products and
technologies that could enhance the Company's supply chain management product
offering. Any material acquisitions or joint ventures could result in a decrease
to the Company's working capital depending on the amount, timing and nature of
the consideration to be paid.
Future Operating Results
This report contains forward-looking statements. For this purpose, any statement
contained herein that are not statements of historical fact may be deemed to be
forward-looking statements. Without limiting the foregoing, the words
"believes", "anticipates", "plans". "expects", and similar expressions are
intended to identify forward-looking statements.
Numerous factors may affect the Company's business and its results of
operations. These factors include the potential for significant fluctuations in
quarterly results; the sale or entry into a distribution agreement for the
CD-ROM properties recently developed by the Company, the integration of CSTI
into the Company's infrastructure, the level and intensity of competition in the
supply chain management market; the Company's ability to continue to improve its
infrastructure to manage the substantial growth of the Company; the timing of
the release and market acceptance of new or enhanced versions of the Company's
software products; the expansion of the Company's operations; the complexity of
the Company's existing software products and new products expected to be
developed; and general economic and business conditions. For a discussion of
these and other factors that may affect the Company's future results, see
"Business" in Item 1 of this Form 10-KSB.
19
<PAGE>
ITEM 7. FINANCIAL STATEMENTS
Report of Independent Auditors
The Board of Directors and Shareholders
Capitol Multimedia, Inc.
We have audited the accompanying consolidated balance sheets of Capitol
Multimedia, Inc. as of March 31, 1997 and 1996, and the related consolidated
statements of operations, shareholders' equity, and cash flows for the years
then ended. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Capitol
Multimedia, Inc. at March 31, 1997 and 1996, and the consolidated results of its
operations and its cash flows for the years then ended in conformity with
generally accepted accounting principles.
ERNST & YOUNG LLP
Boston, Massachusetts
May 22, 1997
20
<PAGE>
Capitol Multimedia, Inc.
Consolidated Balance Sheets
<TABLE>
<CAPTION>
March 31
1997 1996
--------------------------------------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 760,065 $ 1,961,393
Short-term investments 997,036 2,362,975
Accounts receivable, less allowance for doubtful
accounts of $126,394 and $12,500 at
March 31, 1997 and 1996, respectively 1,027,307 503,306
Notes and guaranteed royalties receivable 250,000 500,000
Prepaid expenses and other current assets 76,602 174,441
--------------------------------------
Total current assets 3,111,010 5,502,115
Property and Equipment:
Technical equipment 1,133,279 1,070,337
Furniture and fixtures 235,003 44,163
Other 260,967 94,176
--------------------------------------
1,629,249 1,208,676
Less: accumulated depreciation (970,874) (841,861)
--------------------------------------
658,375 366,815
Notes and guaranteed royalties receivable 1,073,600 1,244,074
Goodwill 827,182
Other long term assets 240,872 32,481
--------------------------------------
Total assets $ 5,911,039 $ 7,145,485
======================================
See accompanying notes
</TABLE>
21
<PAGE>
Capitol Multimedia, Inc.
Consolidated Balance Sheets
<TABLE>
<CAPTION>
March 31
1997 1996
---------------------------------
<S> <C> <C>
Liabilities and shareholders' equity Current liabilities:
Accounts payable and accrued expenses $ 430,768 $ 173,019
Unearned revenue and other current liabilities 395,382 66,160
---------------------------------
Total current liabilities 826,150 239,179
Notes payable to related parties 1,552,069
Deferred rent 83,328 97,115
---------------------------------
Total Liabilities 2,461,547 336,294
Shareholders' equity:
Common stock, $.10 par value, 25,000,000 and
10,000,000 shares authorized, 6,857,153 and
5,657,153 shares issued and outstanding at
March 31, 1997 and 1996 respectively
685,715 565,715
Additional paid-in capital 16,747,202 15,817,202
Accumulated deficit (11,933,081) (7,523,382)
---------------------------------
5,499,836 8,859,535
Less Treasury stock, at cost, 825,088 shares at
March 31, 1997 and 1996 (2,050,344) (2,050,344)
---------------------------------
Total shareholders' equity 3,449,492 6,809,191
---------------------------------
Total liabilities and shareholders' equity $ 5,911,039 $ 7,145,485
=================================
See accompanying notes.
</TABLE>
22
<PAGE>
Capitol Multimedia, Inc.
Consolidated Statements of Operations
<TABLE>
<CAPTION>
Year ended March 31
1997 1996
--------------------------
<S> <C> <C>
Net Sales $ 1,925,913 $ 4,349,980
--------------------------
Operating expenses:
Research and development 2,181,457 2,368,511
General and administrative 1,523,682 1,513,106
Depreciation 200,633 334,598
In process research and development 2,200,000
Consolidation expenses 462,567
--------------------------
Total operating expenses 6,568,339 4,216,215
--------------------------
Operating income (loss) (4,642,426) 133,765
--------------------------
Other Income ( Expense):
Interest and other income, net 270,710 363,695
Gain (loss) on disposition of assets (37,983) 2,539,820
--------------------------
Income (loss) before taxes (4,409,699) 3,037,280
Provision for income taxes 60,744
--------------------------
Net income (loss) ($4,409,699) $ 2,976,536
==========================
Net income (loss) per share $ (.91) $ .58
==========================
Weighted average number of shares outstanding 4,835,353 5,235,483
==========================
</TABLE>
See accompanying notes.
23
<PAGE>
<TABLE>
<CAPTION>
Capitol Multimedia, Inc.
