<PAGE> 1
- --------------------------------------------------------------------------------
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 8-K
CURRENT REPORT
OCTOBER 30, 1996
Date of Report (Date of earliest event reported)
SANCTUARY WOODS MULTIMEDIA CORPORATION
(Exact name of Registrant as specified in its charter)
BRITISH COLUMBIA, CANADA
(State or other jurisdiction of incorporation)
<TABLE>
<S> <C>
0-21510 75-2444109
(Commission File No.) (IRS Employer Identification Number)
</TABLE>
1825 SOUTH GRANT STREET
SAN MATEO, CA 94402
(415) 286-6000
(Address of Principal Executive Offices)
NOT APPLICABLE
(Former name or former address, if changed since last report)
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<PAGE> 2
ITEM 5. OTHER EVENTS
Sanctuary Woods Multimedia Corporation (the "Company") is reissuing its
audited consolidated financial statements as of and for the year ended December
31, 1995 with an unqualified opinion and is also issuing audited consolidated
financial statements as of and for the three months ended March 31, 1996 and
June 30, 1996.
In their report dated April 12, 1996, the Company's independent auditors
were unable to express and did not express an opinion on the Company's 1995
consolidated financial statements because of the possible material effects of
the uncertainty about the Company's ability to continue as a going concern.
In their updated report dated October 11, 1996, the Company's independent
auditors issued an unqualified opinion on the Company's consolidated financial
statements as of and for the year ended December 31, 1995 and also issued an
unqualified opinion on the Company's consolidated financial statements as of and
for the three months ended March 31, 1996 and June 30, 1996.
ITEM 7. EXHIBITS
The following items contain 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 risk factors discussed in
Management's Discussion and Analysis of Financial Condition and Results of
Operations contained in the Company's reports filed on Form 10-Q for the three
month periods ended June 30, 1996 and March 31, 1996 and on Form 10-K, as
amended, for the year ended December 31, 1995.
<TABLE>
<C> <S>
23.1 Independent Auditors' Consent
99.1 Consolidated Financial Statements of Sanctuary Woods Multimedia Corporation and
its subsidiary companies as of and for the periods ended June 30, 1996, March
31,1996, and December 31, 1995, together with the report of Deloitte & Touche LLP,
independent auditors.
</TABLE>
2
<PAGE> 3
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the registrant has duly caused this report to be signed on its behalf
by the undersigned hereunto duly authorized.
Sanctuary Woods Multimedia Corporation
By: /s/ CHARLOTTE J. WALKER
------------------------------------
Charlotte J. Walker
President and Chief Executive
Officer
Dated: October 30, 1996
3
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EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT NO. PAGE NO.
- ----------- --------
<C> <S> <C>
23.1 Independent Auditors' Consent............................................ F-1
99.1 Consolidated Financial Statements of Sanctuary Woods Multimedia F-2
Corporation and its subsidiary companies as of and for the periods ended
June 30, 1996, March 31, 1996, and December 31, 1995, together with the
report of Deloitte & Touche LLP, independent auditors....................
</TABLE>
4
<PAGE> 1
EXHIBIT 23.1
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statement No.
33-96212 of Sanctuary Woods Multimedia Corporation and its subsidiaries (the
"Company") on Form S-8 and Registration Statement No. 33-95464 of the Company on
Form S-3 of our report dated October 11, 1996 appearing in this Current Report
on Form 8-K to be filed on or about October 30, 1996.
DELOITTE & TOUCHE LLP
October 29, 1996
F-1
<PAGE> 1
EXHIBIT 99.1
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of Sanctuary Woods Multimedia
Corporation:
We have audited the accompanying consolidated balance sheets of Sanctuary
Woods Multimedia Corporation as of June 30, 1996, March 31, 1996, and December
31, 1995, and the related consolidated statements of operations, stockholders'
equity (deficit), and cash flows for the three month periods ended June 30, 1996
and March 31, 1996 and the year ended December 31, 1995. Our audits also
included the consolidated financial statement schedule for the periods ended
June 30, 1996, March 31, 1996, and December 31, 1995 appearing on page F-19.
These consolidated financial statements and the consolidated financial statement
schedule are the responsibility of the Company's management. Our responsibility
is to express an opinion on these consolidated financial statements and the
consolidated financial statement schedule 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 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 report dated April 12, 1996, we disclaimed an opinion on the
consolidated financial statements and consolidated financial statement schedule
as of and for the year ended December 31, 1995 because of the possible material
effects of the uncertainty about the Company's ability to continue as a going
concern. As discussed in Note 2, the Company received $5,302,000 from the
issuance of convertible subordinated debentures in September 1996 and has
reduced and amended its bank credit line. Accordingly, our present opinion on
the consolidated financial statements and consolidated financial statement
schedule as of and for the year ended December 31, 1995, as expressed herein, is
different from our prior report on the 1995 consolidated financial statements
and consolidated financial statement schedule.
In our opinion, the accompanying consolidated financial statements present
fairly, in all material respects, the financial position of the Company as of
June 30, 1996, March 31, 1996 and December 31, 1995, and the results of its
operations and its cash flows for the three month periods ended June 30, 1996
and March 31, 1996 and the year ended December 31, 1995 in conformity with
generally accepted accounting principles. Also, in our opinion, the accompanying
consolidated financial statement schedule, when considered in relation to the
basic consolidated financial statements taken as a whole, presents fairly, in
all material respects, the information set forth therein.
