<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1997
Commission file number 0-21510
SANCTUARY WOODS MULTIMEDIA CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 75-2444109
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
1250 45TH STREET, SUITE 350
EMERYVILLE, CALIFORNIA 94608-2924
(Address of principal executive offices)
(Zip Code)
(510) 594-3200
(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 No X
--- ---
As of October 22, 1998, 5,193,303 shares of the Registrant's Common
Stock, $0.001 par value, and 99,993 shares of the Registrant's Series A
Preferred Stock, $0.001 par value, were issued and outstanding.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
SANCTUARY WOODS MULTIMEDIA CORPORATION
INDEX
<TABLE>
<CAPTION>
PAGE NO.
--------
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets --
As of September 30, 1997 and March 31, 1997........................ 3
Condensed Consolidated Statements of Operations --
Three and Six Months Ended September 30, 1997 and
September 30, 1996................................................. 4
Condensed Consolidated Statements of Cash Flows --
Six Months Ended September 30, 1997 and
September 30, 1996................................................. 5
Notes to Condensed Consolidated Financial Statements.................. 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations............................................. 12
Item 3. Quantitative and Qualitative Disclosures About Market Risk.............. 24
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.................................................... 24
Item 2. Changes in Securities................................................ 26
Item 3. Defaults Upon Senior Securities...................................... 26
Item 4. Submission of Matters to a Vote of Securities Holders................ 26
Item 5. Other Information.................................................... 26
Item 6. Exhibits and Reports on Form 8-K..................................... 27
SIGNATURES........................................................................ 27
</TABLE>
-2-
<PAGE>
Sanctuary Woods Multimedia Corporation
Condensed Consolidated Balance Sheet
As of September 30, 1997 and March 31, 1997 (Unaudited)
<TABLE>
<CAPTION>
9/30/97 3/31/97
------- -------
<S> <C> <C>
ASSETS
Current assets:
Cash $ 45,000 $ 102,000
Accounts receivable, net 162,000 275,000
Inventories 433,000 656,000
Prepaid royalties - 198,000
Prepaid expenses - 244,000
Prepaid offering expenses - 91,000
---------- ----------
Total current assets 640,000 1,566,000
Property and equipment, net 271,000 462,000
Deferred warrant expense and other 24,000 258,000
---------- ----------
Total assets $ 935,000 $2,286,000
---------- ----------
---------- ----------
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable $2,118,000 $1,343,000
Accrued expenses and interest 1,080,000 804,000
Royalty obligations 289,000 371,000
Capital lease obligations 500,000 14,000
Line of credit 394,000
---------- ----------
Total current liabilities 4,381,000 2,532,000
8% convertible subordinated debentures - 5,302,000
---------- ----------
Total liabilities 4,381,000 7,834,000
Commitments and contingencies
Stockholders' deficit:
Preferred stock, authorized 5,000,000 shares;
$0.001 par value; Series A issued and outstanding
99,993 and nil shares at September 30, 1997 and
March 31, 1997, respectively
Common stock, authorized 50,000,000 shares;
$0.001 par value; issued and outstanding
5,193,303 and 1,171,582 shares at September 30,
1997 and March 31, 1997, respectively 5,000 1,000
Additional paid-in capital 51,618,000 34,754,000
Accumulated deficit (54,317,000) (39,551,000)
Accumulated translation adjustments (752,000) (752,000)
---------- ----------
Total stockholders' deficit (3,446,000) (5,548,000)
---------- ----------
Total liabilities and stockholders' deficit $ 935,000 $ 2,286,000
---------- ----------
---------- ----------
</TABLE>
See notes to consolidated financial statements
-3-
<PAGE>
Sanctuary Woods Multimedia Corporation
Condensed Consolidated Statement of Operations (Unaudited)
<TABLE>
<CAPTION>
Three Months ended Six Months ended
September 30, September 30,
------------- -------------
1997 1996 1997 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net revenues $ 319,000 $1,176,000 $ 1,006,000 $3,096,000
Cost of revenues 606,000 245,000 932,000 927,000
------------ ---------- ------------ ----------
Gross margin (deficit) (287,000) 931,000 74,000 2,169,000
Operating expenses:
Research and development 2,466,000 272,000 2,849,000 806,000
Marketing and sales 1,081,000 638,000 1,815,000 1,287,000
Administration 405,000 529,000 939,000 1,061,000
Write-off of goodwill 8,142,000 - 8,142,000 -
------------ ---------- ------------ ----------
Total operating expenses 12,094,000 1,439,000 13,745,000 3,154,000
------------ ---------- ------------ ----------
Operating income (loss) (12,381,000) (508,000) (13,671,000) (985,000)
Other income (expense):
Foreign exchange loss - (3,000)
Interest (expense) income, net (16,000) (32,000) (17,000) (115,000)
Net gain (loss) on sale and
disposal of assets (1,076,000) - (1,076,000) 875,000
Other income (7,000) 120,000 (2,000) 151,000
------------ ---------- ------------ ----------
Total other income (expense) (1,099,000) 88,000 (1,095,000) 908,000
------------ ---------- ------------ ----------
Net loss $(13,480,000) $ (420,000) $(14,766,000) $ (77,000)
------------ ---------- ------------ ----------
------------ ---------- ------------ ----------
Basic and diluted loss per share $ (3.58) $ (0.36) $ (5.18) $ (0.07)
------------ ---------- ------------ ----------
------------ ---------- ------------ ----------
Shares used in computation of basic
and diluted loss per share 3,767,517 1,162,058 2,848,705 1,063,409
------------ ---------- ------------ ----------
------------ ---------- ------------ ----------
</TABLE>
See notes to consolited financial statements
-4-
<PAGE>
Sanctuary Woods Multimedia Corporation
Condensed Consolidated Statement of Cash Flows (Unaudited)
<TABLE>
<CAPTION>
Six Months Ended
September 30,
-------------
1997 1996
---- ----
<S> <C> <C>
Cash flows from operating activities:
Net loss $(14,766,000) $ (77,000)
Depreciation and amortization 102,000 214,000
Stock option and warrant compensation - 82,000
Sale of intellectual property rights in
consideration for a reduction in royalty
obligations - (430,000)
Net loss (gain) on sale and disposal of assets 1,076,000 (875,000)
Write off of research and development purchased 2,036,000 -
Write off of goodwill 8,142,000 -
Provision for inventories 453,000 -
Changes in assets and liabilities, net of assets
and liabilities acquired:
Accounts receivable 328,000 (42,000)
Inventories (55,000) 457,000
Prepaid royalties, expenses and other 950,000 (140,000)
Accounts payable and accrued expenses (824,000) (2,160,000)
----------- -----------
Net cash used in operating activities (2,558,000) (2,971,000)
Cash flows from investing activities:
Proceeds from sale of assets - 1,900,000
Cash acquired in acquisition 455,000 -
Purchase of property and equipment (38,000) (31,000)
----------- -----------
Net cash provided by (used) in investing
activities 417,000 1,869,000
Cash flows from financing activities:
Proceeds from exercise of warrants - 750,000
Proceeds from issuance of convertible debentures - 5,302,000
Common stock issued, net of issue costs 2,157,000 -
Net (repayments) borrowing on bank debt (73,000) (1,377,000)
Repayments on long-term debt - (16,000)
----------- -----------
Net cash provided by financing activities 2,084,000 4,659,000
Effect of exchange rate changes on cash 6,000
----------- -----------
Net increase (decrease) in cash (57,000) 3,563,000
Cash, beginning of period 102,000 8,000
----------- -----------
Cash, end of period $ 45,000 $ 3,571,000
----------- -----------
----------- -----------
</TABLE>
See notes to consolidated financial statements
-5-
<PAGE>
SANCTUARY WOODS MULTIMEDIA CORPORATION
NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS (UNAUDITED)
1. NATURE OF OPERATIONS AND BASIS OF PRESENTATION
Sanctuary Woods Multimedia Corporation and its subsidiaries (the "Company")
develop, market and distribute interactive multimedia software products
("consumer titles") targeted at the children's education market. Products are
sold primarily through distributors into retail outlets. Sales are also made
directly to schools educational dealers and distributors, 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.
