<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1996
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission file number: 0-21510
Sanctuary Woods Multimedia Corporation
(Exact name of registrant as specified in its charter)
British Columbia, Canada 75-2444-109
State or other jurisdiction of (I.R.S. Employer
incorporation or organization Identification No.)
1825 South Grant Street
San Mateo, California 94402
(Address of principal executive offices) (Zip Code)
(415) 286-6000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No[ ]
The number of Common Shares of the registrant outstanding as of November 11,
1996 was 23,241,164.*
Except where the context otherwise requires, as used herein, the term "Company"
means Sanctuary Woods Multimedia Corporation and its subsidiaries.
- ------------------
Does not include 4,000,000 voting Performance Shares which are held in escrow
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<TABLE>
<S> <C>
PART I - Financial Information
ITEM 1 - Condensed Consolidated Financial Statements (unaudited)
Condensed consolidated balance sheets -
September 30, 1996 and March 31, 1996 3
Condensed consolidated statements of operations -
three months ended September 30, 1996 and 1995 4
Condensed consolidated statements of operations -
six months ended September 30, 1996 and 1995 5
Condensed consolidated statements of cash flows -
six months ended September 30, 1996 and 1995 6
Notes to condensed consolidated financial statements 7
ITEM 2 - Management's Discussion and Analysis of Financial Condition and
Results of Operations 12
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 26
Item 6. Exhibits and Reports on Form 8-K 26
Signatures 27
</TABLE>
The following description of the Company's business in this Item and other Items
in this Report contains forward looking statements within the meaning of section
27A of the Securities Act of 1933, as amended, and section 21E of the Securities
Exchange Act of 1934, as amended. Actual results could differ materially from
those projected, as a result of the risk factors discussed in this section, and
in Management's Discussion and Analysis of Financial Condition and Results of
Operations contained in the Company's reports on Form 10-K/A-1 and A-2 for the
year ended December 31, 1995 and on Form 10-Q for the three month periods ended
March 31, 1996 and June 30, 1996.
2
<PAGE> 3
SANCTUARY WOODS MULTIMEDIA CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
AS OF SEPTEMBER 30, 1996 AND MARCH 31, 1996 (UNAUDITED)
<TABLE>
<CAPTION>
SEPTEMBER 30, MARCH 31,
1996 1996
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash $ 3,570,979 $ 8,455
Accounts receivable 842,876 800,701
Inventories 927,895 1,384,840
Prepaid royalties 185,243 127,000
Prepaid expenses 370,027 294,203
------------ ------------
Total current assets 5,897,020 2,615,199
PROPERTY AND EQUIPMENT 747,895 1,834,266
DEFERRED ROYALTIES & OTHER ASSETS 275,832 144,396
------------ ------------
TOTAL ASSETS $ 6,920,747 $ 4,593,861
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Bank debt $ 850,000 $ 2,226,781
Notes payable 1,563,666
Accounts payable 1,892,500 3,087,886
Accrued expenses 355,154 1,395,359
Royalty obligations 376,700 611,905
Current portion of capital lease obligations 26,771 28,715
------------ ------------
Total current liabilities 3,501,125 8,914,312
8% CONVERTIBLE DEBENTURES DUE 1999 5,302,000
LONG-TERM ROYALTY OBLIGATIONS 84,000 534,000
CAPITAL LEASE OBLIGATIONS 13,781
------------ ------------
Total liabilities 8,887,125 9,462,093
------------ ------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY (DEFICIT):
Authorized, 100,000,000 common shares, no par value;
issued and outstanding,
27,241,164 shares at September 30, 1996 and
22,158,580 shares at March 31, 1996 34,736,887 31,763,839
Accumulated deficit (35,951,394) (35,874,113)
Accumulated translation adjustments (751,871) (757,958)
------------ ------------
Total stockholders' equity (deficit) (1,966,378) (4,868,232)
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) $ 6,920,747 $ 4,593,861
============ ============
</TABLE>
See notes to condensed consolidated financial statements.
3
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SANCTUARY WOODS MULTIMEDIA CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 1996 AND 1995 (UNAUDITED)
<TABLE>
<CAPTION>
1996 1995
<S> <C> <C>
SALES:
Consumer titles $ 533,735 $ 8,838,884
Licensing revenue 642,237 339,103
Publisher services 174,078
------------ ------------
Total sales 1,175,972 9,352,065
------------ ------------
COST OF SALES:
Consumer titles 244,634 3,719,673
Technology amortization 183,090
Publisher services 145,174
------------ ------------
Total cost of sales 244,634 4,047,937
------------ ------------
GROSS MARGIN 931,338 5,304,128
------------ ------------
OPERATING EXPENSES:
Research and development 250,298 1,232,925
Marketing and sales 621,694 2,164,984
Administration 490,425 803,080
Depreciation 76,512 204,110
------------ ------------
Total operating expenses 1,438,929 4,405,099
------------ ------------
OPERATING INCOME (LOSS) (507,591) 899,029
------------ ------------
OTHER INCOME (EXPENSE)
Foreign exchange loss (280) (7,412)
Interest (expense) income - net (32,579) 2,686
Other income 120,191 7,059
------------ ------------
Total other income 87,332 2,333
------------ ------------
NET INCOME (LOSS) $ (420,259) $ 901,362
============ ============
PRIMARY NET INCOME (LOSS) PER SHARE ($ 0.02) $ 0.05
FULLY DILUTED NET INCOME (LOSS)
PER SHARE ($ 0.02) $ 0.04
PRIMARY SHARES USED IN COMPUTATION 23,241,164 19,171,452
FULLY DILUTED SHARES USED IN
COMPUTATION 23,241,164 23,171,452
</TABLE>
See notes to condensed consolidated financial statements.
4
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SANCTUARY WOODS MULTIMEDIA CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
SIX MONTHS ENDED SEPTEMBER 30, 1996 AND 1995 (UNAUDITED)
<TABLE>
<CAPTION>
1996 1995
<S> <C> <C>
SALES:
Consumer titles $ 1,528,451 $ 10,162,647
Licensing revenue 1,567,890 904,235
Publisher services 344,053
------------ ------------
Total sales 3,096,341 11,410,935
------------ ------------
COST OF SALES:
Consumer titles 927,734 4,683,695
Technology amortization 344,180
Publisher services 290,348
------------ ------------
Total cost of sales 927,734 5,318,223
------------ ------------
GROSS MARGIN 2,168,607 6,092,712
------------ ------------
OPERATING EXPENSES:
Research and development 709,362 2,211,245
Marketing and sales 1,254,500 3,977,762
Administration 978,331 1,922,166
Depreciation 211,917 325,256
------------ ------------
Total operating expenses 3,154,110 8,436,429
------------ ------------
OPERATING LOSS (985,503) (2,343,717)
------------ ------------
OTHER INCOME (EXPENSE)
Foreign exchange (loss) gain (3,269) 4,068
Interest (expense) income, net (114,747) 11,688
Net gain on sale and disposal of assets 875,161
Other income (expense) 151,078 (32,985)
------------ ------------
Total other income (expense) 908,223 (17,229)
------------ ------------
NET LOSS $ (77,280) $ (2,360,946)
============ ============
PRIMARY NET LOSS PER SHARE ($ 0.00) ($ 0.13)
PRIMARY SHARES USED IN COMPUTATION 21,268,183 17,755,425
</TABLE>
See notes to condensed consolidated financial statements.