DELOITTE & TOUCHE LLP
October 11, 1996
F-2
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SANCTUARY WOODS MULTIMEDIA CORPORATION
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
JUNE 30, MARCH 31, DECEMBER 31,
1996 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
ASSETS
CURRENT ASSETS:
Cash........................................... $ 88,447 $ 8,455 $ 11,484
Accounts receivable............................ 804,996 800,701 1,308,603
Inventories.................................... 1,006,967 1,384,840 1,977,858
Prepaid royalties.............................. 177,000 127,000 80,000
Prepaid expenses............................... 220,492 294,203 662,179
------------ ------------ ------------
Total current assets...................... 2,297,902 2,615,199 4,040,124
PROPERTY AND EQUIPMENT........................... 793,636 1,834,266 2,367,589
DEFERRED ROYALTIES & OTHER....................... 93,571 144,396 190,921
------------ ------------ ------------
TOTAL ASSETS..................................... $ 3,185,109 $ 4,593,861 $ 6,598,634
============ ============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Bank debt...................................... $ 1,135,904 $ 2,226,781 $ 1,800,000
Notes payable.................................. 1,563,666
Accounts payable............................... 2,517,352 3,087,886 2,486,497
Accrued expenses............................... 795,365 1,395,359 1,557,648
Royalty obligations............................ 454,723 611,905 480,884
Current portion of capital lease obligations... 27,810 28,715 29,626
------------ ------------ ------------
Total current liabilities................. 4,931,154 8,914,312 6,354,655
LONG-TERM ROYALTY OBLIGATIONS.................... 84,000 534,000 581,000
CAPITAL LEASE OBLIGATIONS........................ 6,956 13,781 20,359
------------ ------------ ------------
Total liabilities........................... 5,022,110 9,462,093 6,956,014
------------ ------------ ------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY (DEFICIT):
Common Stock, authorized 100,000,000 shares, no
par value, issued and outstanding,
27,241,164 shares, 22,158,580 shares, and
22,153,580 shares respectively.............. 34,446,006 31,763,839 31,754,188
Accumulated deficit............................ (35,531,135) (35,874,113) (31,359,942)
Accumulated translation adjustments............ (751,872) (757,958) (751,626)
------------ ------------ ------------
Total stockholders' equity (deficit)... (1,837,001) (4,868,232) (357,380)
------------ ------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
(DEFICIT)...................................... $ 3,185,109 $ 4,593,861 $ 6,598,634
============ ============ ============
</TABLE>
See notes to consolidated financial statements.
F-3
<PAGE> 3
SANCTUARY WOODS MULTIMEDIA CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
THREE MONTHS ENDED
-------------------------- YEAR ENDED
JUNE 30, MARCH 31, DECEMBER 31,
1996 1996 1995
---------- ----------- ------------
<S> <C> <C> <C>
SALES:
Consumer titles................................... $ 994,716 $ 592,985 $ 8,733,313
Licensing revenue................................. 925,653 338,820 1,678,240
Publisher services................................ 5,807 569,544
---------- ----------- ------------
Total sales............................... 1,920,369 937,612 10,981,097
---------- ----------- ------------
COST OF SALES:
Consumer titles................................... 683,099 759,288 11,413,590
Technology amortization........................... 532,305
Publisher services................................ 164,922 629,936
---------- ----------- ------------
Total cost of sales....................... 683,099 924,210 12,575,831
---------- ----------- ------------
GROSS MARGIN (DEFICIT).............................. 1,237,270 13,402 (1,594,734)
---------- ----------- ------------
OPERATING EXPENSES:
Research and development.......................... 459,064 1,261,391 4,495,963
Marketing and sales............................... 632,080 1,789,866 8,263,739
Administration.................................... 488,631 1,196,553 3,477,922
Depreciation...................................... 135,405 210,932 852,211
---------- ----------- ------------
Total operating expenses.................. 1,715,180 4,458,742 17,089,835
---------- ----------- ------------
OPERATING LOSS...................................... (477,910) (4,445,340) (18,684,569)
---------- ----------- ------------
OTHER INCOME (EXPENSE):
Foreign exchange loss............................. (2,988) (203) (4,307)
Interest expense, net............................. (82,168) (68,628) (9,565)
Net gain on sale and disposal of assets........... 875,161
Other income...................................... 30,883
---------- ----------- ------------
Total other income (expense).............. 820,888 (68,831) (13,872)
---------- ----------- ------------
NET INCOME (LOSS)................................... $ 342,978 $(4,514,171) $(18,698,441)
========== =========== ============
PRIMARY NET INCOME (LOSS) PER SHARE................. $ 0.02 $ (0.25) $ (1.11)
FULLY DILUTED NET INCOME (LOSS) PER SHARE........... $ 0.01 $ (0.25) $ (1.11)
PRIMARY SHARES USED IN COMPUTATION.................. 20,265,464 18,158,085 16,873,748
FULLY DILUTED SHARES USED IN COMPUTATION............ 24,282,820 18,158,085 16,873,748
</TABLE>
See notes to consolidated financial statements.