Consolidated Statements of Shareholders' Equity
Common Stock Additional
Par Paid-in Treasury Stock Accumulated
Shares Value Capital Shares Cost Deficit Total
------ ----- ------- ------ ---- ------- -----
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at March 31,
1995 5,636,537 $ 563,654 $ 15,760,921 $(10,499,918) $ 5,824,657
Issuance of common
stock pursuant
to exercise of
employee stock
options 20,616 2,061 56,281 58,342
Repurchase of
shares of common
stock (825,088 $(2,050,344) (2,050,344)
Net Income 2,976,536 2,976,536
-------------------------------------------------------------------------------------------------
Balance at March 31,
1996 5,657,153 565,715 15,817,202 (825,088) (2,050,344) (7,523,382) 6,809,191
Issuance of
restricted
common stock for
acquisition of
CSTI, Inc. 1,200,000 120,000 930,000 1,050,000
Net loss (4,409,699) (4,409,699)
-------------------------------------------------------------------------------------------------
Balance at March 31,
1997 6,857,153 $ 685,715 $ 16,747,202 (825,088) $(2,050,34 $(11,933,081) $ 3,449,492
=================================================================================================
See accompanying notes.
</TABLE>
24
<PAGE>
<TABLE>
<CAPTION>
Capitol Multimedia, Inc.
Consolidated Statements of Cash Flows
Year ended March 31
1997 1996
------------------------------------
<S> <C> <C>
Operating activities:
Net income (loss) $(4,409,699) $ 2,976,536
Adjustments to reconcile net income to net cash provided
(used) by operating activities:
Depreciation 200,633 334,598
Write-off of in-process technology from CSTI 2,200,000
(Gain) Loss on sale of assets 37,983 (2,539,820)
Changes in operating assets and liabilities:
Accounts receivable 44,171 425,762
Prepaid expenses and other current assets 122,720 (79,890)
Short-term guaranteed royalty receivable 500,000
Long-term notes, royalties, and other assets (87,917) (74,530)
Accounts payable and accrued expenses 184,971 (656,446)
Unearned revenue and deferred rent (59,191) (278,471)
------------------------------------
Net cash provided (used) by operating activities (1,266,329) 107,739
Investing activities:
Purchases of short-term investments (404,165) (3,793,569)
Proceeds from sales of short-term investments 1,770,104 3,210,004
Proceeds from sale of assets 1,951 500,000
Proceeds from note receivable 300,000
Purchase of CSTI, Inc. , net of cash acquired (1,095,562)
Capital expenditures (207,327) (106,663)
------------------------------------
Net cash (used in) provided by investing activities 65,001 109,772
Financing activities:
Proceeds from sale of common stock 58,342
------------------------------------
Net cash provided (used) by financing activities 58,342
------------------------------------
Net increase (decrease) in cash & cash equivalents (1,201,328) 275,853
Cash at beginning of year 1,961,393 1,685,540
------------------------------------
Cash at end of year $ 760,065 $ 1,961,393
====================================
</TABLE>
Non-cash financing activities:
The Company purchased all shares of Client Server Technologies, Inc. for
$3,853,060. This transaction was partially financed by the issuance of 1,200,000
shares of common stock and with seller notes payable totaling $1,552,069. See
the Acquisition footnote.
25
<PAGE>
1. ORGANIZATION AND BUSINESS
Capitol Multimedia, Inc. (the "Company"), a Delaware corporation organized in
1982, creates, produces, and licenses interactive software for the CD-ROM (PC
and Mac) platform.
On March 31,1997 the Company executed one of its strategic initiatives to
revitalize the Company through entry into the business software market by
acquiring Client Server Technologies, Inc.(CSTI). CSTI's "Continuum" product set
provides software solutions and integration services for logistics, planning,
distribution and financial functions. CSTI has over 75 customers in the U.S. and
over 30 customers in Europe in the middle market of manufacturing, distribution,
and retail businesses. CSTI employs approximately 40 people with offices in
Dedham, Massachusetts; Denver, Colorado; and Los Angeles, California. Please see
Footnote 5 " Acquisition of Client Server Technologies, Inc." for more detailed
information on the acquisition.
The environment of rapid technological change and intense competition which is
characteristic of the software development industry results in frequent new
products and evolving industry standards. The Company's continued success
depends upon its ability to enhance current products and develop new products on
a timely basis which keeps pace with the changes in technology and competitors'
innovations.
On April 16, 1997, the Company sold selected multimedia assets to Davidson &
Associates, Inc. (Davidson), a division of CUC International, Inc. The assets
that were sold include art, animation and audio production capabilities located
in St. Petersburg, Russia, and Concord, Mass. Please see Footnote 15 "Subsequent
Event." for more detailed information.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and
its wholly owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated.
Cash and Cash Equivalents
For purposes of the statements of cash flows, cash and cash equivalents consist
of cash in banks and investments in highly liquid, short-term instruments with
original maturities of 90 days or less. Cash equivalents consist principally of
overnight repurchase agreements.
The Company believes that existing cash and cash equivalent balances, short term
investment balances, and potential cash flow from operations, as a result of the
acquisition as described in footnote 5 and the disposition as described in
footnote 15, will satisfy the Company's working capital and capital expenditure
requirements for at least the next 12 months.
Short-Term Investments
The Company accounts for its short-term investments under Statement of Financial
Accounting Standards (SFAS) No. 115, " Accounting for Certain Investments in
Debt and Equity Securities." The Company has classified all marketable
investment securities as available-for-sale. Available-for-sale securities are
carried at fair market value with unrealized gains and losses reported as a
separate component of shareholders' equity. Any realized gains or losses and
declines in value judged to be other than temporary are included in other income
(expense). The difference between cost and fair value was immaterial at
26
<PAGE>
March 31, 1997 and 1996, and no adjustments have been made to the historical
carrying value of the investments and no unrealized gains or losses have been
recorded as a separate component of stockholders' equity. At March 31, 1997,
marketable investment securities consisted of corporate bonds and U.S.