5
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SANCTUARY WOODS MULTIMEDIA CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED SEPTEMBER 30, 1996 AND 1995 (UNAUDITED)
<TABLE>
<CAPTION>
1996 1995
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (77,280) $(2,360,946)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 213,763 615,603
Stock option and warrant compensation 81,981 66,275
Sale of intellectual property rights in consideration for a reduction
in royalty obligations (429,688)
Net gain on sale and disposal of assets
(875,161) (203)
Changes in assets and liabilities:
Accounts receivable (42,175) (5,384,852)
Inventories 456,945 (803,493)
Prepaid royalties, expenses and other (140,400) 1,243,032
Accounts payable and accrued expenses (2,160,091) 1,274,888
----------- -----------
Net cash used by operating activities (2,972,106) (5,349,493)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of assets 1,900,000
Purchase of property and equipment (30,951) (495,864)
----------- -----------
Net cash provided (used) in investing activities 1,869,049
(495,864)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of warrants 750,000
Issuance of convertible debentures 5,302,000
Issuance of common stock net of issue costs 7,991,484
Net payments on bank debt (1,376,781) (200,000)
Payments on long-term debt (15,725)
----------- -----------
Net cash provided in financing activities $ 4,659,494 7,791,484
----------- -----------
EFFECT OF EXCHANGE RATE CHANGES ON CASH
6,087
----------- -----------
NET INCREASE IN CASH 3,562,524 1,946,127
CASH, BEGINNING OF PERIOD 8,455 268,552
----------- -----------
CASH, END OF PERIOD $ 3,570,979 $ 2,214,679
=========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest $ 68,587 $ 63,933
Income taxes 800 1,600
SUPPLEMENTAL SCHEDULE OF NON-CASH FINANCING AND INVESTING INFORMATION:
Conversion of notes payable into common stock $ 1,563,666
Sale of intellectual property in exchange for a reduction in royalty
obligations and issuance of common stock 550,000
Conversion of account payable into common stock
195,000
</TABLE>
See notes to condensed consolidated financial statements.
6
<PAGE> 7
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
SIX MONTHS ENDED SEPTEMBER 30, 1996 AND 1995
1. NATURE OF OPERATIONS AND CHANGE IN FISCAL YEAR-END
Sanctuary Woods Multimedia Corporation and its subsidiaries (the
"Company") develop, market and distribute interactive multimedia software
products ("consumer titles") targeted at the childrens' education market.
Products are sold primarily through distributors into retail outlets.
Sales are also made directly to schools, hardware manufacturers and
bundlers (OEM), and to international distributors. Revenue is also
generated from licensing and other activities related to the Company's
products and intellectual properties. Prior to 1996, the Company published
interactive entertainment products and provided interactive multimedia
services to trade and textbook publishers.
In 1996, the Board of Directors determined that it would be in the best
interests of the Company and its shareholders to change the Company's
reporting and tax fiscal year to March 31 from December 31. The change was
effected April 1, 1996. Accordingly, the accompanying condensed
consolidated financial statements include the three and six month periods
ended September 30, 1996 and 1995.
The accompanying unaudited condensed consolidated financial statements
have been prepared in conformity with U.S. generally accepted accounting
principles ("GAAP") for interim financial statements and include all
adjustments which, in the opinion of management, are necessary for a fair
statement of the consolidated financial position, results of operations
and cash flows as of and for the interim periods. Such adjustments
consist of items of a normal recurring nature except as described herein.
The unaudited condensed consolidated financial statments included herein
should be read in conjunction with the Company's audited financial
statements for the year ended December 31, 1995 and the three month
periods ended March 31 and June 30, 1996 included in Form 8-K as
filed on October 31, 1996. Results of operations for interim periods
are not necessarily indicative of results for the full year.
2. HISTORICAL OPERATING LOSSES AND CERTAIN MANAGEMENT ACTIONS
Net loss for the six month period ended September 30, 1996 was ($77,280)
compared to a net loss of ($2,360,946) for the six months ended September
30, 1995. The net loss from operations for the six month period ended
September 30, 1996 totalled ($985,503) compared to a net operating loss of
($2,343,717) for the same period one year ago. Net cash used by operating
activities was ($2,972,106) for the six month period ended September 30,
1996 compared to ($5,349,493) for the same period one year ago. At
September 30, 1996 the Company had $3,570,979 in cash and bank borrowings
totalling $850,000.
7
<PAGE> 8
1996 Management Actions
During 1996, the Company instituted measures to improve operations and
cash flows to continue its operations. Specific items accomplished through
November 11, 1996 included the following:
- Appointment of a new President and Chief Executive Officer, Vice
President of Marketing, and a Controller, and promotion of the Vice
President of the Education Division to Senior Vice President.
- Reduction of head count from 148 employees at December 31, 1995 to
35 at November 11, 1996 and elimination of many part-time, temporary
and contract positions.
- Ceasing publication of new entertainment titles.
- Closure of the Publisher Services Division.
- Sale of substantially all of the fixed assets of the Entertainment
Division. This included the sale of a studio in Victoria, British
Columbia during May 1996 for $1,900,000, of which $500,000 was used
to reduce bank borrowings. The gain on the sale of the studio,
included in other income for the six month period ended September 30,
1996, totaled $897,260.
- Reduction by $2,038,000 of the outstanding borrowings under the bank
line of credit from its January 1996 peak level of $2,572,000 to
$534,000 at November 11, 1996.
- A 10% reduction in senior management salaries.
- Termination of all software development projects through outside
developers.
- The hiring of Strategic Marketing Partners to represent the
Company's product line in the retail distribution channel.
- Sale in June, 1996 of certain entertainment product rights to one of
its licensors in consideration for a $429,688 reduction in royalty
obligations. Such sale was included as licensing revenue in the six
month period ended September 30, 1996. The transaction also
encompassed the issuance of 175,000 shares of the Company's common
stock in consideration of an additional $120,000 reduction in royalty
obligations.
- Sale of other entertainment product rights (included in licensing
revenue) for $150,000 in the six month period ended September 30,
1996.
8
<PAGE> 9
Bank Line of Credit
The Company has a revolving bank line of credit which expires April 3,
1997 and provides for working capital borrowings not to exceed $750,000.
Borrowings under the line of credit are limited to 65% of eligible trade
accounts receivable. Interest is payable based on the bank's prime rate
plus 2.50% (4% if the Company is out of compliance with its borrowing
base) and was 12.25% at September 30, 1996.
The credit agreement contains restrictions on the Company's ability to
incur or guarantee indebtedness, enter into mergers or acquisitions, pay
dividends or lease property. The agreement also requires the Company to
maintain minimum levels of profitability and tangible net worth and to
maintain certain defined ratios of cash flow, liquidity and leverage and
limit capital expenditures. Amounts outstanding under the revolving credit
agreement are secured by substantially all of the Company's assets.