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 statements included herein
should be read in conjunction with the Company's audited financial statements
for the year ended March 31, 1998, included in the Company's Form 10-K as
filed October 6, 1998 and the Form 8-K/A as filed on October 5, 1998 related
to the acquisition of Theatrix Interactive, Inc. Results of operations for
interim periods are not necessarily indicative of results for the full year.
On April 15, 1997, the Company's stockholders approved a special resolution
authorizing the Company to change its jurisdiction of incorporation from
British Columbia, Canada to the state of Delaware and the adoption by the
Company of a Certificate of Incorporation and Bylaws under Delaware's
corporate legislation. The domestication became effective April 16, 1997. In
addition, the Company's stockholders approved a one-for-twenty share
consolidation of the Company's common stock and an increase in the number of
the Company's authorized shares of common stock to 50,000,000. All references
in the accompanying consolidated financial statements to share information,
per share amounts and stock option data of the Company's common stock have
been restated to reflect such stock consolidation.
The consolidated financial statements include the accounts of Sanctuary Woods
Multimedia Corporation and its wholly-owned subsidiaries, Theatrix
Interactive, Inc., Magic Quest Inc. and Sanctuary Woods Multimedia Inc. All
inter-company balances and transactions are eliminated in consolidation.
In August 1997, the Company acquired 100% of the outstanding shares of
Theatrix Interactive, Inc. ("Theatrix"). The Company issued 3,089,203 shares
of the Company's common stock in consideration (see Note 6).
The Company's line of credit allowed for borrowings up to $750,000.
Borrowings are payable in 36 monthly installments of principal and interest.
Interest accrues on the outstanding balance at the bank's prime rate (6.5% at
September 30, 1997) plus 1.5% per annum. Borrowings are secured by
substantially all of the Company's assets and the agreement requires that the
Company comply with certain financial covenants. At September 30, 1997, the
Company was not in compliance with certain of these covenants and,
accordingly, the outstanding balance as of September 30, 1997 was classified
as a current liability in the balance sheet and the Company does not have
access to the unused line of credit.
At September 30, 1997, the Company was not in compliance with certain
covenants of its capital lease agreements. Accordingly, the outstanding
balance as of September 30, 1997 was classified as a current liability in the
balance sheet.
-6-
<PAGE>
SANCTUARY WOODS MULTIMEDIA CORPORATION
NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS (UNAUDITED)
In the second quarter of 1998, the Company wrote off goodwill of $8,142,000
(see Note 6).
In fiscal 1998, the Company adopted Statement of Financial Accounting
Standards No. 128, "Earnings Per Share" (SFAS 128). All earnings per share
data for prior periods have been restated to conform with SFAS 128.
SFAS 128 requires a dual presentation of basic and diluted loss per share.
Basic earnings per share excludes dilution and is computed by dividing net
income (loss) available to common stockholders (numerator) by the weighted
average number of common shares outstanding (denominator) during a period.
Diluted earnings per share reflects the potential dilution that could occur
if securities or other contracts to issue common stock were exercised or
converted into common stock during a period.
The Company accounts for stock based awards to employees using the intrinsic
value method in accordance with APB No. 25, "Accounting For Stock Issued To
Employees." As allowed under the provisions of Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation"
("SFAS 123"), the Company provides pro forma disclosures (see Note 13) of net
income (loss) and earnings (loss) per share as if the accounting provisions
of SFAS 123 had been adopted.
In February 1997, the FASB issued Statement of Financial Accounting Standards
No. 129, "Disclosure of Information about Capital Structure" ("SFAS 129").
SFAS 129 requires disclosure of certain information related to the Company's
capital structure and is not anticipated to have a material impact on the
Company's financial position or results of operations.
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income"
("SFAS 130"). This statement is effective for the Company's fiscal year
ending March 31, 1999. The statement establishes presentation and disclosure
requirements for reporting comprehensive income. Comprehensive income
includes charges or credits to equity that are not the result of transactions
with owners. The Company expects there to be no material impact on the
Company's financial position and results of operations as a result of the
adoption of this new accounting standard.
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, "Disclosures About Segments of an
Enterprise and Related Information" ("SFAS 131"). The statement requires the
Company to report certain information about operating segments in annual
financial statements. It also establishes standards for related disclosures
about products and services, geographic areas and major customers. The
Company will adopt SFAS 131 beginning in fiscal year 1999 and does not expect
such adoption to have a material effect on the consolidated financial
statement disclosures.
In October 1997 and March 1998, the American Institute of Certified Public
Accountants issued Statements of Position No. 97-2, "Software Revenue
Recognition," ("SOP 97-2) and No. 98-4, "Deferral of the Effective Date of
the Provisions of SOP 97-2, "Software Revenue Recognition" ("SOP 98-4"),
which the Company is currently required to adopt for transactions entered
into in the fiscal year beginning April 1, 1998. SOP 97-2 and SOP 98-4
provide guidance on recognizing revenue on software transactions and
supersedes previous guidance provided by SOP 91-1. The Company believes that
the adoption of SOP 97-2 and SOP 98-4 will not have a significant impact on
its current licensing or revenue recognition practices. However, should the
Company amend its existing licensing practice, the Company's revenue
recognition practices may be subject to change to comply with the accounting
guidance provided by SOP 97-2 and SOP 98-4.
-7-
<PAGE>
SANCTUARY WOODS MULTIMEDIA CORPORATION
NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS (UNAUDITED)
In March 1998, the American Institute of Certified Public Accountants issued
Statement of Position No. 98-1, "Software for Internal Use" ("SOP 98-1")
which provides guidance on accounting for the cost of computer software
developed or obtained for internal use. SOP 98-1 is effective for the
Company's fiscal year ending March 31, 2000. The Company does not expect that
the adoption of SOP 98-1 will have a material effect on the Company's
financial position or results of operations.
Certain prior year amounts have been reclassified to conform with the current
year presentation.
2. GOING CONCERN UNCERTAINTY
The Company has been through a period of dramatic restructuring and
repositioning. The Company has had operating losses each of its last six
fiscal years. There can be no assurances that the Company will cease to incur
losses in the foreseeable future, if ever. Further sustained losses will
necessitate the infusion of additional capital, which could negatively impact
the current position of the Company's shareholders. See the Company's Form
10-K for the year ended March 31, 1998 for additional information.
The accompanying consolidated financial statements have been prepared on the
going concern basis, which contemplates the realization of assets and
satisfaction of liabilities in the normal course of business. The matters
discussed above, among others, may indicate that the Company will be unable
to continue as a going concern for a reasonable period of time.
The consolidated financial statements do not include any adjustments relating
to the recoverability and classification of recorded asset amounts or the
amounts and classification of liabilities that might be necessary should the
Company be unable to continue as a going concern. The Company's continuation
as a going concern is dependent upon its ability to generate sufficient cash
flow to meet its obligations on a timely basis; to obtain additional
financing or refinancing; and ultimately to attain successful operations.
Management is continuing its efforts to obtain additional funds so that the
Company can meet its obligations and sustain its operations.