Government backed notes, maturing at various dates, and in varying amounts,
between 1997 and 2000. These securities are recorded at cost which approximates
fair market value.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to credit risk
consist primarily of accounts receivable. The risk is minimized by the
creditworthiness of the Company's customers, and the Company's credit and
collection policies. The Company performs ongoing credit evaluations of its
customers, generally does not require collateral, and maintains allowances for
potential credit losses which, when realized, have been within the range of
management's expectations. As of March 31, 1997, approximately 73% of accounts
receivable were concentrated with five customers.
Long-Lived Assets
The Company has adopted Statement of Financial Accounting standards No. 121,
"Accounting for the impairment of long-lived assets and for long-lived assets to
be disposed of" which establishes criteria for the recognition of an impairment
loss related to long-lived assets. The Company periodically assesses the
recoverability of long-lived assets, including property and equipment and
intangibles, when there are indications of potential impairment based on
estimates of undiscounted future cash flows. The amount of impairment is
calculated by comparing anticipated discounted future cash flows with the
carrying value of the related asset. This has not had a material effect on the
Company.
Property and Equipment
Property and equipment are recorded at cost and depreciated on a straight line
basis over estimated useful lives. Repair and maintenance expenditures are
charged to operations as incurred. Estimated useful lives are as follows:
Furniture and fixtures 5 years
Computers and equipment 3- 5 years
Purchased Software 3 years
Leasehold improvements 3-10 years
Capitalized Software Costs
The Company accounts for software development costs in accordance with Statement
of Financial Accounting Standards No. 86, "Accounting for Software Development
Costs" (SFAS No. 86). Under SFAS No. 86, software development costs incurred
until technological feasibility is established are expensed as research and
development. Software development costs incurred after technological feasibility
is established are capitalized and amortized over the products' useful life
commencing with general release. Amortization is provided using the
straight-line method over the useful life which generally is five years or less.
All capitalized software is amortized on a product-by-product basis using the
ratio that current gross revenues bear to the total of current and anticipated
future gross revenues with minimum amortization based on a straight-line method
over the product's useful life. The establishment of technological feasibility
and the ongoing assessment of recoverability of capitalized software costs
requires considerable judgment by management with respect to
27
<PAGE>
numerous external factors, including, but not limited to, anticipated future
gross revenues, competition, estimated economic lives and changes in software
and hardware technologies. Provisions for declines in the net realizable value
of capitalized software costs are made in the period in which they first become
determinable (See Footnote 3).
Goodwill
Goodwill represents the excess purchase price paid over the net assets acquired
in the purchase of CSTI on March 31, 1997. ( See footnote 5) Goodwill will be
amortized on a straight line basis over a 12 year period, which is management's
estimate of the useful life.
Revenue Recognition
Revenue derived from the sale of software and hardware products and software
licensing arrangements is recognized in accordance with Statement of Position
91-1 "Software Revenue Recognition" issued by the American Institute of
Certified Public Accountants. Revenue from the sale of hardware and software
products related to the multimedia business, net of allowances for returns, is
recognized upon shipment. Licensing fees and royalties pursuant to licensing
arrangements are recognized when the Company fulfills all its obligations in
accordance with such agreements. Unearned revenue represents payments received
in advance of the performance of software related services
Revenues related to the multimedia business's software development services are
recorded as services are rendered and costs incurred. The Company accounts for
long-term contracts under the percentage of-completion method and records
revenues as work on contracts progresses. Provisions for anticipated losses are
made in the period in which they first become determinable. Under software
development arrangements, the Company may retain a residual royalty interest for
product sales and/or ownership of software or other assets for the Company's
future use.
The Company generally warrants that its products will function substantially in
accordance with documentation provided to customers for approximately six months
following initial installation. As of March 31, 1997, the company had not
incurred any significant expenses related to warranty claims.
Stock-Based Compensation
In October 1995, the Financial Accounting Standards Board issued Statement No.
123 (FAS No. 123), "Accounting for Stock-Based Compensation" which is effective
for fiscal years beginning after December 15, 1995. FAS No. 123 permits a
company to choose either a new fair value-based method or the current Accounting
Principles Board Opinion No. 25 ( APB 25) intrinsic value-based method of
accounting for its stock-based compensation arrangements. The Company has
elected to continue to account for its stock-based compensation plans utilizing
the provisions of APB 25. FAS No. 123 requires disclosure of pro forma
information regarding net income and net income per share based on fair value
accounting for stock-based compensation plans. This disclosure is presented in
Footnote 9.
Income Taxes
The Company accounts for income taxes under the liability method.
28
<PAGE>
Net Income (Loss) Per Share
Primary net income (loss) per share is based on the weighted average number of
common shares and dilutive common stock equivalents outstanding during the
period. Common share equivalents consist of options and warrants to purchase
common stock using the treasury stock method. Common share equivalents have been
excluded from the computation of net loss per share for the period ended March
31, 1997 as their effect is anti-dilutive.
Use of Estimates
The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities at the
date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Significant areas in which estimates are
used include revenue recognition, useful lives of furniture and equipment and
certain accrued expenses. Actual results could differ from those estimates.
Reclassification
Certain amounts in the 1996 financial statements have been reclassified to
conform to the 1997 presentation.
Geographic Area of Operations
At March 31, 1997, approximately 65% of the Company's labor force was employed
by Company's subsidiary in St. Petersburg, Russia. The Russian labor force was
transferred to Davidson as part of the sale of select multimedia assets as more
fully explained in Footnote 15. This transaction will significantly reduce the
Company's presence in Russia. Economic conditions in Russia, including lower
wage rates and lower standards of living, allow the Company to transact business
in St. Petersburg at a relatively low cost structure. Changes in the political,
social, or economic stability , or significant changes in the exchange rate of
the Russian Ruble could have an affect on the Company's operations.