As a result of significant losses, the Company was in violation of certain
covenants of its bank line of credit at December 31, 1995 and thereafter.
In addition, the Company had borrowed in excess of the amounts then
allowed under the credit agreement. As of August 15, 1996, the credit
agreement was amended to waive all previous covenant violations and to
provide the revolving credit described above.
At November 11, 1996 the Company was in compliance with the terms of its
bank credit agreement.
September 1996 Convertible Subordinated Debenture Issue
In September 1996, the Company privately placed for cash $5,302,000 in
8% convertible debentures due July 31, 1999. A substantial portion of the
proceeds were used to repay bank and trade indebtedness. Interest is
payable annually in arrears and is to be paid only in shares of the
Company's common stock valued at a price equal to the average closing
price for the ten trading days prior to the date of payment. Interest
will continue to accrue until the debentures are paid or converted.
The debentures are convertible into shares of the Company's common stock
at the rate of one share for each $.55 of principal (9,640,000 shares)
plus accrued interest. The debentures are automatically convertible on
July 31, 1999 or upon occurrence of either of the following events: (a)
the Company's obtaining any equity financing in an amount not less than
$2,000,000 at prices not less than $1.00 per share or (b) the common stock
of the Company having closed trading at a price of $1.375 or more per
share for any 21 trading days in any consecutive 40 day trading period.
From April 1, 1997 to July 31, 1999 the debentures are convertible at the
option of the holder. The debentures are subordinate to senior debt and to
the security interest of the Company's bank. The Company may prepay the
debentures at any time without penalty.
9
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The Company issued to each purchaser of the debentures a warrant to
purchase one share of common stock for each $2.00 invested or 2,651,000
shares in total. Each warrant may be exercised at a price of $.6875 per
share until September 1999. Pursuant to the warrant issue, the Company
incurred a deferred charge totaling $265,100 with an offsetting increase
to paid-in capital. The deferred charge is being expensed ratably over the
life of the warrants.
The holders of stock issued upon conversion of debentures or exercise
of warrants have certain rights to have these shares registered.
* * * *
At November 11, 1996, the Company had cash of $2,200,000 and bank
borrowings of $534,000. Management believes that the Company's existing
cash resources, cash flows from operations and additional proceeds, if
necessary, from debt or equity financing (including the exercise of
warrants) will enable the Company to comply with its bank covenants
through April 3, 1997 and meet its financial obligations and conduct its
operations through September 30, 1997.
3. ACCOUNTS RECEIVABLE
The Company allows customers to exchange and/or return products. In order
to promote sell-through and limit product returns, the Company also
provides "price protection" on slow moving products. In addition, the
Company's products are sold with a ninety-day warranty against defects.
The Company has recorded reserves for sales returns and allowances and
price protection based on historical experience and management's current
estimates of potential returns and necessary price protection.
Accounts receivable consisted of:
<TABLE>
<CAPTION>
September 30 March 31
1996 1996
---- ----
<S> <C> <C>
Accounts receivable - trade $ 2,125,293 $ 4,814,104
Less allowances for:
Doubtful accounts (221,138) (207,352)
Sales returns and allowances (1,061,279) (3,806,051)
----------- -----------
Accounts receivable - net $ 842,876 $ 800,701
=========== ===========
</TABLE>
10
<PAGE> 11
4. INVENTORIES
Inventories consisted of:
<TABLE>
<CAPTION>
September 30, March 31,
1996 1996
---- ----
<S> <C> <C>
Finished goods $ 1,091,912 $ 1,967,558
Raw materials 573,595 866,957
----------- -----------
1,665,507 2,834,515
Less allowance for obsolete, slow-moving and
non-salable inventory (737,612) (1,449,675)
----------- -----------
Inventories-net $ 927,895 $ 1,384,840
=========== ===========
</TABLE>
5. COMMON STOCK OPTIONS AND WARRANTS
At November 11, 1996 there were outstanding options to purchase 2,019,750
shares of common stock at $.50 to $5.75 per share and warrants to
purchase 4,771,000 shares of common stock at $0.50 to $0.6875 per share.
6. PERFORMANCE SHARES
In October 1991, in connection with the sale of 1,800,000 common shares to
the Company's founders and principal stockholders, the Company issued
4,000,000 common "performance" shares (the "Performance Shares") at CDN
$0.01 per share to certain of these individuals. These Performance Shares
were issued pursuant to Local Policy #3-07 of the British Columbia
Securities Commission ("BCSC") and Policy 19 of the Vancouver Stock
Exchange, which provide the guidelines for the issuance of performance
shares. In July 1996, a total of 1,200,000 of these shares were sold and
transferred to certain members of current management at their then
estimated fair market value of $.03 per share.
The Performance Shares are held in escrow to be released as the Company
achieves positive operating cash flow on an annual basis as defined by the
BCSC ("BCSC Operating Cash Flow"). The holders of Performance Shares will
be entitled to a pro rata release from escrow on the basis of one share
for every CDN $0.653 of annual positive BCSC Operating Cash Flow, subject
to approval by the BCSC and the Vancouver Stock Exchange. Performance
Shares are permitted to be released from escrow on an annual basis, and
all of the Performance Shares will be released once CDN $2,612,000 of
annual positive BCSC Operating Cash Flow has been generated by the
Company.
At the time when BCSC Operating Cash Flow justifying release of the
Performance Shares, or a pro rata portion thereof, is probable, the
Company will record as compensation expense an amount equal to the
difference between the CDN $0.01
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<PAGE> 12
per share originally paid for the Performance Shares then issuable and the
market price of its common stock at that time. Such a pro rata or full
expense recognition will occur prior to the pro rata or full release from
escrow of the Performance Shares. If and when such expense recognition
criteria are achieved, based on the closing price of the Company's common
stock on the Vancouver Stock exchange at November 11, 1996, of
approximately US$.20 per share (for example purposes only), the aggregate
compensation expense that would be recognized as a result of earning of
all the performance shares would be approximately $800,000. Any
compensation expense recognized related to the Performance Shares will be
a noncash charge against income and will have no net impact on total
stockholders' equity (deficit).
The Company may pursue an early release of all or a large portion of the
Performance Shares. Such an early release from escrow would reduce a
source of continuing uncertainty surrounding the Company's consolidated
financial statements, but could also result in compensation expense in the
quarter in which the release is made. If and when the Performance Shares
are earned, the number of shares used to calculate primary net income
(loss) per share will increase by the number of Performance Shares earned.
Through November 11, 1996, no Performance Shares have been earned or
released.
ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
The following information should be read in conjunction with the
unaudited condensed consolidated financial statements and the notes thereto
included in item 1 of this Quarterly Report, the audited consolidated financial
statements and notes thereto included in the Company's report on Form 8-K dated
October 30, 1996 and Management's Discussion and Analysis of Financial
Condition and Results of Operations contained in the Company's Annual Report on
Form 10-K/A-1 and A-2 for the fiscal year ended December 31, 1995, and Forms
10-Q for the three month periods ended March 31 and June 30, 1996 as filed with
the Securities and Exchange Commission.