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,
1997 1997
---- ----
<S> <C> <C>
Accounts Receivable $920,000 $1,210,000
Less allowance for:
Doubtful accounts (635,000) (123,000)
Sales returns and allowance (123,000) (812,000)
-------- ----------
Accounts receivable, net $162,000 $275,000
-------- ----------
-------- ----------
</TABLE>
-8-
<PAGE>
SANCTUARY WOODS MULTIMEDIA CORPORATION
NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS (UNAUDITED)
4. INVENTORIES
Inventories consisted of:
<TABLE>
<CAPTION>
September 30, March 31,
1997 1997
---- ----
<S> <C> <C>
Finished Goods $ 609,000 $ 489,000
Raw Materials 492,000 339,000
---------- ---------
1,101,000 828,000
Less allowance for obsolete,
slow moving and non-salable inventories (668,000) (172,000)
---------- ---------
Inventories, net $ 433,000 $ 656,000
---------- ---------
---------- ---------
</TABLE>
5. COMMON STOCK, CONVERTIBLE SUBORDINATED DEBENTURES, OPTIONS AND WARRANTS
In September 1996, the Company privately placed for cash $5,302,000 in 8%
convertible subordinated debentures due July 31, 1999. The debentures were
convertible into shares of the Company's common stock at the rate of one
share for each $11.00 of principal (482,000 shares) plus accrued interest. In
addition, the Company issued to each purchaser of the debentures a warrant to
purchase one share of common stock for each $40.00 invested or 132,550
shares. Each warrant was exercisable at a price of $13.75 per share until
September 1999.
In April 1997, the Company exchanged all of these 8% convertible subordinated
debentures for 99,993 shares of the Company's Series A Preferred Stock. The
Series A Preferred Stock has an aggregate liquidation preference of
$5,302,000 and is convertible into common stock at a rate of $2.40 per share
(2,209,167 shares) and has voting privileges on an "as converted" basis. The
Series A Preferred automatically converts into common stock on July 1, 1999
or upon the occurrence of either (i) the Company's obtaining equity financing
of not less than $2,000,000 at a price not less than $4.40 per share or (ii)
the closing price of the Company's common stock having been 250% of the
conversion price of Series A Preferred Stock ($6.00) for any 21 trading days
in any consecutive 40 day trading period.
In addition, the Company issued to the debenture holders warrants to purchase
an additional 1,154,024 shares of the Company's common stock at an exercise
price of U.S. $3.00 per share. The warrants must be exercised if the closing
price of the Company's common stock equals or exceeds 300% of the exercise
price ($9.00) for any 21 trading days in any consecutive 40 day trading
period. In consideration for the exchange, the Debenture Holders agreed to
retroactively forgo interest ($225,000 at March 31, 1997, which was payable
in common stock) on the Convertible Debentures. The holders of common stock
issued upon conversion of preferred stock or exercise of the warrants have
certain rights to have these shares registered. Management ascribed a value
of $1,143,000 to the warrants using a fair value method and such amount is
included in the value of preferred stock and additional paid in capital.
In April 1997, the Company's stockholders ratified a fixed option plan (1996
Stock Option Plan) allowing the Company to grant options for up to 400,000
shares of common stock. Under the plan, the Company intends that the exercise
price of each option shall equal the market price of the Company's stock on
the date of grant. The options generally vest over a three-year period and
expire ten years from the date of grant.
-9-
<PAGE>
SANCTUARY WOODS MULTIMEDIA CORPORATION
NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS (UNAUDITED)
At September 30, 1997 there were outstanding options to purchase 151,756
shares of common stock at $2.3828 to $24.00 per share and warrants to
purchase 1,988,857 shares of common stock at $3.00 to $117.88 per share.
6. THEATRIX ACQUISITION
On August 12, 1997, the Company acquired 100% of the outstanding shares of
Theatrix Interactive, Inc. ("Theatrix"). The acquisition was accounted for as
a purchase. See the Company's Form 8-K/A for further details on this
acquisition. The Company issued 3,089,203 shares of the Company's common
stock in consideration for all the shares of Theatrix capital stock. Up to an
additional 500,000 shares of the Company's common stock are issuable one year
and three months after the effective date of the merger if certain revenue
goals are met with respect to products acquired from Theatrix. In addition,
Sanctuary Woods set aside 300,000 shares, pursuant to its 1996 Stock Option
Plan, for issuance to former Theatrix employees who became employees of
Sanctuary Woods and issued a warrant to Kingdom Capital, a shareholder of
Theatrix, to purchase 500,000 Sanctuary Woods common shares at $3.00 per
share. Management ascribed a value of $726,000 to the warrant. In exchange
for services provided, an investment banker received cash and a warrant to
purchase 100,000 shares of Sanctuary Woods common stock at $3.00 per share.
Management ascribed a value of $142,000 to the warrant. In addition, the
Company recorded a charge of $2,036,000 to write-off in-process research and
development acquired in the transaction.
The results of operations of Theatrix are included in the consolidated
financial statements of the Company since the date of the acquisition. The
unaudited pro forma combined condensed results of operations of the Company
and Theatrix for the periods ended September 30, 1997 and 1996, assuming the
acquisition had taken place on April 1 of each year, after giving effect to
certain pro forma adjustments, are as follows:
<TABLE>
<CAPTION>
Six Months Ended: September 30, 1997 September 30,1996
------------------ -----------------
<S> <C> <C>
Net revenues $ 1,168,000 $ 4,733,000
Net loss $(17,509,000) $(7,159,000)
Basic and diluted loss per share $ (3.43) $ (1.72)
</TABLE>
The pro forma combined condensed results of operations is provided for
information purposes only and does not purport to be indicative of the future
results or financial position of the Company or what the results of
operations or financial position would have been had the acquisition been
effective on the dates indicated. This information should be read in
conjunction with the audited financial statements as provided in the
Company's Form 10-K for the year ended March 31, 1998.
Subsequent to the acquisition in this quarter of fiscal year 1998 the Company
determined that the goodwill recorded in the transaction was impaired and
recorded a charge of $8,142,000 to write-off the goodwill. The goodwill was
to be amortized over three years. Management determined that the goodwill was
impaired and recorded the charge after management developed the plan of
settlement with the Company's general unsecured Creditors (see Note 8).
7. COMMITMENT AND CONTINGENCIES
The Company has recorded liabilities in the consolidated financial statements
for judgements against the Company arising from employee severance and vendor
liabilities (see Note 8). The Company is a party to various claims,
litigation and threatened litigation in the normal course of operations.
Management believes, based upon the advice of counsel, that the ultimate
resolution of such matters will not have a material adverse effect on the
Company's financial statements taken as a whole.
-10-
<PAGE>
SANCTUARY WOODS MULTIMEDIA CORPORATION
NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS (UNAUDITED)
8. SUBSEQUENT EVENTS
On November 4, 1997, Sanctuary Woods and Theatrix proposed a plan of
settlement (the "Proposed Settlement") to all their general unsecured
creditors (the "Creditors"). The Proposed Settlement excluded a
first-priority secured claim of $525,000 due under an arrangement with a
bank. In addition, the Proposed Settlement excluded $500,000 in amounts due
under software license agreements and $90,000 of amounts due to software
fulfillment houses as the licensing and fulfillment houses are necessary to
the continued operations of Sanctuary Woods and Theatrix. The Proposed
Settlement provided that (1) the Creditors owed less than $50,000, receive a
payment of fifteen percent of the aggregate claim on or before December 27,
1997 or seventeen percent of the aggregate claim on or before March 20, 1998
and (2) the Creditors owed more than $50,000, receive seventeen percent of
aggregate claims by March 20, 1998. Sanctuary Woods and Theatrix met with the
Creditors on November 21, 1997 and requested that the Creditors vote on the
Proposed Settlement by December 5, 1997. In December 1997, the Creditors who
elected to receive a payment of fifteen percent of the aggregate claims
totaling $491,000 were paid an amount totaling $74,000. No other amounts have
been paid under the Proposed Settlement. All outstanding trade claims have
been included in these financial statements at their face value.
In November 1997, the Company executed a note purchase agreement with its
principal stockholder for borrowings of up to $3,000,000. The notes bear
interest at 15% per annum. The notes mature on varying dates from November of
2000 through January of 2001. At maturity, the note holder may elect to i)
convert the outstanding principal and unpaid accrued interest to shares of
common stock at a rate of $0.20 per share of common stock; ii) demand payment
in cash of any outstanding balance, or iii) extend the maturity date.