Foreign Currency Transactions
As the functional currency of the Company's foreign subsidiary is the United
States dollar, the Company does not record foreign currency translation
adjustments. Foreign currency transaction gains and losses are a result of the
effect of exchange rate changes on transactions denominated in currencies other
than the functional currency and are generally included in determining net
income (loss) for the period in which the exchange rate changes. Such amounts
were not material for fiscal years 1997 or 1996.
3. CAPITALIZED SOFTWARE COSTS
The Company recognizes that the increase in the number of emerging formats and
new titles in the entertainment software industry has significantly reduced the
predictability of market acceptance and shelf life for products and therefore,
has not capitalized any software development costs since April 1, 1995. There
were no operations of CSTI included in the financial statements as this
transaction occurred on the last day of the year. As part of the purchase
accounting $200,000 has been recorded as developed software and is being
amortized over five years.
29
<PAGE>
4. SALE OF ASSETS
Professional CD-i Assets
On August 11, 1995, the Company entered into an Asset Purchase Agreement ("the
Agreement") with Philips Media, Inc. ("Philips") to sell certain assets used by
its professional CD-i operations. The terms of the sale provided for the return
of all of Philips' 825,088 shares of Capitol Multimedia, Inc. Common Stock, a
$500,000 cash payment at closing, and the payment of certain royalties to the
Company for a four year period, including minimum royalty guarantees of $500,000
in November 1996 and $250,000 in November 1997. Under the Agreement, total
royalty payments are not to exceed $2,000,000. In connection with the sale, the
Company recognized a gain of approximately $2,500,000. The non-cash portions of
this transaction have been excluded from the statements of cash flows. Pro forma
unaudited statements of operations, assuming the sale of assets was consummated
on April 1, 1995, are presented below.
Year ended
March 31, 1996
---------------
Net sales $ 3,968,235
Operating expenses:
Research and development 2,030,802
Depreciation 131,871
General and administrative 1,393,951
---------------
Total operating expenses 3,556,624
Operating income 411,611
Other income:
Interest and other income, net 293,923
Gain on sale of assets --
---------------
Income before income taxes 705,534
---------------
Provision for income taxes 15,762
Net income $ 689,772
===============
Net income per share $ .14
===============
Weighted average number of shares outstanding 4,821,919
===============
Video Post-Production Assets
In connection with its June 1993 sale of video post-production assets, the
Company holds a secured note for $800,000, interest accruing at 8.0% and
compounding annually, principal plus accrued interest due on July 31, 1998 with
an option to convert the note into stock of the purchaser at any time after the
purchaser, in its sole discretion, reorganizes as contemplated from an S
Corporation to a C Corporation. The interest rate on the note may be adjusted
from time to time over the term of the obligation as interest is charged at a
rate equal to the interest rate set by the purchaser's bank in its loan for the
purchase of the assets. Under the terms of the asset sale agreement, the Company
agreed not to compete with the purchaser in the video post-production business
for a five year period commencing June 1993.
30
<PAGE>
5. ACQUISITION OF CLIENT SERVER TECHNOLOGIES, INC.
On March 31, 1997, the Company acquired all of the outstanding stock of CSTI for
$3,853,060. The purchase price is composed of 1,200,000 unregistered shares of
the Company's common stock discounted to a value of $1,050,000, issuance of
non-interest bearing convertible long-term notes totaling $1,945,000 to sellers
and discounted to a value of $1,552,069, and cash payments totaling $1,250,991.
Debt holders have the right to convert interest and principal owed under the
notes into shares of common stock at a $3.00 per share conversion price. The
transaction was accounted for under the purchase method of business
combinations. CSTI had no operations between the acquisition date and the year
ended March 31, 1997. As a result of the acquisition, $827,182 of goodwill was
recorded which will be amortized on a straight line basis over 12 years, and
$2,200,000 of "In-Process Technology" which was written off at March 31, 1997.
Supplemental pro forma results of operations, assuming the acquisition was
consummated prior to April 1, 1995, are presented below.
Year Ended March 31
1997 1996
-------------------------------
Net Sales $ 5,578,504 $ 8,368,456
===============================
Net income (loss) $(2,095,376) $ 3,344,480
===============================
Net income (loss) per share $ (.35) $ .52
===============================
6. FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair value of the company's financial instruments are as follows:
<TABLE>
<CAPTION>
March 31, 1997 March 31, 1996
-------------- --------------
Carrying Fair Carrying Fair
Amount Value Amount Value
--------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Assets:
Cash and Cash equivalents $ 760,065 $ 760,065 $1,961,393 $1,961,393
Short-term investments 997,036 997,036 2,362,975 2,362,975
Notes and guaranteed
royalties receivable 250,000 250,000 500,000 500,000
Long-term notes and
guaranteed royalties
receivables 1,073,600 1,073,600 1,244,074 1,244,074
Liabilities:
Notes payable to related
parties 1,552,069 1,552,069
</TABLE>
Fair values were determined as follows:
The carrying amounts of cash and cash equivalents and short-term notes and
guaranteed royalties receivable approximates fair value because of the
short-term maturity of these instruments.
31
<PAGE>
Short-term investments approximate fair value because of the short-term maturity
of these investments. These securities have been recorded at cost which
approximates fair market value.
Long-term notes receivable are estimated by discounting future cash flow using
the current rates at which similar loans would be made to borrowers with similar
credit ratings. This estimated fair value approximates the historical carrying
value of the receivable.
Long-term notes payable to related parties are estimated by discounting the
future cash flow by the estimated current rates offered to the Company for debt
of the same maturities. This was done at March 31, 1997 in connection with the
debt recognition as of the same date, thus the book value approximates the fair
value of the payable.