F-4
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SANCTUARY WOODS MULTIMEDIA CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
COMMON STOCK ACCUMULATED
------------------------- ACCUMULATED TRANSLATION
SHARES AMOUNT DEFICIT ADJUSTMENTS TOTAL
---------- ----------- ------------ ----------- ------------
<S> <C> <C> <C> <C> <C>
Balances, December 31,
1994...................... 19,590,263 $23,396,255 $(12,661,501) $(750,991) $ 9,983,763
Exercise of warrants........ 8,000 22,905 22,905
Exercise of stock options... 555,317 1,033,617 1,033,617
Shares issued for cash...... 2,000,000 7,168,868 7,168,868
Stock option compensation... 132,543 132,543
Foreign currency translation
adjustments............... (635) (635)
Net loss.................... (18,698,441) (18,698,441)
---------- ----------- ------------ -------- ------------
Balances, December 31,
1995...................... 22,153,580 31,754,188 (31,359,942) (751,626) (357,380)
Exercise of stock options,
net of issuance costs..... 5,000 (2,730) (2,730)
Stock option compensation... 12,381 12,381
Foreign currency translation
adjustments............... (6,332) (6,332)
Net loss.................... (4,514,171) (4,514,171)
---------- ----------- ------------ -------- ------------
Balances, March 31, 1996.... 22,158,580 31,763,839 (35,874,113) (757,958) (4,868,232)
Exercise of warrants........ 1,500,000 750,000 750,000
Conversion of notes payable
into common stock......... 3,127,584 1,562,501 1,562,501
Conversion of accounts
payable and royalty
obligations............... 455,000 316,312 316,312
Stock option and warrant
compensation.............. 53,354 53,354
Foreign currency translation
adjustments............... 6,086 6,086
Net income.................. 342,978 342,978
---------- ----------- ------------ -------- ------------
Balances, June 30, 1996..... 27,241,164 $34,446,006 $(35,531,135) $(751,872) $ (1,837,001)
========== =========== ============ ======== ============
</TABLE>
See notes to consolidated financial statements.
F-5
<PAGE> 5
SANCTUARY WOODS MULTIMEDIA CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
THREE MONTHS ENDED
--------------------------- YEAR ENDED
JUNE 30, MARCH 31, DECEMBER 31,
1996 1996 1995
----------- ----------- ------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)................................ $ 342,978 $(4,514,171) $(18,698,441)
Adjustments to reconcile net income (loss) to net
cash used in operating activities:
Depreciation and amortization................. 136,230 211,457 1,709,552
Stock option and warrant compensation......... 53,254 12,381 132,543
Sale of intellectual property rights in
consideration for a reduction in royalty
obligations................................. (429,688)
Net (gain) loss on sale and disposal of
assets...................................... (875,161)
Consolidation of facilities and other items... 401,658
Changes in assets and liabilities:
Accounts receivable......................... (4,295) 507,902 1,609,655
Inventories................................. 377,873 593,018 (1,277,633)
Prepaid royalties, expenses and other....... 73,711 366,976 2,559,527
Accounts payable and accrued expenses....... (1,095,208) 439,100 2,148,494
Accrued royalty obligations................. (57,182) 84,021 91,884
----------- ----------- ------------
Net cash used in operating activities.... (1,477,488) (1,897,658) (11,724,419)
----------- ----------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of assets..................... 1,900,000
Purchase of property and equipment............... (79,267) (958,283)
----------- ----------- ------------
Net cash provided (used) in investing
activities............................. 1,900,000 (79,267) (958,283)
----------- ----------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of notes.................. 1,556,177
Proceeds from exercise of warrants............... 750,000
Common stock issued -- net of issue costs........ (2,730) 8,225,390
Net (repayments) borrowings on bank debt......... (1,090,877) 426,781 1,800,000
Repayments on long-term debt..................... (7,730)
----------- ----------- ------------
Net cash used (provided) in financing
activities............................. (348,607) 1,980,228 10,025,390
----------- ----------- ------------
EFFECT OF EXCHANGE RATE CHANGES ON CASH............ 6,087 (6,332) (635)
----------- ----------- ------------
NET INCREASE (DECREASE) IN CASH.................... 79,992 (3,029) (2,657,947)
CASH, BEGINNING OF PERIOD.......................... 8,455 11,484 2,669,431
----------- ----------- ------------
CASH, END OF PERIOD................................ $ 88,447 $ 8,455 $ 11,484
=========== =========== ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest...................................... $ 2,200 $ 57,985 $ 73,972
Income taxes.................................. 800 1,600
SUPPLEMENTAL SCHEDULE OF NON-CASH FINANCING AND
INVESTING ACTIVITIES:
Conversion of notes payable into common
stock....................................... $ 1,562,501
Reduction in royalty obligations in exchange
for issuance of common stock and sale of
intellectual property rights................ 549,688
Conversion of account payable into common
stock....................................... 195,000
Capital lease obligations..................... $ 49,985
</TABLE>
See notes to consolidated financial statements.
F-6
<PAGE> 6
SANCTUARY WOODS MULTIMEDIA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 consolidated financial statements include
the Company's fiscal year ended December 31, 1995 and the three month periods
ended March 31, 1996 and June 30, 1996 (the first quarter of the fiscal year
ending March 31, 1997).
2. HISTORICAL OPERATING LOSSES AND CERTAIN MANAGEMENT ACTIONS
1995 Net Loss
The Company incurred a net loss of $18,698,441 in 1995. Net cash used by
operating activities in 1995 was $11,724,419. At December 31, 1995 the Company
had cash of $11,484 and bank borrowings of $1,800,000 which were due April 15,
1996. A number of factors contributed to the Company's 1995 net loss. Sales of
the Company's products in the fourth quarter 1995 were significantly below
expectations and the Company experienced significantly higher than expected
returns. In light of the continued competitive pressures in the marketplace,
inventory levels in the retail channel, the introduction of competitive
products, downward pricing pressures and the focusing of the Company's
operations and cash resources on products targeted at the children's education
markets in the fourth quarter of 1995, the Company accelerated write-offs of
certain prepaid and deferred royalties and made additional provisions for
returns, price protection and inventory obsolescence.
The Company's 1995 net loss included certain significant adjustments
recorded in the fourth quarter related to these matters as follows:
<TABLE>
<S> <C>
Estimated sales returns and price protection............................ $ 5,475,002
Write-offs of unrecoverable prepaid and deferred royalties.............. 4,260,532
Provision for inventory obsolesence..................................... 1,033,389
Write-offs of licenses and other intangibles............................ 235,000
-----------
Total......................................................... $11,003,923
===========
</TABLE>
Calendar 1996 Operations
Beginning in 1996, the Company commenced reorganization of its operations.