Interest is payable every six months in the form of cash or shares of common
stock at the conversion rate described above at the option of the note
holder. The Company will incur a 15% prepayment penalty of the outstanding
principal amount and the note holder can elect the payment in the form of
cash or shares of common stock at the conversion rate described above.
In addition, the Company issued a warrant to the note holder for one share of
the Company's common stock for each dollar loaned to the Company. The
exercise price for each warrant is $0.15. Management ascribed a nominal value
to the warrants using a fair value method. As such, no amounts were recorded
in the consolidated financial statements to reflect the issuance of the
warrants. At March 31, 1998, the Company had issued 869,000 warrants
associated with the convertible notes payable.
On October 27, 1998, the Company announced in a press release that three of
its board members had resigned leaving Dr. Michelle Kraus as the remaining
director of the Company. The Company said the resignations did not result
from any disagreements with management.
-11-
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
The following discussion contains "forward-looking statements" within the
meaning of the U.S. Federal securities laws, including statements reflecting
the Company's current views with respect to future events and financial
performance. Because such statements include risks and uncertainties, actual
results may differ materially from those anticipated in such forward-looking
statements as a result of certain factors, including those set forth in the
following Management's Discussion and Analysis of Financial Condition and
Results of Operations and Risk Factors.
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, and Management's Discussion and Analysis of
Financial Condition and Results of Operations contained in the Company's
Annual Report on Form 10-K for the fiscal year ended March 31, 1998 as filed
with the Securities and Exchange Commission on October 6, 1998, and Quarterly
Report on Form 10-Q for the three month periods ended June 30, 1997 as filed
with the Securities and Exchange Commission on August 14, 1997.
Overview and Recent Developments.
The Company is engaged in the development, publication and sale of
interactive multimedia educational software products for the home and
education markets.
The Company sells its products in North America through educational dealers
and distributors as well as directly to schools. In addition, the Company
distributes products on a limited basis in the consumer retail channel.
International product sales occur through license agreements with foreign
distributors and re-publishers.
During the last few years the Company has been through a period of dramatic
restructuring and repositioning. In fiscal 1997, management discontinued the
development of home entertainment products and narrowed the Company's focus
to the development of children's educational software products and of youth
oriented Web sites for the NFL and Major League Baseball on a contract basis.
In fiscal 1996 and 1997, the Company took various steps to restructure its
operations, including changing the Company's year-end from December 31 to
March 31. Personnel changes included the installation of new senior
management and a substantial reduction of headcount from 148 employees as of
December 31, 1995 to 32 employees at March 31, 1997. Operational changes
included the closing of the Publisher Services division, the sale of the
majority of the fixed assets of the Entertainment division, and elimination
of the Company's outstanding debt at that time, and the cancellation of the
performance shares in March 1997 (see note 17 to the financial statements in
the Company's Form 10-K).
During fiscal 1998, the Company changed its jurisdiction of incorporation
from British Columbia, Canada to Delaware, U.S.A., effected a one-for-twenty
share consolidation of its outstanding Common Stock, exchanged $5,302,000 in
outstanding convertible debentures for Series A Preferred Stock and warrants
and raised $2,157,000 in a rights offering.
In August 1997, in an attempt to increase market share for its products, the
Company acquired Theatrix Interactive, Inc., in exchange for 3,089,203 shares
of its Common Stock. The aggregate purchase price of Theatrix was $9,271,000.
This included recognition of goodwill of $8,142,000 and in-process research
and development of $2,036,000 as well as the assets and liabilities of
Theatrix, net of the transaction costs for the merger. The in-process
research and development expenses were charged to income immediately in
accordance with generally accepted accounting principles.
In addition, the reliance on the retail distribution channel by both
companies resulted in major financial problems for the newly-formed entity.
Many of the Company's large distributors and consumer-channel retailers of
both the Company's
-12-
<PAGE>
and Theatrix' products returned excess inventory for credit. However, in
order to gain shelf space in the popular consumer retail channels the Company
had to continue to issue promotional credits based on the original orders
placed by its distributors, and some customer balances remain outstanding.
By September 1997, the Company was under extreme financial and operational
constraints. Extensive employee changes and the complicated merger of
Sanctuary Woods' and Theatrix operating systems, as well as limited capital
resources, prohibited the Company from paying its debts and operating
expenses. During this period, Michelle Kraus, a software industry expert,
became the Company's Chief Executive Officer.
In September 1997, the Company retained counsel and adopted a formal plan of
voluntary liquidation of debt. Under this plan, approximately 61 of the
Company's trade creditors with claims for an aggregate of $491,000 entered
into a settlement with the Company pursuant to which the Company agreed to
pay $0.15 for every dollar it owed to the trade creditors in full and
complete satisfaction of the Company's obligations to them. This resulted in
a net gain for forgiveness of debt of $356,000 in the third quarters of
fiscal 1998. Subject to available capital, the Company expects to continue
its program of debt restructuring and voluntary liquidation of debt for many
of the current liabilities which were outstanding at September 30, 1997 in
the aggregate of $4,381,000 (see Legal Proceedings section), but it is
possible that the creditors could force the Company to initiate insolvency
proceedings.
As a result of the impairment to the capital of the business, goodwill of
$8,142,000 which was initially capitalized as a part of the purchase price of
Theatrix, was written off in the second quarter of fiscal 1998 and accounts
for a significant portion of the second quarter fiscal 1998 loss.
In the third quarter of fiscal 1998, the Company continued to restructure its
operations, and was able to secure $869,000 in debt financing from
Dawson-Samberg Capital Management, Inc. ("DSCM"), a significant stockholder
of the Company, in convertible promissory notes which include warrants to
purchase 869,000 shares at an exercise price of $0.15 per share.
Notwithstanding this one-time financing, the Company's capital situation
remains unstable, and the Company has not paid its creditors on a timely
basis.
As a result of the Company's financial situation, the Company failed to
comply with its periodic reporting obligations under the Exchange Act. In
July 1998 the Securities and Exchange Commission notified the Company that it
must correct its non-compliance with the periodic reporting obligations under
the Securities Exchange Act of 1934, as amended. Because of the Company's
financial condition, the Company had been unable to hire auditors and other
professionals necessary to prepare and file the requisite reports. The
Company is currently working to file the delinquent reports by mid November
1998. In order to facilitate this reporting process, DCSM has agreed to lend
to the Company, on a secured note, certain amounts necessary to pay the costs
of professionals and other service organizations necessary to complete the
reporting process.
During this period the Company's accounting controls were adversely affected
by the Company's difficult financial position, staff turnover and reductions,
and the significant volume of returns and promotional credits from the
previous retail distribution channel and related events. As a result, during
the audit of the Company's financial statements for the fiscal year ended
March 31, 1998, the Company's independent accountants, PricewaterhouseCoopers
LLP, determined that the Company's existing accounting systems have certain
material weaknesses, including deficiencies in its internal controls.
PricewaterhouseCoopers LLP issued a letter of material weakness in accounting
internal controls to the Company. Management is aware of the accounting
control issues and believes that with proper staffing the Company will be
able to address this issue in the near future. However, there can be no
assurance that the Company will be able to obtain additional financing and
will be able to address its accounting control issues in the future.