7. LONG-TERM DEBT:
Long-term debt consist of the following:
Year Ended
March 31, 1997
-----------------
Convertible unsecured non-interest bearing notes
payable to various employee stockholders, with
payments totaling $376,185 due 12/31/98 $ 320,157
Convertible secured non-interest bearing note payable to
Officer, with a $568,815 payment due 12/31/98 and 12
quarterly payments of $83,333 each beginning
April 1, 1998. 1,231,912
-----------------
Total long-term debt $1,552,069
=================
Notes are convertible into common shares at $3.00 per share( conversion price)
by debt holders with respect to the portion due on the notes on December 31,
1998 and on the last business day of the quarter in relation to which a
principal payment is due.
The $1,231,912 convertible note is secured by a continuing security interest in
and all right , title, and interest of CSTI or the Company in collateral,
provided that CSTI held such right , title, and interest to the collateral as of
the closing on March 31, 1997.
Both of the above long-term notes have been discounted from there face value
using an assumed interest rate of 10%.
32
<PAGE>
8. NET INCOME (LOSS) PER SHARE
The following table presents the components of the shares used to compute
weighted average number of shares outstanding for the net income (loss) per
share calculation.
Year Ended March 31
1997 1996
------------------------
Weighted average number of shares outstanding
during the year 4,835,353 5,120,117
Incremental shares issuable pursuant to
outstanding options and warrants 115,366
------------------------
Weighted average number of shares used in the
computation of net income (loss) per share 4,835,353 5,235,483
========================
In computing net income per share using the treasury stock method, net income
has been increased by $74,500 in interest income for the year ended March 31,
1996. Fully diluted and primary net income per share for the year ended March
31, 1996 were not materially different.
9. CAPITAL STOCK
Warrants
At March 31, 1997, the Company had outstanding warrants to purchase 572,700
shares of its common stock, as follows:
In April 1992, the Company issued Series A Warrants to purchase 492,700 shares
(344,500 warrants, each of which entitles the holder to purchase 1.43 shares of
Common Stock) at an exercise price of $4.37 per share through March 31, 1997.
The number of shares and exercise price above are recalculations based on
anti-dilutive provisions in the Warrants. These Warrants have been extended
through March 31, 1998.
In April 1993, in connection with the Regulation S offering, the Company issued
a warrant to purchase 80,000 shares of common stock to the placement agent at a
price of $8.25 per share, exercisable for a four year period commencing April 9,
1994.
Stock Options
At March 31, 1997, the Company had outstanding options to purchase 1,514,661
shares of its Common Stock as follows:
Grants Pursuant to Employment Arrangements
During 1995, the Company granted options to purchase 330,000 shares of common
stock, with a $3.898 weighted average exercise price per share, pursuant to
various employment arrangements. At September 13, 1996 options to purchase
230,000 shares were canceled. At March 31, 1997, options to purchase 100,000
shares of common stock at $3.75 per share were outstanding with expiration dates
of March 31, 2006. 10,000 shares were exercisable at the $3.75 exercise price
per share at March 31, 1997.
33
<PAGE>
Non-Qualified Employee Stock Option Plan
In 1993, the Company adopted the Amended and Restated 1991 Non-Qualified Capitol
Multimedia, Inc. Employee Stock Option Plan (the Employee Plan). The Employee
Plan permits the Company to grant options for 1,500,000 shares of common stock
to its employees and consultants. Options are granted at the fair market value
of the Company's common stock on the date of grant.
The following table sets forth employee stock options granted, exercised,
canceled, and outstanding under the Employee Plan:
Outstanding Options
-------------------
Number of Options Weighted Average
Exercise Price
----------------------------------------
Balance at March 31, 1995 343,018 $6.393
Granted 334,761 $4.578
Exercised (20,616) $2.830
Canceled (240,402) $6.726
----------------------------------------
Balance at March 31, 1996 416,761 $4.913
Granted 1,091,476 $2.177
Canceled 313,576 $4.439
----------------------------------------
Balance at March 31, 1997 1,194,661 $2.537
========================================
At March 31, 1997, 474,161 options outstanding under the Employee Plan were
exercisable. There were 176,053 and 69,954 option shares available for grant
under the Employee Plan at March 31, 1997 and 1996, respectively.
Non-Qualified Stock Option Plan for Non-Employee Directors
In 1995, the Company adopted the Amended and Restated 1992 Non-Qualified Stock
Option Plan for Non-Employee Directors (the Director Plan). The Director Plan
permits the Company to grant options to purchase 300,000 shares of common stock
to its non-employee directors. Grants of options to purchase 15,000 shares of
common stock at fair market value are automatic upon a director's election to
the Board and on the date of each subsequent annual meeting during a director's
tenure. Each option granted under the Director Plan is exercisable for five
years from the date of grant. The following table sets forth non-employee
director stock options granted, exercised, canceled, and outstanding under the
Director Plan:
Outstanding Options
-------------------
Number of Options Weighted Average
ExercisePrice
--------------------------------------
Balance at March 31,1995 275,000 $10.194
Granted 175,000 $ 3.916
Canceled (290,000) $10.194
--------------------------------------
Balance at March 31,1996 160,000 $ 3.916
Granted 60,000 $ 2.920
--------------------------------------
Balance at March 31,1997 220,000 $ 3.916
======================================
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<PAGE>
Non-Qualified Stock Option Plan for Non-Employee Directors
At March 31, 1997, 160,000 options outstanding under the Director Plan were
exercisable. There were 80,000 and 140,000 option shares available for grant
under the Director Plan at March 31, 1997 and 1996, respectively.
