<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 December 31, 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 November 11, 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 December 31, 1997 and March 31, 1997................ 3
Condensed Consolidated Statements of Operations -- Three and Nine Months Ended December
31, 1997 and December 31, 1996................................................................. 4
Condensed Consolidated Statements of Cash Flows -- Nine Months Ended December 31, 1997 and
December 31, 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>
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<PAGE>
Sanctuary Woods Multimedia Corporation
Condensed Consolidated Balance Sheet
As of December 31, 1997 and March 31, 1997 (Unaudited)
<TABLE>
<CAPTION>
12/31/97 3/31/97
---------- ---------
<S> <C> <C>
ASSETS
Current assets:
Cash $ 96,000 $ 102,000
Accounts receivable, net 408,000 275,000
Inventories 336,000 656,000
Prepaid royalties - 198,000
Prepaid expenses - 244,000
Prepaid offering expenses - 91,000
------------ ------------
Total current assets 840,000 1,566,000
Property and equipment, net 233,000 462,000
Deferred warrant expense and other 14,000 258,000
------------ ------------
Total assets $ 1,087,000 $ 2,286,000
------------ ------------
------------ ------------
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable $ 2,021,000 $ 1,343,000
Accrued expenses and interest 1,192,000 804,000
Royalty obligations 473,000 371,000
Capital lease obligations 500,000 14,000
Line of credit 394,000
------------ ------------
Total current liabilities 4,580,000 2,532,000
Convertible notes payable 774,000 -
8% convertible subordinated debentures - 5,302,000
------------ ------------
Total liabilities 5,354,000 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 December 31, 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
December 31, 1997 and March 31, 1997, respectively 5,000 1,000
Additional paid-in capital 51,625,000 34,754,000
Accumulated deficit (55,145,000) (39,551,000)
Accumulated translation adjustments (752,000) (752,000)
------------ ------------
Total stockholders' deficit (4,267,000) (5,548,000)
------------ ------------
Total liabilities and stockholders' deficit $ 1,087,000 $ 2,286,000
------------ ------------
------------ ------------
</TABLE>
See notes to condensed consolidated financial statements
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<PAGE>
Sanctuary Woods Multimedia Corporation
Condensed Consolidated Statement of Operations (Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
December 31, December 31,
------------ ------------
1997 1996 1997 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net revenues $ 557,000 $ 1,202,000 $ 1,563,000 $ 4,298,000
Cost of revenues 315,000 312,000 1,247,000 1,239,000
----------- ------------ ------------- ------------
Gross margin (deficit) 242,000 890,000 316,000 3,059,000
Operating expenses:
Research and development 267,000 427,000 3,115,000 1,232,000
Marketing and sales 747,000 997,000 2,562,000 2,284,000
Administration 390,000 781,000 1,329,000 1,843,000
Write-off of goodwill - - 8,142,000 -
----------- ------------ ------------- ------------
Total operating expenses 1,404,000 2,205,000 15,148,000 5,359,000
----------- ------------ ------------- ------------
Operating income (Loss) (1,162,000) (1,315,000) (14,832,000) (2,300,000)
Other income (expense):
Gain on the forgiveness of debt, net 356,000 - 356,000 -
Foreign exchange loss - (1,000) (4,000)
Interest (expense) income, net (25,000) (148,000) (43,000) (263,000)
Net gain (loss) on sale and disposal of assets - (48,000) (1,076,000) 827,000
Other income 3,000 (26,000) 1,000 125,000
----------- ------------ ------------- ------------
Total other income (expense) 334,000 (223,000) (762,000) 685,000
----------- ------------ ------------- ------------
Net loss $ (828,000) $ (1,538,000) $ (15,594,000) $ (1,615,000)
----------- ------------ ------------- ------------
----------- ------------ ------------- ------------
Basic and diluted loss per share $ (0.16) $ (1.32) $ (4.29) $ (1.47)
----------- ------------ ------------- ------------
----------- ------------ ------------- ------------
Shares used in computation of
basic and diluted loss per share 5,193,303 1,162,058 3,635,942 1,096,292
----------- ------------ ------------- ------------
----------- ------------ ------------- ------------
</TABLE>
See notes to condensed consolidated financial statements
-4-
<PAGE>
Sanctuary Woods Multimedia Corporation
Condensed Consolidated Statement of Cash Flows (Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
December 31,
------------
1997 1996
---- ----
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (15,594,000) $ (1,615,000)
Depreciation and amortization 147,000 292,000
Stock option and warrant compensation - 111,000
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 (827,000)
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 82,000 (3,000)
Inventories 42,000 500,000
Prepaid royalties, expenses and other 960,000 (183,000)
Accounts payable and accrued expenses (625,000) (2,653,000)
-------------- -------------
Net cash used in operating activities (3,281,000) (4,808,000)
Cash flows from investing activities:
Proceeds from sale of assets - 1,920,000
Cash acquired in acquisition 455,000 -
Purchase of property and equipment (38,000) (31,000)
-------------- -------------
Net cash provided by investing activities 417,000 1,889,000
Cash flows from financing activities:
Proceeds from exercise of warrants - 750,000
Proceeds from issuance of notes, debentures and warrants 774,000 5,302,000
Common stock issued, net of issue costs 2,157,000 -
Net repayments on bank debt (73,000) (2,072,000)
Repayments on long-term debt - (22,000)
-------------- -------------
Net cash provided by financing activities 2,858,000 3,958,000
Effect of exchange rate changes on cash 6,000
Net increase (decrease) in cash (6,000) 1,045,000
Cash, beginning of period 102,000 8,000
-------------- -------------
Cash, end of period $ 96,000 $ 1,053,000
-------------- -------------
-------------- -------------
</TABLE>
See notes to condensed consolidated financial statements
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<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 7).