A major part of that reorganization involved ceasing publication of new
entertainment titles and eliminating the Publisher Services Division. In the
three months ended March 31, 1996, the Company incurred a net loss of
$4,514,171. Net cash used by operating activities was $1,897,658 in this period.
Costs incurred from reorganization, including severance, site closure and
consolidation, significantly contributed to the net loss. Additionally, there
were charges taken against accounts receivable and inventories. These charges
(mostly for entertainment titles) resulted from a review of product inventories
in the distribution channel and the price relief required to sell
F-7
<PAGE> 7
SANCTUARY WOODS MULTIMEDIA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
them through to the consumer and an evaluation of the salability of inventories
on hand. The amount of these expenses included the following:
<TABLE>
<S> <C>
Closure of Publisher Services Division................................... $ 437,000
Severance expenses....................................................... 210,000
Consolidation of facilities and related items............................ 358,000
Estimated sales returns and price protection............................. 426,000
Provision for inventory obsolescence..................................... 250,000
----------
Total.......................................................... $1,681,000
==========
</TABLE>
In the three months ended June 30, 1996, the Company had net income of
$342,978. Net cash used by operating activities was $1,477,488 in such period.
The net income was primarily due to the gain of $897,260 on the sale of the
Company's studio in Victoria, British Columbia and related entertainment assets.
During the three months ended June 30, 1996, the Company continued actions
to eliminate its entertainment business and related products (see "1996
Management Actions" below). Revenues and expenses for the three months ended
June 30, 1996 included the following items related to entertainment operations
and products:
<TABLE>
<S> <C>
Revenues --
Sale of rights to certain entertainment products.......................... $580,000
========
Expenses --
Victoria studio operating expenses (studio sold in May 1996).............. $250,000
Consolidation of facilities and related items............................. 47,500
Estimated sales returns and price protection.............................. 150,000
Provision for inventory obsolescence...................................... 100,000
--------
Total........................................................... $547,500
========
Other income -- net gain on sale and disposal of assets................... $875,161
========
</TABLE>
Operating losses totalled more than $23,600,000 for the eighteen months
ended June 30, 1996. Due to these operating losses, the Company experienced
severe liquidity problems through September 18, 1996. The Company had difficulty
generating sufficient cash flows to meet its obligations and sustain its
operations. On June 30, 1996 the Company had $88,447 in cash and bank borrowings
of $1,135,904.
1996 Management Actions
During 1996, the Company instituted measures to improve operations and cash
flows to continue its operations. Specific items accomplished through October
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 43 at
October 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 the studio in Victoria, British
Columbia during May 1996 for $1,900,000, of which $500,000 was used to
F-8
<PAGE> 8
SANCTUARY WOODS MULTIMEDIA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
reduce bank borrowings. The gain on the sale of the studio, included in
other income for the three months ended June 30, 1996, totaled $897,260.
- Reduction by $1,822,000 of the outstanding borrowings under the bank line
of credit from its January 1996 peak level of $2,572,000 to $750,000 at
October 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 three
months ended June 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 three months ended June 30, 1996.
March 1996 Financing
In February and March 1996, the Company privately placed for cash
$1,500,000 principal amount of 10% convertible notes. These notes included
$100,000 principal amount of notes sold to two of the Company's officers. In
June 1996, all of the notes, plus accrued interest, were converted into
3,077,584 shares of common stock, the holders of which have certain registration
rights. In connection with the issuance of the notes, warrants were issued to
purchase a total of 1,875,000 shares of common stock at an exercise price of
$.50 per share. In June 1996, certain of the convertible note holders exercised,
for $750,000 in cash, warrants to purchase 1,500,000 shares of stock. The
holders of these shares have certain registration rights.
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 10.75% at June
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.
As part of the consideration for the original revolving credit facility,
the bank was granted a warrant to purchase 100,000 shares of common stock at
$2.80 per share (the fair market value of the Company's common stock at March
10, 1995). This warrant contained a stock appreciation right which when
exercised resulted in a non-cash charge to administrative expenses in the second
quarter of 1995 totaling $395,000 based upon the $6.75 per share fair market
value of the Company's common stock at the notice date. On October 25,
F-9
<PAGE> 9
SANCTUARY WOODS MULTIMEDIA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1995 the Company paid the bank $428,750 in settlement of the stock appreciation
right and recorded an additional $33,750 of expense related to this payment.
In connection with the 1996 amendments to the bank credit agreement, the
Company issued the Bank warrants to purchase 400,000 shares of common stock at
prices from $.50 to $.5625 per share and agreed to pay $69,626 in fees and legal
expenses.
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. 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 will be shown on the Company's consolidated balance
sheet as long-term debt.
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 converted 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.
* * * *
At October 11, 1996, the Company had cash of $2,800,000 and bank borrowings
of $750,000. 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. SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION -- The consolidated financial statements have been
prepared in accordance with generally accepted accounting principles of the
United States of America (U.S. GAAP).
a.Consolidation -- The consolidated financial statements include the accounts of
Sanctuary Woods Multimedia Corporation (a Canadian corporation) and its
wholly-owned subsidiaries, Magic Quest Inc. (California, U.S.A.) and Sanctuary
Woods Multimedia Inc. (Nevada, U.S.A.). All intercompany balances and
transactions are eliminated in consolidation.
b. Foreign Currency Translation -- The consolidated financial statements are
stated in U.S. dollars. Assets and liabilities of foreign operations that
have a different functional currency are translated into their U.S. dollar
equivalents based on the rate of exchange as of the balance sheet dates.