-13-
<PAGE>
RESULTS OF OPERATIONS
NET LOSS
For the quarter and year to date periods ended September 30, 1997, the
Company incurred a net loss of $13,480,000 and $14,766,000 and an operating
loss of $12,381,000 and $13,745,000, respectively. This resulted in increases
in operating losses of $11,873,000 for the quarter and $12,686,000 for the
six months, and increased net loss of $13,060,000 for the quarter and
$14,689,000 for the six months ended September 30, 1997 which were primarily
due to the following items:
<TABLE>
<CAPTION>
For the For the Six
September 30, 1997 Quarter months ended
------------------ ------- ------------
<S> <C> <C>
Write off of goodwill $ 8,142,000 $ 8,142,000
Charge for Theatrix in-process research
and development 2,036,000 2,036,000
Loss of gross margin due to lower sales 678,000 1,464,000
Loss on disposal of fixed assets, versus
a gain in the year ago periods 1,076,000 1,951,000
----------- -----------
TOTAL $11,932,000 $13,593,000
----------- -----------
----------- -----------
</TABLE>
Each of these variances is further discussed below.
NET REVENUES
Net Revenues in for the quarter and six months ended September 30, 1997 were
lower than the quarter and six months ended September 30, 1996 by $857,000 or
72.9% and $2,090,000 or 67.5%, respectively. Net revenues for the quarter
were $319,000 versus $1,176,000 in the same period of the prior year. For the
six month period net revenues were $1,006,000,as compared to $3,096,000 in
the prior year. The reduction in revenues was primarily due to lower sales in
connection with the Company's decision to focus on sales of educational
software programs and shift out of the retail market as well as the volume of
returns from retail distributors and promotional credits given by the Company
resulting from, and which was exacerbated by, the collapse of the software
market during this period. Revenue from website development and maintenance
was not material in fiscal 1998 or 1997.
The Company intends to develop its internet Web site, WWW.THEATRIX.COM, as an
alternative distribution channel to increase sales. There is no assurance,
however, that the Company will be successful in developing its Web site as a
distribution channel, or that the Web site will generate significant sales.
In addition, retailers of the Company's products typically have a limited
amount of shelf space and promotional resources, and there is intense
competition for high quality and adequate levels of shelf space and
promotional support from retailers. Industry practice and competitive
pressures generally require the Company to accept returns of unsold product
from wholesale distributors and retailers. Alternatively, the Company may
choose to reduce the price of previously shipped products to encourage
retailers to maintain the products on the retailers' shelves. This
competition has caused a downward pressure on the prices of the Company's
products and an adverse effect on the Company's gross margins. The Company
believes that competition for shelf space will become more intense in the
future and that the downward pressure on the Company's prices will continue.
COST OF SALES
Cost of revenues for the quarter were $606,000 versus $245,000 in the quarter
ended September 30, 1996, which is an increase of $361,000 or 147.3%. For the
six months ended September 30, 1997 cost of revenues were $932,000 which were
$5,000 or .5% higher than the six months ended September 30, 1996 of
$927,000. The primary increase in cost of revenues in both periods was an
increase in the Company's expense for royalties of $241,000 for the quarter
and
-14-
<PAGE>
$306,000 for six months ended September 30, 1997. This increase in expense
was to recognize the Company's obligations under its royalty contracts.
Gross margin for the quarter and six months ended September 30, 1997 were
negative by $287,000 and positive by $74,000 respectively. This resulted in
gross margin being lower than the comparable year ago periods by $1,218,000
and $2,095,000 for the quarter and six months ended September 30, 1997. As a
result of the lower revenues, the gross margin was negatively impacted by
$678,000 for the quarter and $1,464,000 for the six months ended September
30, 1997. Gross margin was also negatively affected by the increase in the
provision for unsalable inventory as a result of the excessive units received
from the retail channel returns and their related costs of freight and
processing, and the increase in royalty expense mentioned above.
OPERATING EXPENSES
RESEARCH AND DEVELOPMENT. Research and development expenses, exclusive of a
one time charge for the acquired Theatrix in-process research and development
of $2,036,000, were $430,000 for the quarter and $813,000 for the six months
ended September 30, 1997. This resulted in an increase in these expenses of
$158,000 or 58.1% for the quarter and $7,000 or .9% increase in the six
month period ended September 30, 1997, as compared to the respective
comparable periods from the previous year. These increases were primarily due
to labor costs within the periods for development projects in process. In the
last quarter of fiscal 1998, the Company ceased its development efforts on
new products. As of fiscal year-end the Company had 7 people in its
development staff working primarily on Web site activities and developing
derivative products.
MARKETING & SALES. Marketing and sales expenses were $1,081,000 for the
quarter and $1,815,000 for the six months ended September 30, 1997, which was
an increase of $443,000 or 69.4% and $528,000 or 41.0%, respectively, over
the quarter and six months ended September 30, 1996. The Company's sales and
marketing expenses increased primarily as a result of the increase in
promotional and product credits that the Company was required to pay to its
distributors in the retail channel. The Company took action to substantially
reduce its marketing and sales expenses later in fiscal 1998, and the
majority of these reductions took effect during the latter half of fiscal
1998.
ADMINISTRATION. Administrative expenses were $405,000, for the quarter and
$939,000 for the six months ended September 30, 1997. These results showed a
reduction of $124,000 for the quarter and $122,000 for the six months ended
September 30, 1997, as compared to the respective comparable periods of 1996,
due primarily to reduction of operating expenses related to the downsizing of
the Company's operating structure.
GOODWILL. The goodwill recognized in the Theatrix merger was written off
within the quarter ended September 30, 1997 and is included in the results
for the six months then ended. The Company's financial situation indicated an
impairment of asset and it was expensed.
OTHER INCOME. Total Other Income was a loss in the quarter of $1,099,000
versus a gain of $88,000 in the quarter ended September 30, 1996, and for the
six months ended was a loss of $1,095,000 versus a gain of $908,000 in
comparable period of 1996. The principal change in these accounts was the
gain in fiscal 1997 on the sale and disposal of assets of $875,000 as opposed
to the loss in fiscal 1998 of $1,076,000, which was due principally to the
cancellation of equipment leases and reductions of fixed assets in accordance
with the headcount reductions within the period. Net Interest and foreign
exchange expense was lower by $16,000 for the quarter and $101,000 for the
six months ended September 30, 1997, when compared to the same periods of
1996, due the conversion of the subordinate debentures into common stock. The
quarter and six months results in the year ago periods had a non-recurring
benefit in other income of $127,000 and $153,000 for the quarter and six
months ended September 30, 1997, respectively.
-15-
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
The Company has had operating losses in each fiscal year since its inception
and as of March 31, 1998, had an accumulated deficit of $56,130,000 and total
stockholders deficit of $5,252,000.
Operating activities for the period ended September 30, 1997 used $2,558,000
in cash. The Company financed its operating activities through the issuance
of $869,000 in debt in November, 1997 through January, 1998 and through the
Rights Offering in April, 1997 in which the Company raised $2,157,000. At
November 5, 1998, cash was $15,000.
The Company has deferred development of new products and is undercapitalized
for its current operations. The Company believes it must continue spending on
the development and acquisition of new products, the maintenance of adequate
personnel, and on distribution, sales and marketing efforts in order to
operate its business. It appears that the Company's current revenues are not
sufficient to cover these expenditures and the Company will likely experience
ongoing losses and require additional capital infusions. The Company is
currently investigating its alternatives for its financial resources as
discussed below.
YEAR 2000 COMPLIANCE
The Company believes that if the Company were to experience any Year 2000
problems, they would occur as a result of problems associated with the
Company's software products, problems arising with its internal information
technology systems or problems experienced by its third party distributors'
reporting systems. The Company's products consist of educational software
programs that typically do not rely upon dates for their operation.
Accordingly, the Company believes that its products are Year 2000 compliant.
Finally, with respect to the Company's internal information technology
systems, the Company relies primarily upon prepackaged shrinkwrap software
products that the Company believes are either currently Year 2000 compliant
or will be Year 2000 compliant in the near future. With respect to the
Company's third-party distributors, the Company has not undertaken any
assessment of whether these third-party distributors may be adversely
affected by any Year 2000 problems. The Company currently does not believe
that the distributors of its products will be materially adversely affected
by the Year 2000.