Overview and Recent Developments.
In 1996, the Company changed its fiscal year to end March 31.
During 1996, the Company instituted measures to improve operations and cash
flows to continue its operations. Specific items accomplished through November
11, 1996 included the following:
12
<PAGE> 13
- - Appointment of a new President and Chief Executive Officer, Vice President
of Marketing, and a Controller, and promotion of the Vice President of the
Education Division to Senior Vice President.
- - Reduction of head count from 148 employees at December 31, 1995 to 35 at
November 11, 1996 and elimination of many part-time, temporary and
contract positions.
- - Ceasing publication of new entertainment titles.
- - Closure of the Publisher Services Division.
- - Sale of substantially all of the fixed assets of the Entertainment
Division. This included the sale of a studio in Victoria, British
Columbia during May 1996 for $1,900,000, of which $500,000 was used
to reduce bank borrowings. The gain on the sale of the studio,
included in other income for the six month period ended September 30,
1996, totaled $897,260.
- - Reduction by $2,038,000 of the outstanding borrowings under the bank line
of credit from its January 1996 peak level of $2,572,000 to $534,000 at
November 11, 1996.
- - A 10% reduction in senior management salaries.
- - Termination of all software development projects through outside
developers.
- - The hiring of Strategic Marketing Partners to represent the Company's
product line in the retail distribution channel.
- - Sale in June, 1996 of certain entertainment product rights to one of its
licensors in consideration for a $429,688 reduction in royalty
obligations. Such sale was included as licensing revenue in the six month
period ended September 30, 1996. The transaction also encompassed the
issuance of 175,000 shares of the Company's common stock in consideration
of an additional $120,000 reduction in royalty obligations.
- - Sale of other entertainment product rights (included in licensing revenue)
for $150,000 in the six month period ended September 30, 1996.
In addition, under the direction of its new management, the Company has
now focused on the development and publishing of its children's
curriculum-based educational software products. The Company develops these
products primarily in its San Mateo, California studio. Since the beginning of
the current fiscal year through November 11, 1996, the Company has completed
the development of six new products: Major League Math(TM), Franklin Learns
Math(TM), How Do You Spell Adventure?(TM), Orion Burger(TM), NFL(TM) Math and
NFL(TM) Reading. The Company currently sells five of the titles and has
sold the publishing rights to Orion Burger(TM) to a third party publisher.
13
<PAGE> 14
Liquidity and Capital Resources.
Due to more than $23,600,000 in operating losses incurred during the eighteen
months ended June 30, 1996, the Company experienced severe liquidity problems
through September 30, 1996.
In September 1996, the Company privately placed for cash $5,302,000 in
8% convertible debentures due July 31, 1999. A substantial portion of the
proceeds were applied to repay banks and trade indebtedness. Interest is
payable annually in arrears and is to be paid only in shares of the Company's
common stock valued at a price equal to the average closing price for the ten
trading days prior to the date of payment. Interest will continue to accrue
until the debentures are paid or converted.
The debentures are convertible into shares of the Company's common stock at the
rate of one share for each $.55 of principal (9,640,000 shares) plus accrued
interest. The debentures are automatically convertible on July 31, 1999 or upon
occurrence of either of the following events: (a) the Company's obtaining any
equity financing in an amount not less than $2,000,000 at prices not less than
$1.00 per share or (b) the common stock of the Company having closed trading at
a price of $1.375 or more per share for any 21 trading days in any consecutive
40 day trading period. From April 1, 1997 to July 31, 1999 the debentures are
convertible at the option of the holder. The debentures are subordinate to
senior debt and to the security interest of the Company's bank. The Company may
prepay the debentures at any time without penalty.
The Company issued to each purchaser of the debentures a warrant to purchase one
share of common stock for each $2.00 invested or 2,651,000 shares in total. Each
warrant may be exercised at a price of $.6875 per share until September 1999.
The holders of stock issued upon conversion of debentures or exercise of
warrants have certain rights to have these shares registered.
The Company also renegotiated its revolving bank line of credit to expire April
3, 1997 and provide for working capital borrowings not to exceed $750,000.
Borrowings under the line of credit are limited to 65% of eligible trade
accounts receivable. Interest is payable based on the bank's prime rate plus
2.50% (4% if the Company is out of compliance with its borrowing base) and was
12.25% at September 30, 1996.
The credit agreement contains restrictions on the Company's ability to incur or
guarantee indebtedness, enter into mergers or acquisitions, pay dividends or
lease property. The agreement also requires the Company to maintain minimum
levels of profitability and tangible net worth and to maintain certain defined
ratios of cash flow, liquidity and leverage and limit capital expenditures.
Amounts outstanding under the revolving credit agreement are secured by
substantially all of the Company's assets.
14
<PAGE> 15
As a result of significant losses, the Company was in violation of
certain covenants of its bank line of credit at December 31, 1995 and
thereafter. In addition, the Company had borrowed in excess of the amounts
allowed under the credit agreement. As of August 15, 1996, the credit agreement
was amended to waive all previous covenant violations and to provide the
revolving credit described above.
At November 11, 1996, the Company had cash of $2,200,000 and bank borrowings of
$534,000. Management believes that the Company's existing cash resources, cash
flows from operations and additional proceeds, if necessary, from debt or equity
financing (including the exercise of warrants) will enable the Company to comply
with its bank covenants through April 3, 1997 and meet its financial obligations
and conduct its operations through September 30, 1997.
NASDAQ Listing.
In July 1996, it was determined that the Company no longer met the requirements
for inclusion on the NASDAQ Small Cap Market because it failed to meet the
continuing inclusion requirements for tangible net worth and minimum bid price.
As of July 1, 1996, the Company's stock ceased trading on the National Small Cap
Market and began trading on the OTC Bulletin Board.
RESULTS OF OPERATIONS - THREE MONTHS ENDED SEPTEMBER 30, 1996 AND 1995
Net Loss. The net loss for the quarter ended September 30 ,1996 was
$(420,259) compared to net income of $901,362 in the quarter ended September
30, 1995. The net loss in the September 1996 quarter was primarily due to lower
sales as compared to the September 1995 quarter. The September 1995 quarter
includes significant sales of two of the Company's entertainment titles, Buried
in Time and Ripleys:Riddle of Master Lu into the retail distribution channel.
Due to the poor sell through of these entertainment titles, and the severe
losses and cash constraints experienced by the Company, management decided in
1996 to discontinue the manufacture and promotion of entertainment titles and
focus its efforts on developing education software titles.
Sales. Sales decreased 87% to $1,175,972 in the quarter ended September
30, 1996 from $9,352,065 in the quarter ended September 30, 1995. Most of the
decrease resulted from the Company's elimination of its entertainment products
business in early 1996. In the quarter ended September 30, 1995, the Company
generated a large sales volume from the release of two entertainment titles,
Buried In Time and Ripleys:Riddle of Master Lu. In the quarter ended September
30, 1996, the Company generated a low volume of sales for its education
consumer titles. For most of the first nine months of calendar 1996, the
Company lacked sufficient capital resources to adequately fund sales, marketing
and other operational activities. The Company estimates that the low volume of
sales was at least partially due to the lack of resources needed to market and
promote its products.