The Financial Accounting Standards Board Statement No. 123 (FAS No. 123),
"Accounting for Stock-Based Compensation" requires disclosure of pro forma
information regarding net income and net income per share based on fair value
accounting for stock-based compensation plans. The following table presents
weighted average price and life information about significant option groups
outstanding at March 31, 1997:
<TABLE>
<CAPTION>
Shares outstanding Options Exercisable
------------------ -------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Range of Exercise Number Contractual Exercise Number Exercise
Prices Outstanding Life (years) Price Exercisable Price
- ------------------- ----------- ------------ -------- ----------- ---------
<S> <C> <C> <C> <C> <C>
$.83 to $ 1.46 655,000 6.30 .910 79,000 .952
$2.92 to $3.9625 713,661 5.33 3.820 540,161 3.929
$4.66 to $6.375 146,000 4.60 6.052 25,000 6.375
- -----------------------------------------------------------------------------------------------------------
$.83 to $6.375 1,514,661 5.68 2.778 644,161 3.656
</TABLE>
Pursuant to the requirements of FAS 123, the following are the pro forma net
income and net income per share for March 31, 1997 and 1996, as if the
compensation expense for the option plans had been determined based on the fair
value at the grant date for grants in the years then ended:
<TABLE>
<CAPTION>
March 31, 1997 March 31, 1996
-------------- --------------
As Reported Pro Forma As Reported Pro Forma
<S> <C> <C> <C> <C>
Net income (loss) (4,409,699) (4,795,905) 2,976,536 2,263,623
Net income (loss) per share $ (.91) $ (.99) $ .58 $ .43
</TABLE>
The fair value of options at the date of grant were estimated using the
Black-Scholes model with the following weighted average assumptions:
Option
------------------------
1997 1996
---- ----
Volatility .768 .768
Expected option life (years) 4 yrs. 4 yrs.
Interest rate ( risk free) 6.20% 6.20%
Volatility was calculated on a monthly basis. The company has never declared nor
paid dividends on any of its capital stock and does not expect to do so in the
foreseeable future. The effects on 1997 and 1996 pro forma net income and net
income per share of expensing the estimated fair value of stock options and
shares are not necessarily representative of the effects on reporting the
results of operations for future years as the periods presented include only one
and two years of option grants under the Company's plans.
35
<PAGE>
10. SIGNIFICANT CUSTOMERS
During 1997, the Company had sales of approximately $673,000 and $491,000 to two
customers which represented 35% and 25% of net sales respectively. During, 1996,
the Company had sales of approximately $1,866,000 and $594,000 to two customers
which represented 43% and 14% of net sales respectively.
11. CONSOLIDATION CHARGES
During the year ended March 31, 1997, the Company recognized $462,567 in
one-time consolidation charges consisting of severance benefits and fees
relating to subleasing its facilities in Maryland. At March 31, 1997
approximately $84,000 remained in unearned revenue and other current liabilities
for anticipated payments relating to subleasing its facility in Maryland.
12. INCOME TAXES
The provision for income taxes includes a federal alternative minimum tax
("AMT") resulting from restrictions on the use of net operating loss
carryforwards for AMT purposes. Significant components of deferred tax assets as
of March 31 are as follows:
1997 1996
----------------------------
Deferred tax assets
Net operating loss carryforwards $ 3,584,000 $ 3,128,000
Depreciable and amortizable assets 868,000
Unearned revenue 3,000 11,000
Allowance for doubtful accounts 51,000 5,000
Alternative minimum tax credit carryfoward 43,000 52,000
Investment tax credit carryforwards 281,000 281,000
Accrued Expenses 58,000 31,000
----------------------------
Total Deferred Assets 4,888,000 3,508,000
Valuation allowance for deferred tax assets (4,765,000) (3,508,000)
----------------------------
Deferred Tax Liability 123,000 0
----------------------------
Deferred Income (110,000)
Prepaid Expense (13,000)
Total Deferred Liability (123,000)
----------------------------
Total Deferred Assets $ 0 $ 0
============================
At March 31, 1997 and 1996, the Company had Federal tax net operating loss
carryforwards of $10,542,000 and $8,427,078 respectively. The valuation
allowance for deferred tax assets decreased by $1,257,000 from 1996 to 1997. Tax
net operating loss and investment tax credit carryforwards expire in varying
amounts beginning in 1998 through 2012. Tax net operating loss and tax credit
carryforwards are subject to limitation in the event of certain corporate
ownership changes under Internal Revenue Code Sections 382 and 383.
13. COMMITMENTS
Lease Commitments
The Company leases facilities under a non-cancelable operating lease expiring in
fiscal 2004 with an option to renew for an additional five year term. Total rent
expense for operating leases amounted to $ 343,448 and $263,400 for the years
ended March 31, 1997 and 1996,
36
<PAGE>
respectively. At March 31, 1997, minimum annual commitments under non-cancelable
operating leases are as follows:
Fiscal year ending March 31:
----------------------------
1998 436,597
1999 427,972
2000 326,246
2001 209,186
2002 211,714
Thereafter 431,147
----------
Total $2,042,862
==========
14. EMPLOYEE RETIREMENT PLAN
On July 1, 1989, the Company adopted a 401K retirement plan ( the Retirement
Plan) that covers substantially all of the Company's employees. Each eligible
employee may contribute up to 15% of their compensation, subject to certain
limitations, to the retirement plan. The Company makes a matching contribution
of 50% on the first 6% of the participant's elective deferral. Company
contributions totaled $23,812 and $13,513 during the years ended March 31, 1997
and 1996 respectively.
15. SUBSEQUENT EVENTS
On April 16, 1997, the Company sold selected multimedia assets to Davidson for
approximately $2,500,000 in cash. The assets that were sold include machinery
and capital equipment utilized in art, animation and audio production in St.
Petersburg, Russia, and Concord, Mass. The net asset value of assets transferred
was $257,835. As part of the transaction, the Company amended its software
development contract with Blizzard Entertainment (the Company was paid all
related receivables from the contract) , entered into a work-for-hire agreement
with Davidson related to software engineering services, and assigned and
transferred its present Concord, Massachusetts Office lease to Davdison. This
office lease represents a future lease commitment of $260,129. The Gain on Sale
resulting from this transaction is approximately $2,000,000.