The Company could in the event of a Year 2000 problem with its vendors,
suppliers or distributors utilize alternative sources of manufacturing,
supply and/or distribution. The Company believes there are adequate
alternative sources available within the software and other related
industries.
Should Year 2000 issues arise with the Company's internal information
technology systems, the Company should be able to rely on the provision of
third party software upgrades for accounting, operations and other related
internal operational procedures. If such third party software upgrades are
not available for the current internal systems, then the Company may incur
the cost of switching vendors and replacing internal software systems with
Year 2000 compliant vendors.
Although the Company has not undertaken a comprehensive assessment of the
potential risks and exposures of the Company which may occur as a result of
the Year 2000 problem, the Company plans to begin more thoroughly and
systematically assessing its exposure. As a result, the potential costs to
address the Company's Year 2000 issues are unknown. However, the Company
believes that such costs will not be material. There can be no assurance that
the Company will have the resources to complete a satisfactory review of
potential Year 2000 risks in the near future or at all in light of the
Company's financial condition and level of staffing. Any Year 2000 compliance
problem experienced by the Company, its strategic partners, its customers or
the Internet infrastructure could result in a material adverse effect on the
Company's future operating performance. See "Risk factors--Year 2000
Compliance."
-16-
<PAGE>
CURRENT STATUS AND MANAGEMENT'S PLANS; GOING CONCERN UNCERTAINTY
CALENDAR 1996 OPERATIONS
Beginning in 1996, the Company commenced the reorganization of its
operations. A major part of that reorganization involved ceasing publication
of new entertainment titles and eliminating the Publisher Services Division.
Costs incurred from reorganization, including severance, site closure and
consolidation, significantly contributed to the net loss in the three months
ended March 31, 1996. 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 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>
Revenues and expenses for the fiscal year ended March 31, 1997 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 48,000
Estimated sales returns and price protection 150,000
Provision for inventory obsolescence 100,000
----------
Total 548,000
----------
----------
Other income - net gain on sale and disposal of assets $875,000
----------
----------
</TABLE>
1996 - 1997 MANAGEMENT ACTIONS
During 1996 and early fiscal 1997, the Company instituted measures to improve
operations and cash flows. Specific items accomplished through June 20, 1997
included the following:
- -- Appointment of a new Chairperson, President and Chief Executive Officer,
Vice President of Marketing and Controller.
- -- Reduction of head count by approximately 70% from December 31, 1995 levels
and elimination of many part-time, temporary and contract positions.
- -- Ceasing publication of new entertainment titles.
- -- Closure of the Publisher Services Division.
-17-
<PAGE>
- -- 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 reduce bank
borrowings. The gain on the sale of the studio, included in other income in
the fiscal year ended March 31, 1997 totaled $897,000.
- -- Repayment of the Company's bank borrowings which reached a peak of
$2,572,000 in January 1996.
- -- Termination of all software development projects through outside
developers.
- -- Sale in June 1996 of certain entertainment product rights to one of its
licensors in consideration for a $430,000 reduction in royalty obligations.
Such sale was included as licensing revenue in the fiscal year ended March
31, 1997. The transaction also encompassed the issuance of 8,750 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 fiscal year ended March 31, 1997.
1997 - 1998 MANAGEMENT ACTIONS
During fiscal 1997 and early fiscal 1998, the Company instituted measures to
improve operations and cash flows. Specific items accomplished through
September 30, 1998, included the following:
- -- Acquisition of Theatrix Interactive in August, 1997 to increase the
quality and volume of products in the Company's revenue pipeline.
- -- Integration and consolidation of companies for better efficiencies and
economies of scale with an overall reduction in operational expenditures,
including the consolidation of facilities at the Company headquarters in
Emeryville, CA; consolidation of manufacturing and warehouse facilities;
reduction of marketing commitments and promotional expenditures; and the
termination of lease agreements for the Company for other than its
headquarters facility.
- -- Development of Internet work with the National Football League (NFL) to
begin the Company's work on the Internet for children and sports.
- -- Restructuring of sales operations from more than 50% concentration on
consumer retail sales to less than 20%, with more than 80% redirected toward
the educational channel through catalogue sales.
- -- Appointment of a new experienced software industry expert as the Chief
Executive Officer and President in September 1997.
- -- Establishment of a new management and operations team.
- -- Development of a debt reduction program for the existing liabilities under
the advice of counsel. Completion of this program requires additional capital
or debt financing.
- -- Settlement of a portion of the Company debt through a Creditor's Meeting
held in November 21, 1997 paying vendors under this program $.15 on the
dollar for their trade settlements, for an aggregate settlement of $491,000
in prior trade debt.
- -- Reduction of headcount from the combined entities of the Company and
Theatrix by approximately 75% from the previous fiscal year.
-18-
<PAGE>
- -- Reduction of R & D expenditures, excluding the $2,036,000 write-down of
R&D in process from the Theatrix merger, by $125,000 with a shift to more
profitable Website development.
- -- Termination of all software development projects through outside
developers by December 31, 1997.
The Company will need to raise significant additional working capital through
debt or equity financing to sustain its operations and fund its fiscal March
31, 1999 operating plan and form strategic relationships that may enhance the
Company's ability to develop, publish and distribute its products. No
assurance can be given that additional financing will be available or that,
if available, such financing will be obtainable on terms favorable to the
Company.
The accompanying consolidated financial statements have been prepared on a
going concern basis, which contemplates the realization of assets and
satisfaction of liabilities in the normal course of business. The matters
discussed above, among others, may indicate that the Company will be unable
to continue as a going concern for a reasonable period of time.
The consolidated financial statements do not include any adjustments relating
to the recoverability and classification of recorded asset amounts or the
amounts and classification of liabilities that might be necessary should the
Company be unable to continue as a going concern. The Company's continuation
as a going concern is dependent upon its ability to generate sufficient cash
flow to meet its obligations on a timely basis, to obtain additional
financing or refinancing, and ultimately to attain successful operations.
Management is continuing its efforts to obtain additional funds so that the
Company can meet its obligations and sustain its operations. There can be no
assurance that the Company will be able to raise additional financing in this
time frame on commercially reasonable terms, or at all. If the Company is
unsuccessful in raising this capital, the Company may be required to cease
operations and declare bankruptcy. Under such circumstances, the Company's
secured creditors would have a first claim on all, or substantially all, of
the Company's assets.
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 156,379
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 93,750 shares of common stock at an exercise price of $10.00 per
share. In June 1996, certain of the convertible note holders exercised, for
$750,000 in cash, warrants to purchase 75,000 shares of stock. The holders of
these shares have certain registration rights.
8% CONVERTIBLE DEBENTURES
In September 1996, the Company privately placed for cash $5,302,000 in 8%
convertible subordinated debentures due July 31, 1999. The debentures were
convertible into shares of the Company's common stock at the rate of one
share for each $11.00 of principal (482,000 shares) plus accrued interest. In
addition, the Company issued to each purchaser of the debentures a warrant to
purchase one share of common stock for each $40.00 invested or 132,550
shares. Each warrant was exercisable at a price of $13.75 per share until
September 1999 (see note 5 of the condensed interim financial statements).
CONVERTIBLE PROMISSORY NOTE FINANCING
From October through December 1997, the Company engaged in a convertible
promissory financing from its largest shareholder, Dawson-Samberg Capital
Management. The monies were allocated to fund operations and repay debt
settlements under the Creditor's program of November 1997. For this series of
notes, the Company issued 868,858 warrants priced at 15 cents. A permit was
filed with the California Department of Corporations on October 29, 1997 for
-19-
<PAGE>
the November notes forward allowing for the usage of a higher interest rate.
The subsequent notes were granted at 15% interest.
In addition, DSCM has filed UCC-1s and has the senior position for repayment
of debt in the Company.