15
<PAGE> 16
Licensing revenues increased 89% to $642,237 in the quarter ended September 30,
1996 from $339,103 in the quarter ended September 30, 1995. The increase was
primarily due to the sale of publishing rights to certain entertainment titles
and increased royalties from international sales.
In January, 1996, the Company decided to close its office in Dallas, Texas and
discontinue its publisher services operation. There were no sales related to
these operations in the quarter ended September 30, 1996.
Gross Margins. Gross margins increased to 79% of total sales in the quarter
ended September 30, 1996 from 57% in the quarter ended September 30, 1995. This
increase is partially due to the increase in licensing revenues, which carry no
costs of sale, the elimination of the publisher services division, and the
decrease in technology amortization which was fully expensed in 1995. This
increase in margin was slightly offset by an increase in cost of sales on
consumer titles to 46% in the quarter ended September 30, 1996 from 42% in the
quarter ended September 30, 1995. Although the September 1995 quarter contained
higher royalty and freight costs relating to the release of Buried In Time and
Ripleys:Riddle of Master Lu, the September 1996 quarter includes increased
provisions for returns and price-protection.
Research and Development Costs. Research and development costs decreased 80% to
$250,298 in the quarter ended September 30, 1996 from $1,232,925 in the quarter
ended September 30, 1995. This decrease is primarily due to a reduction in
personnel and facility costs associated with the sale of the Company's Victoria
studio and the overall reduction of the Company's work force. As a percentage of
sales, research and development costs were 21% in the quarter ended September
30, 1996 compared to 13% in the same quarter last year. The increase is
primarily due to substantially reduced sales resulting from the elimination of
the Company's entertainment products.
Marketing and Sales. Marketing and sales expenditures decreased 71% to $621,694
in the quarter ended September 30, 1996 from $2,164,984 in the quarter ended
September 30, 1995. This decrease was due primarily to the Company's lack of
resources to fund advertising and promotion activities until the latter part of
the quarter. In addition, the Company has reduced personnel expenses due to the
elimination of its entertainment products. In the quarter ended September 1995,
the Company invested substantial sums to promote the release of its then
premiere entertainment titles Buried In Time and Ripleys:Riddle of Master Lu. As
a percentage of sales, sales and marketing costs were 53% in the quarter ended
September 30, 1996 compared to 23% in the same quarter last year. The increase
is primarily due to substantially reduced sales resulting from the elimination
of the Company's entertainment products.
Administrative Costs. Administrative expenses decreased 39% to $490,425
in the quarter ended September 30, 1996 from $803,080 in the quarter ended
September 30, 1995, primarily due to the reduction in the Company's work force.
As a percentage of sales, administrative costs were 42% in the quarter ended
September 30, 1996 compared to 9% in the same quarter last year. This increase
is primarily due to substantially reduced sales resulting from the elimination
of the Company's entertainment products and to increased bad debt expense and
consulting and professional fees.
16
<PAGE> 17
As of November 11, 1996, the Company had 35 full time employees and operated
facilities in San Mateo, California and Toronto, Canada. These employees were
employed in the following functions:
<TABLE>
<S> <C>
Product Development- Children's Educational Products 12
Marketing, Sales, Customer Service & Technical Support 14
General and Administrative 9
--
Total 35
</TABLE>
In November 1996, management decided to close the Company's Toronto office
effective January 31, 1997 and relocate the activities conducted there to its
San Mateo headquarters. The closure will force the layoff of 4 full-time
product development employees.
RESULTS OF OPERATIONS - SIX MONTH PERIODS ENDED SEPTEMBER 30, 1996 AND 1995
Net Loss. The net loss for the six month period ended September 30,
1996 was $(77,280) compared to a net loss of $(2,360,946) in the six month
period ended September 30, 1995. The net loss in the September 1996 period was
due to reduced sales compared to the September 1995 period. The six month
period ended September 1995 included significant sales of two of the Company's
entertainment titles, Buried in Time and Ripleys:Riddle of Master Lu into the
retail distribution channel. In 1996 due to the poor sell through of these
entertainment titles, and the severe losses and cash constraints experienced by
the Company, management decided to discontinue the manufacture and promotion of
entertainment titles and focus its efforts on developing education software
titles.
For most of the first nine months of calendar 1996, the Company lacked
sufficient capital resources to adequately fund sales, marketing and other
operational activities. The Company estimates that the low sales volume during
the six month period ended September 30, 1996 was at least partially due to the
lack of resources needed to market and promote its titles. However, the
permanent reductions in headcount and operating overhead somewhat offset the
negative impact on the operating loss of these financial constraints.
Net Sales. Sales decreased 73% to $3,096,341 for the six month period
ended September 30, 1996 from $11,410,935 in the six month period ended
September 30, 1995 primarily due to the elimination of the entertainment
products business. In the quarter ended September 30, 1996, the Company
experienced a low volume of sales for its education consumer titles. For most
of the first nine months of calendar 1996, the Company lacked sufficient
capital resources to adequately fund sales, marketing and other operational
activities. The Company estimates that the low volume of sales was at least
partially due to the lack of resources needed to market and promote its
products.
17
<PAGE> 18
Licensing revenues increased 73% to $1,567,890 in the six month period ended
September 30, 1996 from $904,235 in the six month period ended September 30,
1995. The increase was primarily due to the sale of publishing rights to certain
entertainment titles and increased royalties from international sales.
Gross Margins. Gross margins increased to 70% of total sales in the six
month period ended September 30, 1996 from 53% in the six month period ended
September 30, 1995. This increase is due to the increase in licensing revenues,
which carry no costs of sale and the decrease in technology amortization which
was fully expensed in 1995. Cost of sales on consumer titles increased to 61%
in the six month period ended September 30, 1996 from 46% in the same period
last year due to increased provisions for product returns and price-protection
in the September 1996 period.
Research and Development Costs. Research and development costs decreased 68% to
$709,362 in the six month period ended September 30, 1996 from $2,211,245 in the
same period last year. This decrease is primarily due to a reduction in
personnel and facility costs associated with the sale of the Company's Victoria
studio and the overall reduction of the Company's work force.
Marketing and Sales. Marketing and sales expenditures decreased 69% to
$1,254,500 in the six month period ended September 30, 1996 from $3,977,762 in
the same period last year. This decrease was due primarily to the Company's lack
of resources to fund advertising and promotion activities until the latter part
of September. In addition, the Company has reduced personnel expenses due to
the elimination of its entertainment products and sale of the studio in
Victoria, Canada. During the six month period ended September 1995, the Company
invested substantial sums to promote the release of its entertainment titles
Buried In Time and Ripleys:Riddle of Master Lu. As a percentage of sales, sales
and marketing costs were 41% in the six month period ended September 30, 1996
compared to 35% for the same period last year. The increase is
primarily due to substantially reduced sales resulting from the elimination of
the Company's entertainment products.