On April 24,1997, the Company entered into an agreement to sublet its former
office in Bethesda Maryland. This sublease agreement runs through the end of the
Company's Lease and requires monthly minimum lease payments to Capitol totaling
$1,503,309.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
Not applicable.
PART III
ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS
The information required by this item is incorporated by reference to the
information contained in the "Election of Directors" and "Executive Officers"
sections of the Company's Proxy Statement for its 1997 Annual Meeting of
Shareholders.
37
<PAGE>
ITEM 10. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference to the
information contained in the "Executive Compensation" section of the Company's
Proxy Statement for its 1997 Annual Meeting of Shareholders.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICAL OWNERS AND
MANAGEMENT
The information required by this item is incorporated by reference to the
information contained in the "Security Ownership of Certain Beneficial Owners"
and "Security Ownership of Management" sections of the Company's Proxy Statement
for its 1997 Annual Meeting of Shareholders.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference to the
information contained in the "Transactions with Beneficial Owners, Directors,
and Executive Officers" section of the Company's Proxy Statement for its 1997
Annual Meeting of Shareholders.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
EXHIBITS:
A list of the exhibits included as part of this report is set forth in the
Exhibit index which immediately precedes such exhibits and which is incorporated
herein by reference.
REPORTS ON FORM 8-K
On October 4, 1996, the Company filed a Form 8-K disclosing plans for
consolidation and management changes. On November 12, 1996, the Company filed a
Form 8-K disclosing its fiscal second quarter results described in a press
release and summary financial statements. On November 14, 1996, the Company
filed a Form 8K/A amending its previous filed Form 8K dated November 12, 1997.
On November 14, 1996, the Company filed a Form 8-K disclosing several employment
and severance agreements with the Company management, as well as amendments to
the Company's Certificate of Incorporation, the Non-Qualified Employee Stock
Option Plan and the Non-Qualified, Non-Employee Director Stock Option Plan. On
December 13, 1996, the Company filed a Form 8-K disclosing employment agreements
and amendments to employment agreements with the Company management. On April
11, 1997, the Company filed a Form 8-K disclosing the acquisition of Client
Server Technologies, Inc. On April 24, 1997, the Company filed a Form 8-K
disclosing the sale of selected multimedia assets to Davidson & Associates, Inc.
38
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
organized.
CAPITOL MULTIMEDIA, INC.
BY: /s/ Luda Kopeikina
-------------------------
Luda Kopeikina, President
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below
thereby constitutes and appoints Luda Kopeikina and Edward Terino and each of
them, his or her true and lawful attorney-in-fact and agent with full power of
substitution and resubstitution, for him or her and in his or her name, place
and stead, in any and all capacities to sign any and all amendments or
supplements to this Form 10-KSB, and to file the same, with all exhibits thereto
and other documents in connection therewith, with the Securities and Exchange
Commission, granting unto said attorney-in-fact and agent full power and
authority to do and perform each and every act and thing necessary or
appropriate to be done in and about the foregoing, as fully to all intents and
purposes as he or she might or could do in person, lawfully do, or cause to be
done by virtue hereof.
In accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.
NAME TITLE & DATE
/s/ Luda Kopeikina President
- ------------------ June 20, 1997
Luda Kopeikina
/s/ Edward Terino Chief Financial Officer
- ------------------ June 20, 1997
Edward Terino
/s/ James P. Dore Controller
- ------------------ June 20, 1997
James P. Dore
/s/ Robert I. Bogin Director
- ------------------ June 23, 1997
Robert I. Bogin
/s/ Craig Cox Director
- ------------------ June 20, 1997
Craig Cox
/s/ Bernard M. Frank Director
- ------------------ June 20, 1997
Bernard M. Frank
/s/ Nico Letschert Director
- ------------------ June 20, 1997
Nico Letschert
/s/ Igor R. Razboff Director
- ------------------ June 20, 1997
Igor R. Razboff
/s/ Philip R. Redmond Director
- ------------------ June 23, 1997
Philip R. Redmond
39
<PAGE>
Exhibit
Number Exhibit Name
2.1 Agreement for the Acquisition of the Outstanding Stock of
Animation Magic, Inc. Management Shareholders, dated December 15,
1994 (incorporated by reference herein to the exhibit filed with
the Company's Form 8-K, dated February 13, 1995).
2.2 Agreement for the Acquisition of the Outstanding Stock of
Animation Magic, Inc. Minority Shareholders, dated December 15,
1994 (incorporated by reference herein to the exhibit filed with
the Company's Form 8-K, dated February 13, 1995).
2.3 Asset Purchase Agreement By and Between Capitol Multimedia, Inc.
(as "Seller") and Philips Media, Inc. (as "Purchaser") dated
August 11, 1995 (incorporated by reference herein to the exhibit
filed with the Company's Form 8-K, dated August 11, 1995).
2.4 Capitol Multimedia, Inc. - CSTI Promissory Notes dated March 31,
1997 (incorporated by reference herein to the exhibits filed with
the Company's Form 8-K, dated April 11, 1997).
2.5 Agreement for the Acquisition of the Outstanding Stock of CSTI by
and between the Company and the Selling Shareholders of CSTI
dated March 31, 1997 (incorporated by reference herein to the
exhibits filed with the Company's Form 8-K dated, April 11,
1997).
2.6 Asset and Stock Purchase Agreement between Davidson & Associates,
Inc. and Capitol Multimedia, Inc. (incorporated herein to the
exhibit filed with the Company's Form 8-K, dated April 24, 1997).