RISK FACTORS:
RISKS RELATED TO BUSINESS AND OPERATIONS OF SANCTUARY WOODS
CONTINUED LOSSES; LIQUIDITY. In the three years ended March 31, 1998, March
31, 1997 and December 31, 1995, the Company reported operating losses of
$15.8 million, $4.1 million and $18.7 million, respectively, and net losses
in each of these years of $16.6 million, $3.7 million and $18.7 million,
respectively. There can be no assurances that the Company will cease to incur
losses in the foreseeable future, if ever. Continued losses have and will
continue to result in liquidity and cash flow problems which have inhibited
and will continue to inhibit the Company's ability to develop new products.
The Company funded its working capital requirements and capital expenditures
during fiscal 1998 through the issuance of senior secured convertible
promissory notes to a significant stockholder. See Legal Proceedings and
Certain Relationships and Related Transactions. Further sustained losses will
necessitate the infusion of additional capital. The Company may seek to raise
additional capital through future additional financings that if raised
through the issuance of equity securities, will reduce the percentage
ownership of the stockholders of the Company. Existing stockholders may
experience additional dilution, and securities issued in conjunction with new
financings may have rights, preferences and privileges senior to those of
holders of the Company's Common Stock. There can be no assurance, however,
that additional financing will be available when needed, if at all, or on
favorable terms. The failure to obtain additional financing would have a
material adverse affect on the Company and may force the Company to seek
bankruptcy protection. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -Liquidity and Capital Resources."
FLUCTUATIONS IN OPERATING RESULTS; SEASONALITY. 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 and educational 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,
budgetary constraints of school districts and other education providers, 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 addition, the Company's
business has been in the past and is expected to continue to be subject to
seasonal fluctuations as a result of the purchasing cycle of consumers,
school districts, and dealers in educational products. 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 to obtain licenses to intellectual properties from third
parties. 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 forecasts, 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 from the sale of its products
upon shipment to its distributors, retailers, and end users (net of an
allowance for product returns and price protection), which is in accordance
with industry practice. There can be no assurance that the Company's reserves
will be adequate and 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. In addition, the Company has experienced in the past, and
continues to experience, significant delays in the collection of certain of
its accounts receivable. Product returns or price protection concessions
-20-
<PAGE>
that exceed the Company's reserves, or the failure to collect accounts
receivable in a timely manner 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.
IMPACT OF REORGANIZATION OF OPERATIONS. The Company recently experienced a
period of reorganization -- including moving its jurisdiction of
incorporation from British Columbia, Canada to Delaware, USA, effecting a
one-for-twenty share consolidation, exchanging outstanding convertible
debentures for equity and the cancelling of outstanding Performance Shares in
consideration for Common Stock of the Company -- that has placed, and could
continue to place a significant strain on the Company's financial,
management, personnel, and other resources. These changes or other future
steps 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.
COMPETITION. The entertainment software industry is intensely competitive and
market acceptance for any of the Company's products may be adversely affected
by competitors introducing 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 and
potential competitors, including large computer or software manufacturers,
entertainment companies, diversified media companies, and book publishers may
continue to broaden their product lines, and 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; consequently
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 them with adequate 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 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.
DEPENDENCE ON KEY PERSONNEL; RETENTION OF EXISTING EMPLOYEES; HIRING OF NEW
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
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 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 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 insurance covering any of its personnel.
-21-
<PAGE>
DEPENDENCE ON NEW PRODUCT DEVELOPMENT; PRODUCT DELAYS. The success of the
Company depends on the continuous and timely introduction of successful new
products. In general, consumer preferences for entertainment software
products are difficult to predict and are often short-lived. The retail life
of edutainment software programs has become shorter, and may now last only 4
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
edutainment CD-ROM title. In addition, some of the Company's edutainment
CD-ROM products are seasonal, especially the sports-based products. 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 timely
introduce new products, or 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 and certain of its products.
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.
CHANGING PRODUCT PLATFORMS AND FORMATS. The Company's software products are
intended for use 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
such products. If the Company invests time developing products for 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 Windows and other PC-based environments, and Macintosh
computers. The Company has terminated virtually all current development for
other platforms, such as CDX, the Sony PlayStation and Sega. There can be no
assurance that the Company has chosen to support platforms that will
ultimately be successful.
CHANGES IN TECHNOLOGY AND INDUSTRY STANDARDS. The edutainment software
industry is continually undergoing rapid changes, including evolving industry
standards and the introduction of new technologies, including audio and video
enhancement technologies such as DVD, MMX and 3D graphic accelerators, and
operating system upgrades. These evolving industry standards and new
technologies can render the Company's existing products obsolete or
unmarketable and may require the Company to expend substantial resources to
develop products that incorporate technological changes and evolving industry
standards. There can be no assurance that the Company will have the resources
necessary to undertake such a development effort, or if such development
effort is undertaken, that the Company will be successful in introducing new
products that keep pace with technological changes or evolving industry
standards, or satisfy evolving consumer preferences. Failure to do so would
have a material adverse effect on the Company's business, operating results
and financial condition.
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,
-22-
<PAGE>
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 of 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 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.
RELATIONSHIPS WITH VENDORS. In the past the Company has experienced
difficulty in paying its vendors. If the Company experiences such difficulty
in the future, it may result in the 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.
MARKET FOR COMMON STOCK; STOCK PRICE VOLATILITY. The Company's Common Stock
has traded solely on the over-the-counter bulletin board since March 12,
1997, when the Company's shares were delisted from the Vancouver Stock
Exchange at the Company's request. Shares traded over-the-counter are subject
to wide fluctuations between bid and ask prices. In addition, the Company's
Common Stock is thinly traded. Based upon these factors and 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.
IMPORTANCE OF INTERNATIONAL SALES. The development of products for foreign
markets requires substantial additional time, effort and expense because of
the large differences among countries' education requirements and cultures.
The Company expects that international sales will continue to represent a
significant percentage of net sales. International sales may be adversely
affected by the imposition of governmental controls, restrictions on export
technology, political instability, trade restrictions, changes in tariffs and
the difficulties associated with staffing and managing international
operations, lack of acceptance of localized products in foreign countries,
longer accounts
-23-
<PAGE>
receivable payment cycles, difficulties in collecting payment, reduced
protection for the Company's intellectual property rights and the burdens of
complying with a wide variety of foreign laws. In addition, international
sales may be adversely affected by the economic conditions in each country.
There can be no assurance that the Company will be able to maintain or
increase international market demand for the Company's products or that such
factors will not have a material adverse effect on the Company's future
international revenue and, consequently, the Company's business, operating
results and financial condition.
The Company's international revenue is currently denominated in a variety of
foreign currencies and the Company does not currently engage in any hedging
activities. Although exposure to currency fluctuations to date has been
insignificant, there can be no assurance that fluctuations in the currency
exchange rates in the future will not have a material adverse effect on the
Company's business, operating results and financial condition.
YEAR 2000 COMPLIANCE. Many currently installed computer systems and software
products are coded to accept only two-digit entries in the date code field.
Beginning in the year 2000, these date code fields will need to accept
four-digit entries to distinguish 21st century dates from 20th century dates.
As a result, computer systems and/or software used by many companies will
need to be upgraded to comply with such "Year 2000" requirements. Significant
uncertainty exists concerning the potential effects associated with
compliance. The Company has not undertaken a comprehensive assessment of the
potential risks and exposures of the Company which may occur as a result of
the Year 2000 problem, the Company plans to begin more thoroughly and
systematically assessing its exposure. In light of the Company's financial
condition and level of staffing, there can be no assurance that the Company
will have the resources to complete a satisfactory review of potential Year
2000 risks in the near future or at all. Any Year 2000 compliance problem
experienced by the Company, its strategic partners, its customers or the
Internet infrastructure could result in a material adverse effect on the
Company's future operating performance.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not applicable.