Revenue and expense accounts are translated based on average rates of
exchange during the period. Gains or losses resulting
F-10
<PAGE> 10
SANCTUARY WOODS MULTIMEDIA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
from foreign currency translation are reported as a separate component of
stockholders' equity. Foreign currency transaction gains and losses are
included in the statements of operations.
c. Use of Estimates. The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amount of assets and
liabilities, the disclosure of contingent assets and liabilities at the date
of the financial statements, and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
d. Inventories consist of finished goods and raw materials and are stated at
the lower of cost (first-in, first-out) or market (net realizable value).
The Company estimates the net realizable value of inventories based on
anticipated future revenues. It is reasonably possible that such estimates
of anticipated future revenues will be significantly reduced in the near
term due to competitive pricing pressures. In the event that inventory
cannot be sold above its estimated net realizable value, the Company could
incur significant additional write-offs in the near term.
e. Prepaid and Deferred Royalties represent prepayments made and current
guaranteed minimum payments to be made under licensing and development
agreements. Prepaid and deferred royalties are expensed as cost of goods
sold based on actual net product sales and are classified as current or
noncurrent based upon estimated product sales within the next year.
Management estimates the future value of prepaid and deferred royalties
quarterly and any amounts that management deems unlikely to be recouped
through anticipated product sales are charged to cost of goods sold.
Royalty Obligations represent guaranteed minimum royalty payments to be made
pursuant to contractual license agreements. Generally, royalties are
calculated based on a percentage of sales ranging from 5% to 35%. Royalty
expense was $50,000 in the three months ended June 30, 1996, $94,340 in the
three months ended March 31, 1996 and $7,233,046 in the fiscal year ended
December 31, 1995. Such 1995 royalty expense includes write-offs of prepaid
and deferred royalties totalling $4,260,532 (see Note 2).
f. Property and Equipment are recorded at cost and depreciation is provided
using the declining balance method over the following useful lives:
<TABLE>
<S> <C>
Computer equipment.......................................... 3 years
Computer software........................................... 3 years
Furniture and equipment..................................... 5 years
</TABLE>
Leasehold improvements are amortized using the straight-line method over
the term of the lease.
g. Technology Amortization represents the amortization of the cost of
technology acquired through the 1994 acquisition of Magic Quest Inc. and
relates to products for which technological feasibility had been
established. Amortization of the deferred development expenditures commenced
in 1994 upon release of such products and is included in cost of sales.
Amounts were amortized using the straight-line method and were fully
amortized as of December 31, 1995.
h. Research and Development Expenses -- Software development costs incurred
prior to achieving technological feasibility are treated as research and
development expenses and are expensed as incurred. All software development
costs incurred by the Company in 1996 and 1995 have been expensed.
The establishment of technological feasibility and the ongoing assessment of
recoverability of capitalized software development costs requires
considerable judgment by management with respect to certain factors
affecting the Company's products, including, but not limited to, anticipated
future gross revenues, estimated economic life and changes in software and
hardware technologies. Amounts that could have been capitalized after
consideration of the above factors, were immaterial and, therefore, no costs
have been capitalized.
F-11
<PAGE> 11
SANCTUARY WOODS MULTIMEDIA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
i. Licenses and Other Intangibles -- The Company capitalizes costs relating to
the acquisition of licenses, copyrights and trademarks. These costs are
capitalized until the related products are available for sale, at which
time they are amortized against income using the straight-line method over
management's estimate of the economic lives of the underlying assets,
generally five years. In the fourth quarter of 1995, such estimates of the
economic lives were significantly reduced and $235,000 of licenses and
other intangibles were written-off.
j. Revenue Recognition -- Revenue from product sales is recognized when
products are shipped. The Company provides estimated reserves for future
returns and price protection. It is reasonably possible that actual future
returns and price protection allowances could exceed such estimates. As a
result, the Company's reserves could be significantly increased in the near
term.
Certain revenue from sales and licensing agreements is recognized when the
Company fulfills its obligations under the related agreements. These
include the Company's delivery of software and associated documentation to
the licensee in reproducible form. Royalty income from subsequent product
sales during the licensing period is recorded in the period the products
are sold by the licensee.
Revenue from publisher services was recognized when earned.
k. Income taxes are recorded using the asset and liability approach as defined
by the Statement of Financial Accounting Standards No. 109 "Accounting for
Income Taxes".
l. Net income (loss) per share. Primary earnings per share equals net income
(loss) divided by the weighted average number of shares outstanding after
giving effect to dilutive stock options and warrants. The weighted average
number of shares used in computing primary net income (loss) per share
excludes 4,000,000 performance shares issued and outstanding but not yet
earned (see note 15).
Fully diluted earnings per share equals net income (loss) divided by the
weighted average number of shares outstanding after giving effect to
dilutive stock options and warrants, the 4,000,000 performance shares and
other dilutive securities, if not anti-dilutive.
Net income (loss) per share calculations for all periods presented exclude
the effects of 12,291,000 contingently issuable common shares related to
the September 1996 issuance of convertible subordinated debentures and
related warrants (see note 2).
m. New accounting standards -- The Company adopted Statement of Financial
Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based
Compensation" in the three months ended March 31, 1996. SFAS No. 123
establishes accounting and disclosure requirements using a fair value-based
method of accounting for stock-based employee compensation plans. As allowed
under the provisions of SFAS No. 123, the Company has chosen to continue
using the intrinsic value-based method of option valuation ("APB 25") and
provide pro forma disclosures (see note 9) of net income (loss) and earnings
(loss) per share as if the accounting provisions of SFAS No. 123 had been
adopted.