3.1 Certificate of Incorporation, as amended (incorporated by
reference herein to the exhibit filed with the Company's Form
10-QSB, dated September 30, 1996).
3.2 Bylaws of the Company (incorporated by reference herein to the
exhibit filed with the Company's Form S-18 (or a Post-Effective
Amendment thereto, Registration No. 33-45725-A).
4.1 Specimen of Stock Certificate-Common stock (incorporated by
reference herein to the exhibit filed with the Company's Form
S-18 (or a Post-Effective Amendment thereto, Registration No.
33-45725-A).
4.2 Specimen of Series A Warrant (incorporated by reference herein to
the exhibit filed with the Company's Form S-18 (or a
Post-Effective Amendment thereto, Registration No. 33-45725-A).
4.4 Form of Warrant Agreement with Warrant Agent (incorporated by
reference herein to the exhibit filed with the Company's Form
S-18 (or a Post-Effective Amendment thereto, Registration No.
33-45725-A).
40
<PAGE>
Exhibit
Number Exhibit Name
4.5 Amended and Restated 1991 Non-Qualified Capitol Multimedia, Inc.
Employee Stock Option Plan (incorporated by reference herein to
the exhibit filed with the Company's Form 10-QSB, dated September
30, 1996).
4.6 Amended and Restated 1992 Non-Qualified Stock Option Plan for
Non- Employee Directors (incorporated by reference herein to the
exhibit filed with the Company's Form 10-QSB, dated September 30,
1996).
4.7 First Amendment to the Warrant Agreement Between Capitol
Multimedia, Inc. and North American Transfer Co. (incorporated by
reference herein to the exhibit filed with the Company's Form
8-K, dated February 26, 1996).
4.8 First Amendment to the Registration Rights Agreement Dated
February 13, 1995 (incorporated by reference herein to the
exhibit filed with the Company's Form 8-K, dated February 26,
1996).
9.1 Voting Trust Agreement-Noble Investment Co. of Palm Beach
(incorporated by reference herein to the exhibit filed with the
Company's Form S-18 (or a Post-Effective Amendment thereto,
Registration No. 33-45725-A).
10.31 Placement Agreement with Noble Investment Co. of Palm Beach,
March 31, 1993 (incorporated by reference herein to the exhibit
filed with the Company's Form 8-K, dated April 8, 1993).
10.32 Placement Agent Warrant to Purchase Shares of Capitol Multimedia,
Inc., April 8, 1993 (incorporated by reference herein to the
exhibit filed with the Company's Form 8-K, dated April 8, 1993).
10.33 Asset Purchase Agreement By And Between Henninger Video, Inc. and
Capitol Multimedia, Inc., June 22, 1993--excluding exhibits and
schedules (incorporated by reference herein to the exhibit filed
with the Company's Form 8-K, dated June 30, 1993).
10.44 Employment Agreement between Capitol Multimedia, Inc. and Igor
Razboff (incorporated by reference herein to Exhibit 2.1 filed
with the Company's Form 8-K, dated February 13, 1995).
41
<PAGE>
Exhibit
Number Exhibit Name
10.45 Employment Agreement between Capitol Multimedia, Inc. and Dale
DeSharone (incorporated by reference herein to Exhibit 2.1 filed
with the Company's Form 8-K, dated February 13, 1995).
10.46 Employment Agreement between Capitol Multimedia, Inc. and Luda
Kopeikina (incorporated by reference herein to the exhibits filed
with the Company's Form 8-K, dated November 14, 1996).
10.47 Severance Agreement between Capitol Multimedia, Inc. and Robert
I. Bogin, dated October 28, 1996 (incorporated by reference
herein to the exhibits filed with the Company's Form 8-K, dated
November 14, 1996). 10.48 Severance Agreement between Capitol
Multimedia, Inc. and Catherine K. Hoopes, dated October 28, 1996
(incorporated by reference herein to the exhibits filed with the
Company's Form 8-K, dated November 14, 1996).
10.49 First Amendment to Employment Agreement between Capitol
Multimedia, Inc. and Igor Razboff, dated December 12, 1996
(incorporated by reference herein to the exhibits filed with the
Company's Form 8-K, dated December 13, 1996).
10.50 Employment Agreement between Capitol Multimedia, Inc. and Edward
Terino, dated November 30, 1996 (incorporated by reference herein
to the exhibits filed with the Company's Form 8-K, dated December
13, 1996).
10.51 Employment Agreement between Capitol Multimedia, Inc. and Paul
Carr, dated March 31, 1997 (incorporated by reference herein to
Exhibit 2.5 filed with the Company's Form 8-K, dated April 11,
1997).
21.1 List of Capitol Multimedia, Inc. Subsidiaries.
23.1 Consent of Independent Auditors.
24.1 Powers of Attorney (contained on signature page hereof).
27.1 Financial Data Schedule.
99.1 Form of Indemnification Agreement as signed by directors and
officers of the Company (incorporated by reference herein to the
exhibit filed with the Company's Form 10-QSB, dated June 30,
1993).
42
Exhibit 21.1
Capitol Multimedia, Inc.
List of Subsidiaries
Name of Subsidiary State or Jurisdiction of Incorporation
- ------------------ --------------------------------------
Animation Magic, Inc. Delaware
AOZT "AMI" St. Petersburg, Russia
Client Server Technologies, Inc. Massachusetts
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration F Statement
Form S-8 pertaining to the 1991 Non-Qualified Employee Stock Option Plan and the
1992 Non-Qualified, Non Employee Director Stock Option Plan of Capitol
Multimedia, Inc. of our report dated May 22, 1997, with respect to the
consolidated financial statements of Capitol Multimedia, Inc. included in the
Annual Report (Form 10-KSB) for the year ended March 31, 1997.
ERNST& YOUNG LLP
Boston, Massachusetts
June 13, 1997
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