SANCTUARY WOODS MULTIMEDIA CORPORATION
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In September 1997 after the acquisition of Theatrix Interactive, the
Company engaged counsel to develop a program to restructure the Company's
debt and develop a program of voluntary liquidation of debt.
At the same time, a significant stockholder (the "Stockholder") of the
Company provided interim financing in the form of a promissory convertible
debt instrument to facilitate in the restructuring of the Company going
forward and allowed it to continue operations. A debt reconciliation program
was devised and a creditor's meeting held on November 4, 1997 to inform the
creditors' of the Company's financial status and intent to settle outstanding
liabilities.
Because of the interim financing supplied, the Stockholder secured a
senior position for the assets of the Company and the program was developed
to protect not only the Stockholder's senior position but also that of
another first priority lien holder, Silicon Valley Bank ("SVB"). The Company
is obligated to SVB for its secured revolving line of credit. SVB asserts
that it is due approximately $392,000 under the line of credit, and the last
partial payment made to SVB by the Company was in January 1998.
In December 1997, approximately 61 of the Company's trade creditors with
claims for an aggregate of $491,000 entered into a settlement with the
Company pursuant to which the Company agreed to pay $0.15 for every dollar it
owed
-24-
<PAGE>
to the trade creditors in full and complete satisfaction of the Company's
obligations to them. This resulted in a net gain for forgiveness of debt of
$356,000 in fiscal 1998. Subject to available capital, the Company expects to
continue its program of debt restructuring and voluntary liquidation of debt
for many of the current liabilities which were outstanding at March 31, 1998
in the aggregate of $5,074,000.
The Company was only able to reconcile a portion of the debt under this
program and as a result, is a party to various claims, threatened litigation
and judgments, as outlined below. It is possible that any of these claims
could cause the Company to become insolvent and seek bankruptcy protection.
However, for the most part, counsel and the Company have been able to
continue to work with the majority of the creditors as the Company continues
to rebuild its operations.
PENDING LITIGATION.
The Company is a party to a legal claim for alleged failure to pay
invoices of Bowne of Los Angeles, Inc. Bowne filed a complaint in the Alameda
County Court on February 18, 1998 seeking approximately $75,000 from the
Company in this matter. A trial for this suit has been set for December 1998.
The Company is a party to a legal claim for distribution, inventory in
the channel and marketing expenses brought by Navarre Corporation in the
State of Minnesota, County of Hennepin. Navarre is seeking damages in excess
of $450,000. The Company and Navarre reached a settlement and release
agreement that required the Company to pay the sum of $37,500 by August 15,
1998, which it failed to do because of lack of funds. The Company believes
that Navarre is likely to go back to Minnesota Court to seek a judgement of
up to $460,000.
THREATENED LITIGATION AND/OR ADVERSE JUDGMENTS.
Threatened litigation and/or judgements against the Company fall broadly
into the following categories. All of the above described judgement amounts
have been accrued for in the Company's financial statements as of March 31,
1998.
DISTRIBUTORS. Certain companies have been involved in the distribution
of the Company's products into the retail consumer channel. Because of the
economic challenges, the Company no longer distributes into this channel and
the distributors listed below may bring claims against the Company for
outstanding inventory, marketing and promotional funds resulting from these
activities in prior years:
The Company was a party to a legal claim for an amount owed to a
software distributor. The plaintiff obtained a judgment against the
Company in July 1998 for a total of $59,200.33 in principal, interest and
fees plus 10% interest per annum. Discussions are ongoing for settlement
by counsel.
The Company has received notice of an action filed against it in June
1998 regarding distribution of the Company's products. The plaintiff in
the action is seeking approximately $56,648.23 plus 10% interest per
annum, and obtained a default judgement in September 1998, but no damages
were specified or awarded at that time.
The Company was a party to a legal claim for trade debt associated
with the distribution of the Company's products. The plaintiff in the
matter obtained a judgment in April 1998 for the amount of $51,833.94.
EQUIPMENT LEASING COMPANIES. The Company had several major equipment
leases. Legal action has been taken by one company as follows:
The Company has been a party to a legal claim of an alleged breach of
an equipment lease. The lessor
-25-
<PAGE>
of the equipment obtained a judgment against the Company for
approximately $26,294.19 in February 1998.
SERVICE PROVIDERS. A variety of service providers that did not receive
settlement by the Company in December 1997 have taken action as follows:
The Company was a party to a legal claim for breach of contract with
an employment placement agency. The plaintiff obtained a judgment against
the Company for approximately $25,540 plus interest and attorneys' fees.
The plaintiff has attempted to collect payment by levying on certain of
the Company's bank accounts. Most, if not all, of the judgment remains
outstanding.
The Company was a party to a legal claim for services provided. The
plaintiff in the matter obtained judgment for $74,469.66 plus interest
1997. The plaintiff has tried to levy various assets of the Company
without success.
The Company has been a party to a legal claim based on an alleged
breach of a consulting agreement in 1997. The plaintiff in the matter
obtained a default judgment in this matter for approximately $6,935 plus
interest of $1.89 per annum and subsequently levied against certain bank
accounts of the Company in 1998. It is believed that a substantial
portion of the default judgment may have been satisfied through such
levies.
PERSONNEL. The Company has a personnel dispute with the prior CEO and
CFO of Theatrix Interactive, Incorporated.
The Company has been a party to a legal claim for severance payment and
vacation accrued. The plaintiffs have obtained judgments for a total of
$138,469.62 in January 1998. It is believed that attempts to levy the
Company's assets have been unsuccessful to date.
In addition, there are a number of matters in which litigation has been
threatened against the Company. The matters involve approximately 47 parties
for claims ranging from $258.84 to $600,000 and have been accrued for in the
Company's financial statements.
ITEM 2. CHANGES IN SECURITIES
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
On October 27, 1998, the Company announced in a press release that three of
its board members had resigned leaving Dr. Michelle Kraus as the remaining
director of the Company. The Company said the resignations did not result
from any disagreements with management.
-26-
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a. Exhibits.
27.1 Financial Data Schedule
b. Reports on Form 8-K:
July 21, 1997 (Items 5 and 7 - Other events and exhibits).
August 12, 1997 (Items 2 and 7 - Acquisition or Disposition of
Assets and Exhibits. Note that unaudited pro forma combined
condensed financial statements were included in an amendment to the
Form 8-K filed on October 5, 1998).
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SANCTUARY WOODS MULTIMEDIA CORPORATION
(Registrant)
Date: November 10, 1998 By: /s/ Michelle Kraus
--------------------------------------
Michelle Kraus,
Chairman, President and
Chief Executive Officer
-27-
<PAGE>
INDEX TO EXHIBITS
EXHIBIT PAGE
27.1 Financial Data Schedule ......................
-28-
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FORM 10-Q
AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> MAR-31-1998
<PERIOD-START> JUL-01-1997
<PERIOD-END> SEP-30-1997
<CASH> 45,000
<SECURITIES> 0
<RECEIVABLES> 920,000
<ALLOWANCES> 758,000
<INVENTORY> 433,000
<CURRENT-ASSETS> 640,000
<PP&E> 757,000
<DEPRECIATION> 486,000
<TOTAL-ASSETS> 935,000
<CURRENT-LIABILITIES> 4,381,000
<BONDS> 0
0
0
<COMMON> 5,000
<OTHER-SE> (3,451,000)
<TOTAL-LIABILITY-AND-EQUITY> 935,000
<SALES> 319,000
<TOTAL-REVENUES> 319,000
<CGS> 606,000
<TOTAL-COSTS> 12,094,000
<OTHER-EXPENSES> (1,083,000)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (16,000)
<INCOME-PRETAX> (13,480,000)
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (13,480,000)
<EPS-PRIMARY> (3.58)
<EPS-DILUTED> (3.58)
</TABLE>