Administrative Costs. Administrative expenses decreased 50% to $978,331
in the six month period ended September 30, 1996 from $1,922,166 in the six
month period ended September 30, 1995, due to the reduction in the Company's
work force. As a percentage of sales, administrative costs were 32% in the six
month period ended September 30, 1996 versus 17% in the same period last year.
This increase is primarily due to substantially reduced sales resulting from
the elimination of the Company's entertainment products and to increased bad
debt expense and consulting and professional fees.
Other. During the quarter ended September 30, 1996, the Company negotiated
settlements with certain trade Creditors to reduce payments owed to them on
past due obligations. Savings generated from the settlements totalling
$115,000 is included in other income for the quarter.
ADDITIONAL RISK FACTORS
There are numerous additional risks associated with the Company's on-going
operations, including without limitation the following:
18
<PAGE> 19
Continued Losses; Fluctuations in Operating Results; Seasonality. The Company
has not been profitable on an annual basis in the last three years. The Company
has experienced, and expects to continue to experience, significant fluctuations
in operating results due to a variety of factors, including the size and rate of
growth of the consumer software market, market acceptance of the Company's
products and those of its competitors, development and promotional expenses
relating to the introduction of new products or new versions of existing
products, projected and actual changes in computing platforms, the timing and
success of product introductions, product returns, changes in pricing policies
by the Company and its competitors, difficulty in securing retail shelf space
for the Company's products, the accuracy of retailers' forecasts of consumer
demand, the timing of orders from major customers, order cancellations and
delays in shipment. In response to competitive pressures, the Company may take
certain pricing or marketing actions that could materially adversely affect the
Company's business, operating results and financial condition. The Company may
be required to pay fees in advance or to guarantee royalties, which may be
substantial, or to obtain licenses to intellectual properties from third parties
before such properties have been introduced or achieved market acceptance. A
significant portion of the Company's operating expenses are relatively fixed,
and planned expenditures are based in part on sales forecasts. If net sales do
not meet the Company's expectations, the Company's business, operating results
and financial condition could be materially adversely affected.
Possible write-offs from Product Returns, Price Protection; Bad Debts;
Collections. The Company recognizes revenue in accordance with industry practice
(net of an allowance for product returns and price protection) from the sale of
its products upon shipment to its distributors and retailers. The Company had a
reserve balance for price protection and returns as of September 30, 1996, of
$1,061,279. Product returns or price protection concessions that exceed the
Company's reserves could materially adversely affect the Company's business,
operating results and financial condition and could increase the magnitude of
quarterly fluctuations in the Company's operating and financial results. In
addition, the Company has experienced in the past, and continues to experience,
significant delays in the collection of its accounts receivable. Further, if the
Company's assessment of the creditworthiness of its customers receiving products
on credit proves incorrect, the Company could be required to significantly
increase the reserves previously established.
Impact of Reorganization of Operations. The Company may take additional steps to
reorganize or consolidate its operations. These steps may include, among other
things, the sale of certain assets of the Company. In an effort to reduce its
expense structure, the Company reorganized its operations during the first half
of calendar 1996, reduced its work force by more than 66% and revised its
product development plans for 1996. These changes or other future actions to
reorganize and reduce expenses could result in the delayed introduction of new
products which could have a material adverse effect on the Company's financial
condition and results of operations.
Dependence on Key Personnel; Retention of Employees. The Company's success
depends in large part on the continued service of its key creative, technical,
marketing, sales and management personnel and its ability to continue to
attract, motivate and retain highly
19
<PAGE> 20
qualified employees. Because of the multifaceted nature of interactive media,
key personnel often require a unique combination of creative and technical
talents. Such personnel are in short supply, and the competition for their
services is intense. The process of recruiting key creative, technical and
management personnel with the requisite combination of skills and other
attributes necessary to execute the Company's strategy is often lengthy. The
Company has entered into at-will employment agreements with its management and
certain other personnel, who may generally terminate their employment at any
time. The loss of the services of key personnel or the Company's failure to
attract additional qualified employees could have a material adverse effect on
the Company's results of operations and research and development efforts. In
particular, the Company has recently reorganized its operations and has
undergone a reduction in force among its employees. Such reduction in force,
combined with the Company's disappointing operating performance, the price of
the Company's stock, and the availability of substantial alternative employment
opportunities for talented employees of the Company, may result in key employees
and managers leaving the Company, which could materially adversely impact the
Company's ability to develop and sell its products. The Company does not have
key person insurance covering any of its personnel.
Dependence on New Product Development; Product Delays. The success of the
Company depends on the continual and timely introduction of successful new
products. In general, consumer preferences for software products are difficult
to predict and are often short-lived. The retail life of software programs has
become shorter, and may now last only 9 to 12 months (or even less for
unsuccessful products), while the Company typically requires 6 to 9 months or
longer for the development of a new educational CD-ROM title. The short life
span of a product combined with a lengthy development cycle makes it especially
difficult to predict whether a product will be a success by the time it comes to
market. There can be no assurance that new products introduced by the Company
will achieve any significant market acceptance or that, if such acceptance
occurs, it will be sustained for any significant period. If the Company does not
correctly anticipate and respond to demand for its products in a timely manner,
the Company's business, operating results and financial condition will be
materially adversely affected.
A significant delay in the introduction of, or the presence of a defect in, one
or more products could have a material adverse affect on the Company's business,
operating results and financial condition, particularly in view of the
seasonality of the Company's business. Further, delays in a product introduction
near the end of a fiscal quarter may materially adversely affect operating
results for that quarter, as initial shipments of a product may move from one
quarter to the next and may represent a substantial percentage of annual
shipments of a product. The timing and success of software development is
unpredictable due to the technological complexity of software products, inherent
uncertainty in anticipating technological developments, the need for coordinated
efforts of numerous creative and technical personnel and difficulties in
identifying and eliminating errors prior to product release. In the past, the
Company has experienced delays in the introduction of certain new products.
There can be no assurance that new products will be introduced on schedule or at
all or that they will achieve market acceptance or generate significant
revenues.
20
<PAGE> 21
Competition. The software industry is intensely competitive, and market
acceptance for any of the Company's products may be adversely affected by the
introduction by the Company's competitors of similar products with greater
consumer demand. The Company competes against a large number of other companies
of varying sizes and resources. Most of the Company's competitors have
substantially greater financial, technical and marketing resources, as well as
greater name recognition and better access to consumers. Existing competitors
may continue to broaden their product lines and potential competitors, including
large computer or software manufacturers, entertainment companies, diversified
media companies, and book publishers, may enter or increase their focus on the
CD-ROM school and home education markets, resulting in increased competition for
the Company. Retailers of the Company's products typically have a limited amount
of shelf space and promotional resources, and there is intense competition among
consumer software producers for high quality and adequate levels of shelf space
and promotional support from retailers. To the extent that the number of
consumer software products and computer platforms increases, this competition
for shelf space may intensify. Due to increased competition for limited shelf
space, retailers and distributors are increasingly in a better position to
negotiate favorable terms of sale, including price discounts and product return
policies. Retailers often require software publishers to pay fees in exchange
for preferred shelf space. There can be no assurance that retailers will
continue to purchase the Company's products or provide the Company's products
with adequate levels of shelf space. Increased competition could result in loss
of shelf space for, and reduction in sell-through of, the Company's products at
retail stores and significant price competition, any of which could materially
adversely affect the Company's business, operating results and financial
condition. In addition, other types of retail outlets and methods of product
distribution, such as on-line services, may become important in the future, and
it may be important for the Company to gain access to these channels of
distribution. There can be no assurance that the Company will gain such access
or that the Company's access will be on terms favorable to the Company.