The Black-Scholes model used by the Company to calculate option values
pursuant to SFAS No. 123, as well as other currently accepted option
valuation models, was developed to estimate the fair value of freely
tradable, fully transferable options without vesting restrictions, which
significantly differ from the Company's stock option awards. These models
also incorporate highly subjective assumptions, including future stock price
volatility and expected time until exercise, which greatly affect the
calculated values. Due to the downward trend in the Company's stock price
over the past 12 months, management believes the future stock price
volatility assumption is extremely high. Under the Black-Scholes pricing
model, stocks with high volatility provide option holders with a greater
economic "upside" potential and, accordingly, result in a high option
valuation. Thus management believes that the Black-Scholes model does not
necessarily provide a reliable single measure of the fair value of the
Company's option awards.
F-12
<PAGE> 12
SANCTUARY WOODS MULTIMEDIA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company adopted SFAS No. 121, "Accounting for the Impairment of Long
Lived Assets and Long Lived Assets to be Disposed Of " in the three months
ended March 31,1996. SFAS No. 121 establishes recognition and measurement
criteria for losses whenever events or changes in circumstances indicate
that the carrying value of assets may not be recoverable. There was no
effect on the Company's consolidated financial statements as a result of
the adoption of SFAS No. 121.
4. 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 allowances and necessary price protection.
Accounts receivable consisted of:
<TABLE>
<CAPTION>
JUNE 30, MARCH 31, DECEMBER
1996 1996 31, 1995
----------- ----------- -----------
<S> <C> <C> <C>
Accounts receivable -- trade................ $ 2,779,921 $ 4,814,104 $ 6,936,840
Less allowances for:
Doubtful accounts......................... (80,810) (207,352) (200,001)
Sales returns and allowances.............. (1,894,115) (3,806,051) (5,428,236)
---------- ---------- ----------
Accounts receivable -- net.................. $ 804,996 $ 800,701 $ 1,308,603
========== ========== ==========
</TABLE>
As a result of reduced fourth quarter 1995 sales and significantly
increased requests for returns in the three months ended March 31, 1996, the
Company provided $5,475,002 for returns and price protection during the fourth
quarter of 1995. These reserves relate primarily to products sold during the
third quarter of 1995 (see Note 2). The provision for returns and price
protection was $376,362 and $510,827 in the three months ended June 30, 1996 and
March 31, 1996, respectively.
5. INVENTORIES
Inventories consisted of:
<TABLE>
<CAPTION>
JUNE 30, MARCH 31, DECEMBER
1996 1996 31, 1995
----------- ----------- -----------
<S> <C> <C> <C>
Finished goods.............................. $ 1,529,355 $ 1,967,558 $ 2,532,033
Raw materials............................... 725,258 866,957 963,825
----------- ----------- -----------
2,254,613 2,834,515 3,495,858
Less allowance for obsolete, slowmoving and
non-salable inventories................... (1,247,646) (1,449,675) (1,518,000)
----------- ----------- -----------
Inventories, net............................ $ 1,006,967 $ 1,384,840 $ 1,977,858
=========== =========== ===========
</TABLE>
Inventory write downs were $150,000 and $250,000 respectively for the three
months ended June 30, 1996, and March 31, 1996, and $1,083,389 for the fiscal
year ended December 31, 1995.
F-13
<PAGE> 13
SANCTUARY WOODS MULTIMEDIA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
6. PROPERTY AND EQUIPMENT
Property and equipment consisted of:
<TABLE>
<CAPTION>
JUNE 30, MARCH 31, DECEMBER 31,
1996 1996 1995
---------- ----------- ------------
<S> <C> <C> <C>
Computer equipment........................... $ 861,507 $ 2,318,965 $ 2,451,876
Computer software............................ 141,823 477,188 516,427
Furniture and equipment...................... 332,917 504,287 840,913
Leasehold improvements....................... 76,864 243,659 270,028
---------- ----------- -----------
Total.............................. 1,413,111 3,544,099 4,079,244
Less accumulated depreciation................ (619,475) (1,709,833) (1,711,655)
---------- ----------- -----------
Property and equipment, net.................. $ 793,636 $ 1,834,266 $ 2,367,589
========== =========== ===========
</TABLE>
As discussed in Note 2, in May 1996 the Company sold its Victoria, British
Columbia studio. At March 31, 1996 and December 31, 1995, net property and
equipment included approximately $1,000,000 related to such operations.
7. LICENSES AND OTHER INTANGIBLES
Licenses and intangibles included in other assets consisted of:
<TABLE>
<CAPTION>
JUNE 30, MARCH 31, DECEMBER 31,
1996 1996 1995
-------- --------- ------------
<S> <C> <C> <C>
Trademarks and copyrights.......................... $ 4,571 $ 4,571 $ 53,960
Product licenses................................... 6,930 6,930 405,608
------- ------- ---------
11,501 11,501 459,568
Less accumulated amortization...................... (1,929) (1,104) (449,647)
------- ------- ---------
Licenses and other intangibles, net................ $ 9,572 $10,397 $ 9,921
======= ======= =========
</TABLE>
In the year ended December 31, 1995, amortization of licenses and
intangibles of $325,036 was included in cost of sales.
8. COMMON STOCK, OPTIONS AND WARRANTS
On July 14, 1995, the Company issued for cash 2,000,000 shares of common
stock at $4.00 per share.
STOCK OPTIONS -- Stock options for employees, officers, independent
contractors and directors are granted by the Board of Directors subject to
approval by the Vancouver Stock Exchange.
Prior to August 1995, options were granted at a discount of 10-15% to fair
market value. Under the provisions of APB 25, the Company recorded as
compensation expense an amount equal to the difference between the fair market
value of the stock and the exercise price of the option at the date of grant or
repricing. The related expense is amortized over the option vesting period.