Changing Product Platforms and Formats. The Company's software products are
intended to be used on machines built by other manufacturers. The operating
systems of machines currently being manufactured are characterized by several
competing and incompatible formats or "platforms," and new platforms will
probably be introduced in the future. The Company must continually anticipate
the emergence of, and adapt its products to, popular platforms for consumer
software. When the Company chooses a platform for its products, it must commit
substantial development time and investment in advance of shipments of products
on that platform. If the Company invests in a platform that does not achieve
significant market penetration, the Company's planned revenues from those
products will be adversely affected and it may not recover its development
investment. If the Company does not choose to develop for a platform that
achieves significant market success, the Company's revenues may also be
adversely affected. The Company is currently developing products only for DOS
and Windows PC, and Macintosh computers. The Company has terminated virtually
all current development for other platforms such as the Sony PlayStation and
Sega Saturn. There can be no assurance that the Company has chosen to support
the platforms that ultimately will be successful.
21
<PAGE> 22
Changes in Technology and Industry Standards. The consumer software industry is
undergoing rapid changes, including evolving industry standards, frequent new
product introductions and changes in consumer requirements and preferences. The
introduction of new technologies, including operating systems and media formats,
can render the Company's existing products obsolete or unmarketable. The
development cycle for products utilizing new operating systems, microprocessors
or formats may be significantly longer than the Company's current development
cycle for products on existing operating systems, microprocessors and formats
and may require the Company to invest resources in products that may not become
profitable. There can be no assurance that the current demand for the Company's
products will continue or that the mix of the Company's future product offerings
will keep pace with technological changes or satisfy evolving consumer
preferences or that the Company will be successful in developing and marketing
products for any future operating system or format.
Limited Protection of Intellectual Property and Proprietary Rights; Risk of
Litigation. The Company regards its software as proprietary and relies primarily
on a combination of trademark, copyright and trade secret laws, and employee and
third-party nondisclosure agreements and other methods to protect its
proprietary rights. However, the Company does not have signed license agreements
with its end-users and does not include in its products any mechanism to prevent
or inhibit unauthorized copying. Unauthorized parties may copy the Company's
products or reverse engineer or otherwise obtain and use information that the
Company regards as proprietary. If a significant amount of unauthorized copying
of the Company's products were to occur, the Company's business, operating
results and financial condition could be materially adversely affected. Further,
the laws of certain countries in which the Company's products are or may be
distributed do not protect applicable intellectual property rights to the same
extent as the laws of the United States. In addition, the Company holds no
patents, and, although the Company has developed and continues to develop
certain proprietary software tools, the copyrights to which are owned by the
Company, most of the technology used to develop the Company's products is not
proprietary. There can be no assurance that the Company's competitors will not
independently utilize existing technologies to develop products that are
substantially equivalent or superior to the Company's. Also, as the number of
software products in the industry increases and the functionality of these
products further overlaps, software developers and publishers may increasingly
become subject to infringement claims. There can be no assurance that third
parties will not assert infringement claims against the Company in the future
with respect to current or future products.
As is common in the industry, from time to time the Company receives notices
from third parties claiming infringement of intellectual property or other
rights of such parties. The Company investigates these claims and responds as it
deems appropriate. There has been substantial litigation regarding copyright,
trademark and other intellectual property rights involving computer software
companies in general. The Company may also face suits as a result of employment
matters, publicity rights, governmental or regulatory investigations, or due to
claims of breach of the Company's obligations under various agreements to
publish or
22
<PAGE> 23
develop products, or for goods or services provided to the Company. Adverse
determinations in such claims or litigation could have a material adverse effect
on the Company's business, operating results and financial condition. The
Company may find it necessary or desirable in the future to obtain licenses
relating to one or more of its products or relating to current or future
technologies. There can be no assurance that the Company will be able to obtain
these licenses or other rights on commercially reasonable terms or at all.
Relationship with Vendors. Failure to pay vendors on a timely basis may result
in loss of the availability of the services of such vendors, which could hamper
the Company's ability to manufacture and ship products, and may ultimately
result in the Company being sued for collection of such amounts as may be owed
to such vendors. If the Company is unable to produce its products to fill
orders, the Company's operating results and financial condition could be
materially adversely affected. In the event that suits by vendors are filed
against the Company, the Company may be required to incur unanticipated legal
expenses or find it necessary to seek protection under the applicable bankruptcy
statutes of Canada and/or the United States.
Market for Common Stock; Stock Price Volatility. The Common Stock has been
quoted on the Vancouver Stock Exchange since December 1991, and was quoted on
the NASDAQ Stock Market from September 8, 1993 until July 2, 1996, when it began
trading the OTC Bulletin Board. Based upon historical trends in the market for
other software company stocks, the Company anticipates that the trading price of
its Common Stock may be subject to wide fluctuations in response to quarterly
variations in operating results, changes in actual earnings or in earnings
estimates by analysts, announcements of technological developments by the
Company or its competitors, general market conditions or other events largely
outside the Company's control. In addition, the stock market has experienced,
from time to time, extreme price and volume fluctuations which have particularly
affected the market prices of high technology stocks. These fluctuations have
often been disproportionate or unrelated to the operating performance of these
companies. These broad market fluctuations, general economic conditions or other
factors outside the Company's control, as well as the Company's results of
operations and financial condition, may adversely affect the market price of the
Company's stock.
Performance Shares and Related Compensation Expense. In October 1991, in
connection with the sale of 1,800,000 common shares to the Company's founders
and principal stockholders, the Company issued 4,000,000 common "performance"
shares (the "Performance Shares") at CDN $0.01 per share to certain of these
individuals. These Performance Shares were issued pursuant to Local Policy #3-07
of the British Columbia Securities Commission ("BCSC") and policy 19 of the
Vancouver Stock Exchange, which provide the guidelines for the issuance of
performance shares. In July 1996, a total of 1,200,000 of these shares were sold
and transferred to certain members of current management at their then estimated
fair market value of $.03 per share.
The Performance Shares are held in escrow to be released as the Company achieves
positive operating cash flow on an annual basis as defined by the BCSC ("BCSC
23
<PAGE> 24
Operating Cash Flow"). The holders of Performance Shares will be entitled to a
pro rata release from escrow on the basis of one share for every CDN $0.653 of
annual positive BCSC Operating Cash Flow, subject to approval by the BCSC and
the Vancouver Stock Exchange. Performance Shares are permitted to be released
from escrow on an annual basis, and all of the Performance Shares will be
released once CDN $2,612,000 of annual positive BCSC Operating Cash Flow has
been generated by the Company.
At the time when BCSC Operating Cash Flow justifying release of the Performance
Shares, or a pro rata portion thereof, is probable, the Company will record as
compensation expense an amount equal to the difference between the CDN $0.01 per
share originally paid for the Performance Shares then issuable and the market
price of its common stock at that time. Such a pro rata or full expense
recognition will occur prior to the pro rata or full release from escrow of the
Performance Shares. If and when such expense recognition criteria are achieved,
based on the closing price of the Company's common stock on the Vancouver Stock
exchange at November 11, 1996, of approximately US$.20 per share (for example
purposes only), the aggregate compensation expense that would be recognized as a
result of earning of all the performance shares would be approximately $800,000.
Any compensation expense recognized related to the Performance Shares will be a
noncash charge against income and will have no net impact on total stockholders'
equity (deficit).
The Company may pursue an early release of all or a large portion of the
Performance Shares. Such an early release from escrow would reduce a source of
continuing uncertainty surrounding the Company's consolidated financial
statements, but could also result in compensation expense in the quarter in
which the release is made.
If and when the Performance Shares are earned, the number of shares used to
calculate primary net income (loss) per share will increase by the number of
Performance Shares earned.Through November 11, 1996, no Performance Shares have
been earned or released.
Shares Eligible for Future Sale; Possible Adverse Effect on Future
Market Price. Sale of substantial amounts of shares in the public market or the
prospect of such sales or the sales or issuance of convertible securities or
warrants could adversely affect the market price of the Company's Common Stock.
Other than the 4,000,000 Performance Shares issued to the Company's founders
and management (which are currently held in an escrow account and are subject
to release upon satisfaction of specified conditions as discussed above)
substantially all of the Company's issued and outstanding shares are freely
tradable, subject to, in certain circumstances, compliance with Rule 144 or
Rule 701 or the effectiveness of a resale registration statement. In addition,
as of November 11, 1996, the Company had outstanding options to purchase
2,019,750 shares of Common Stock, warrants to purchase 4,771,000 shares of
Common Stock and debentures convertible into 9,640,000 shares of Common Stock.
Furthermore, the Company has reserved approximately 443,000 additional shares
of Common Stock for future issuance pursuant to the Company's Stock Option
Plan.
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<PAGE> 25
No Dividends. The Company has not paid any cash dividends since inception and
does not anticipate paying cash dividends in the foreseeable future. The
Company's bank credit agreement prohibits the payment of cash dividends without
the prior written consent of the lender.
25
<PAGE> 26
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
In 1996, Sanctuary Woods was sued by Starpak, Inc. in the state courts of
Colorado. This action was settled and dismissed with prejudice in November,
1996. The Company's payment to Starpak in connection with the settlement had
been accrued at September 30, 1996.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit
Number Description
11 Computation of Net Income (Loss) Per Common Share
27 Financial Data Schedule
(b) Reports on Form 8-K:
October 30, 1996 (Items 5 and 7 - Other events and exhibits).
26
<PAGE> 27
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
SANCTUARY WOODS MULTIMEDIA CORPORATION
By:____________________________________
Charlotte J. Walker, President
and Chief Executive Officer
By:____________________________________
Peter Nichter
Controller
Principal Financial and
Accounting Officer
Dated: November 13, 1996
27
<PAGE> 28
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
SANCTUARY WOODS MULTIMEDIA CORPORATION
By: /s/ CHARLOTTE J. WALKER
-----------------------------------
Charlotte J. Walker, President
and Chief Executive Officer
By: /s/ PETER NICHTER
-----------------------------------
Peter Nichter
Controller
Principal Financial and
Accounting Officer
Dated: November 13, 1996
28
<PAGE> 29
EXHIBIT LIST
Exhibit Item
- ------- ----
27.1 Financial Data Schedule
11.1 Computation of Net Income (Loss) Per Common Share
29
<PAGE> 1
Exhibit 11.1
COMPUTATION OF NET INCOME (LOSS) PER COMMON SHARE
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
September 30, September 30,
------------- -------------
1996 1995 1996 1995
<S> <C> <C> <C> <C>
NET INCOME (LOSS) $ (420,259) $ 901,362 $ (77,280) $ (2,360,946)
============ ============ ============ ============
PRIMARY SHARES OUTSTANDING:
Common Shares 27,241,164 21,746,262 25,268,183 20,796,651
Performance shares held in escrow (4,000,000) (4,000,000) (4,000,000) (4,000,000)
Common stock equivalents (including stock
options and warrants) 1,425,190 958,774
------------ ------------ ------------ ------------
Total 23,241,164 19,171,452 21,268,183 17,755,425
============ ============ ============ ============
PRIMARY NET LOSS PER SHARE $ (0.02) $ 0.05 $ (0.00) $ (0.13)
============ ============ ============ ============
FULLY DILUTED NET LOSS PER SHARE (1)
NET LOSS $ (420,259) $ 901,362 $ (77,280) $ (2,360,946)
============ ============ ============ ============
FULLY DILUTED SHARES OUTSTANDING:
Common Shares 27,241,164 21,746,262 25,268,183 20,796,651
Convertible Debt 1,271,209 632,131
Common stock equivalents (including stock
options and warrants) 27,090 1,425,190 533,596 1,110,843
------------ ------------ ------------ ------------
Total 28,539,463 23,171,452 26,433,910 21,907,494
============ ============ ============ ============
FULLY DILUTED NET LOSS PER SHARE $ (0.01) $ 0.04 $ (0.00) $ (0.11)
============ ============ ============ ============
</TABLE>
(a) Fully Diluted Net Loss Per Common Share has been presented in accordance
with Regulation S-K Item 601(b)(11) even though the amount of fully diluted loss
per share is not required to be presented in the statement of operations under
the provisions of APB Opinion No. 15 because of the anti-dilutive effects of
including common stock equivalents.
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> MAR-31-1997
<PERIOD-START> JUL-01-1996
<PERIOD-END> SEP-30-1996
<CASH> 3,570,979
<SECURITIES> 0
<RECEIVABLES> 2,125,293
<ALLOWANCES> 1,282,417
<INVENTORY> 927,895
<CURRENT-ASSETS> 5,897,020
<PP&E> 747,895
<DEPRECIATION> 76,512
<TOTAL-ASSETS> 6,920,747
<CURRENT-LIABILITIES> 3,501,125
<BONDS> 0
0
0
<COMMON> 34,736,887
<OTHER-SE> (751,871)
<TOTAL-LIABILITY-AND-EQUITY> 6,920,747
<SALES> 0
<TOTAL-REVENUES> 1,175,972
<CGS> 244,634
<TOTAL-COSTS> 244,634
<OTHER-EXPENSES> 1,438,929
<LOSS-PROVISION> 132,000
<INTEREST-EXPENSE> 32,579
<INCOME-PRETAX> (420,259)
<INCOME-TAX> 0
<INCOME-CONTINUING> (420,259)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (420,259)
<EPS-PRIMARY> (.02)
<EPS-DILUTED> (.02)
</TABLE>