Compensation expense was $8,254, $12,381 and $132,543 in the three months ended
June 30, 1996 and March 31, 1996 and the year ended December 31, 1995,
respectively.
In August 1995, the Company adopted a fixed option plan allowing the
Company to grant options for up to 1,970,000 shares of common stock. Under the
plan, the exercise price of each option equals the market price of the Company's
stock on the date of grant. The options generally vest over a three-year period
and expire five years from the date of grant.
F-14
<PAGE> 14
SANCTUARY WOODS MULTIMEDIA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Option activity is summarized as follows:
<TABLE>
<CAPTION>
OUTSTANDING OPTIONS
-----------------------------
NUMBER PRICE PER
OF SHARES SHARE
---------- --------------
<S> <C> <C>
Outstanding at December 31, 1994......................... 1,742,443 $ .71 - 6.34
Granted.................................................. 1,640,500 $ 2.34 - 6.31
Exercised................................................ (555,317) $ .73 - 3.66
Canceled................................................. (284,788) $ 1.89 - 6.13
----------
Outstanding at December 31, 1995......................... 2,542,838 $ .72 - 6.34
Granted.................................................. 404,000 $0.875 - 1.375
Exercised................................................ (5,000) $ 1.91
Canceled................................................. (854,864) $ 1.90 - 6.31
----------
Outstanding at March 31, 1996............................ 2,086,974 $ .72 - 6.34
Granted.................................................. 1,818,750 $0.875
Canceled................................................. (1,282,089) $0.875 - 6.31
----------
Outstanding at June 30, 1996............................. 2,623,635
==========
Shares exercisable at June 30, 1996...................... 1,205,102
==========
Shares available for grant at June 30, 1996.............. 93,000
==========
</TABLE>
On May 31, 1996, the Company repriced 826,750 options (originally granted
at an exercise price of $1.375 to $6.125) to $0.875 per share.
STOCK WARRANTS -- During 1996, warrants to purchase a total of 1,585,000
shares of common stock were issued to a bank (see Note 2), and to others who
provide professional services to the Company. Warrants to purchase 1,960,000
shares of common stock at $0.50 to $0.6875 per share were outstanding at June
30, 1996. See Note 2 for discussion regarding warrants to purchase 2,651,000
shares issued in September 1996 in conjunction with the issuance of convertible
subordinated debentures.
9. SFAS NO. 123 PRO FORMA DISCLOSURES
The Company applies APB No. 25 in accounting for its stock options. Had
compensation cost been determined consistent with SFAS No. 123, the Company's
net income (loss) and earnings (loss) per share would have been changed to the
pro forma amounts indicated below:
<TABLE>
<CAPTION>
THREE MONTHS ENDED YEAR ENDED
---------------------- ------------
JUNE 30, MARCH 31, DECEMBER 31,
1996 1996 1995
-------- ----------- ------------
<S> <C> <C> <C>
Net income (loss):
As reported.................................... $342,978 $(4,514,171) $(18,698,441)
Pro forma...................................... (87,738) (4,836,135) (19,286,849)
Primary net income (loss) per share:
As reported.................................... $ .02 $ (.25) $ (1.11)
Pro forma...................................... .00 (.27) (1.20)
Fully diluted net income (loss) per share:
As reported.................................... $ .01 $ (.25) $ (1.11)
Pro forma...................................... .00 (.27) $ (1.20)
</TABLE>
F-15
<PAGE> 15
SANCTUARY WOODS MULTIMEDIA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The fair value of each option grant was estimated on the date of grant
using the Black-Scholes option pricing model with the following weighted-average
assumptions:
<TABLE>
<CAPTION>
THREE MONTHS ENDED YEAR ENDED
-------------------- ------------
JUNE 30, MARCH 31, DECEMBER 31,
1996 1996 1995
-------- --------- ------------
<S> <C> <C> <C>
Dividend Yield......................................... 0% 0% 0%
Volatility............................................. .98 .98 .89
Risk free Interest..................................... 5.75% 5.75% 5.31%
Expected Term (yrs).................................... .72 .72 .72
</TABLE>
The following table summarizes information about fixed stock options
outstanding at June 30, 1996:
<TABLE>
<CAPTION>
OUTSTANDING
-----------------------------------------
WEIGHTED EXCERCISABLE
AVERAGE ---------------------------
NUMBER REMAINING WEIGHTED NUMBER WEIGHTED
RANGE OF OUTSTANDING AT LIFE AVERAGE EXERCISABLE AT AVERAGE
EXERCISE JUNE 30, (IN EXERCISE JUNE 30, EXERCISE
PRICES 1996 YEARS) PRICE 1996 PRICE
- ------------ -------------- --------- -------- -------------- --------
<S> <C> <C> <C> <C> <C>
$.875 2,118,084 4.73 $ .875 702,551 $ .875
$1.84 - 2.85 337,551 2.27 $ 2.29 337,551 $ 2.29
$5.75 - 6.31 168,000 4.12 $ 5.79 165,000 $ 5.78
--------- ---------
2,623,635 1,205,102
========= =========
</TABLE>
10. INCOME TAXES
Deferred income taxes, which result from temporary differences in the
recognition of revenue and expense for tax and financial reporting purposes,
relate to:
<TABLE>
<CAPTION>
JUNE 30, MARCH 31, DECEMBER 31,
1996 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
Reserves and accruals........................ $ 1,384,000 $ 2,327,000 $ 3,397,000
Deferred development expenditures............ 321,000 321,000 321,000
Depreciation and amortization................ 204,000 (84,000) (105,000)
Operating loss carryforwards................. 12,612,000 11,530,000 9,246,000
Tax credits.................................. 239,000 239,000 239,000
Valuation allowance.......................... (14,760,000) (14,333,000) (13,098,000)
------------ ------------ ------------
Net deferred taxes........................... $ 0 $ 0 $ 0
============ ============ ============
</TABLE>
The Company has recorded a 100% valuation allowance against the deferred
tax assets reflecting the uncertainty of their future realization.
At June 30, 1996 the Company had approximately $15,100,000, $15,600,000 and
$7,900,000 of net operating loss carryforwards to reduce future taxable income
for foreign, federal and state purposes, respectively. If not utilized, these
carryforwards expire beginning in the year 2000.
11. MAJOR CUSTOMERS
During the three months ended June 30,1996 the Company had sales to two
customers that represented 20% and 11% of total net sales. During the three
months ended March 31, 1996 the Company had sales to two customers that
represented 22% and 16% of total net sales. During the year ended December 31,
1995, the Company had sales to two customers that represented 16% and 11% of
total net sales.
F-16
<PAGE> 16
SANCTUARY WOODS MULTIMEDIA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
12. RELATED PARTY TRANSACTIONS
At December 31, 1995 the Company had a $24,500 non-interest-bearing
unsecured loan receivable from an officer. The amount was included in accounts
receivable. Pursuant to a severance package for the officer, the note was
forgiven and expensed (net of repayments totalling $4,655) as compensation in
March 1996.
13. COMMITMENTS AND CONTINGENCIES
a. Litigation -- The lawsuit Quadra Interactive v Presto Studios, Sanctuary
Woods, et al. was settled as of May 24, 1996, and the entire case was dismissed
with prejudice. Sanctuary Woods received a full release of all claims and made
no payment to settle the case.
In 1996, Sanctuary Woods was sued by Starpak, Inc. in the state courts of
Colorado. Starpak's complaint alleges breach of contract, and claims damages in
the amount of $103,093 plus fees, interest and costs. Starpak was engaged by
Sanctuary Woods to provide high quality technical support, customer service, and
product fulfillment services to Sanctuary Woods' customers; however it is
Sanctuary Woods' contention that Starpak failed to do so. Sanctuary Woods has
removed the case to the United States District Court for the District of
Colorado. Sanctuary Woods denies any liability for this claim, and has
counterclaimed against Starpak stating causes of action for breach of fiduciary
duty, fraud and deceit, negligent misrepresentation, conversion, breach of
contract, breach of the implied covenant of fair dealing, interference with
contractual relations, interference with prospective economic advantage and
declaratory relief. The case is in a very early stage of litigation. Management
believes that the ultimate outcome of the case will not have a material adverse
impact on the Company's financial statements or the results of its operations
taken as a whole.
The Company is a party to various other claims, litigation and threatened
litigation in the normal course of operations. Management believes, based upon
the advice of counsel, that the ultimate resolution of all the litigation
matters described above will not have a material adverse effect on the Company's
financial statements taken as a whole.
b. Lease Obligations -- The Company leases its facilities and certain
equipment under noncancellable operating lease agreements. The lease terms
include future rent increases based on inflation.
The future minimum annual lease payments are as follows:
<TABLE>
<S> <C>
Fiscal year ending March 31:
1997............................................................ $312,387
1998............................................................ 284,165
1999............................................................ 218,325
Thereafter...................................................... 43,426
-------
Total................................................... $858,303
=======
</TABLE>
Rent expense under operating leases totalled $82,320, $134,188 and $494,711
in the three months ended June 30, 1996 and March 31, 1996 and the year ended
December 31, 1995, respectively.
F-17
<PAGE> 17
SANCTUARY WOODS MULTIMEDIA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company also leases certain equipment under a capital lease. Future
minimum annual lease payments are as follows:
<TABLE>
<S> <C>
Fiscal year ending March 31:
1997............................................................. $25,360
1998............................................................. 13,748
-------
39,108
Interest......................................................... 3,014
-------
Total.................................................... $42,122
=======
</TABLE>
15. 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
$0.01 per share originally paid for the Performance Shares then issuable and the
market price of its common stock at that time. Such a pro rata or full expense
recognition will occur prior to the pro rata or full release from escrow of the
Performance Shares. If and when such expense recognition criteria are achieved,
based on the closing price of the Company's common stock on the Vancouver Stock
exchange at October 11, 1996, of aprroximately US$.46 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
$1,840,000. 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 October 11, 1996,
no Performance Shares have been earned or released.
F-18
<PAGE> 18
SANCTUARY WOODS MULTIMEDIA CORPORATION
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
BALANCE AT CHARGED BALANCE AT
BEGINNING TO WRITE-OFFS/ END
OF PERIOD EXPENSE RETURNS OTHER OF PERIOD
---------- ---------- ----------- -------- ----------
<S> <C> <C> <C> <C> <C>
THREE MONTHS ENDED JUNE 30, 1996
Allowance For Doubtful Accounts...... $ 207,352 $ $ (126,542) $ $ 80,810
Sales Returns & Allowances........... 3,806,051 564,096 (2,476,032) 1,894,115
Inventory Obsolescence............... 1,449,675 150,000 (352,029) 1,247,646
THREE MONTHS ENDED MARCH 31, 1996
Allowance For Doubtful Accounts...... 200,000 16,071 (8,719) 207,352
Sales Returns & Allowances........... 5,428,236 623,385 (2,245,570) 3,806,051
Inventory Obsolescence............... 1,518,000 250,000 (318,325) 1,449,675
YEAR ENDED DECEMBER 31, 1995
Allowance For Doubtful Accounts...... 217,000 118,968 (135,967) 200,001
Sales Returns & Allowances........... 414,275 8,168,460 (3,396,414) 241,915 5,428,236
Inventory Obsolescence............... 298,723 1,083,389 (132,255) 268,143 1,518,000
</TABLE>
F-19