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
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<PAGE>
SANCTUARY WOODS MULTIMEDIA CORPORATION
NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS (UNAUDITED)
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. 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
December 31, 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 December 31, 1997, the Company was not in
compliance with certain of these covenants and, accordingly, the outstanding
balance as of December 31, 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 December 31, 1997, the Company was not in compliance with certain covenants
of its capital lease agreements. Accordingly, the outstanding balance as of
December 31, 1997 was classified as a current liability in the balance sheet.
In the second quarter of 1998, the Company wrote off goodwill of $8,142,000 (see
Note 7).
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.
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
-7-
<PAGE>
SANCTUARY WOODS MULTIMEDIA CORPORATION
NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS (UNAUDITED)
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.
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.
-8-
<PAGE>
SANCTUARY WOODS MULTIMEDIA CORPORATION
NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS (UNAUDITED)
Accounts receivable consisted of:
<TABLE>
<CAPTION>
December 31, March 31,
1997 1997
------------ -----------
<S> <C> <C>
Accounts Receivable $1,261,000 $1,210,000
Less allowance for:
Doubtful accounts (651,000) (123,000)
Sales returns and allowance (202,000) (812,000)
---------- ----------
Accounts receivable, net $408,000 $275,000
---------- ----------
---------- ----------
</TABLE>
4. INVENTORIES
Inventories consisted of:
<TABLE>
<CAPTION>
December 31, March 31,
1997 1997
------------ -----------
<S> <C> <C>
Finished Goods $494,000 $489,000
Raw Materials 491,000 339,000
----------- -----------
985,000 828,000
Less allowance for obsolete,
slow moving and non-salable
inventories (649,000) (172,000)
----------- -----------
Inventories, net $336,000 $656,000
----------- -----------
----------- -----------
</TABLE>
5. CONVERTIBLE NOTES PAYABLE
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.
During the third quarter the Company borrowed $774,000 under these agreements.
In January 1998 the Company borrowed an additional $95,000 for an aggregate
balance of $869,000.
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
December 31, 1997, the Company had issued 774,000 warrants associated with the
convertible notes payable. Additional 95,000 warrants were issued in January
1998 associated with the borrowings at that time.
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<PAGE>
SANCTUARY WOODS MULTIMEDIA CORPORATION
NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS (UNAUDITED)
6. 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.
At December 31, 1997 there were outstanding options to purchase 140,981 shares
of common stock at $2.38 to $24.00 per share and warrants to purchase 2,763,237
shares of common stock at $.15 to $117.88 per share.
7. 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
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<PAGE>
SANCTUARY WOODS MULTIMEDIA CORPORATION
NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS (UNAUDITED)
$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 December 31, 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>
Nine Months Ended: December 31, 1997 December 31,1996
----------------- ----------------
<S> <C> <C>
Net revenues $1,725,000 $6,337,000
Net loss $(18,337,000) $(12,584,000)
Basic and diluted loss per share $(3.57) $(3.01)
</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 the second 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 1).
8. 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 1). 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.
9. SUBSEQUENT EVENTS
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.
On November 24, 1998, the Company announced that it had added two members to
their Board of Directors.
-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 Reports on Form 10-Q
for the three month periods ended June 30, 1997, and for the six month periods
ended September 30, 1997 as filed with the Securities and Exchange Commission on
August 14, 1997 and November 13, 1998, respectively.
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 and Theatrix' products returned excess inventory for credit. However,
in order to gain shelf space in the popular
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<PAGE>
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 quarter 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 December 31, 1997 in the aggregate of
$4,589,000 (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 $774,000 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
774,000 shares at an exercise price of $0.15 per share. In January 1998 the
Company borrowed an additional $95,000, and issued 95,000 warrants related to
this debt. 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 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.
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<PAGE>
RESULTS OF OPERATIONS
NET LOSS
For the quarter and year to date periods ended December 31, 1997, the Company
incurred a net loss of $828,000 and $15,594,000 and an operating loss of
$1,162,000 and $14,832,000, respectively. This resulted in decreases in
operating losses of $153,000 and a decrease of net losses of $710,000 for the
quarter. For the nine months ended December 31, 1997 operating losses increased
by $12,532,000 and increased in net loss by $13,979,000 which were primarily due
to the following items:
<TABLE>
<CAPTION>
For the Nine Months
December 31, 1997 Ended
----------------- ---------------------
<S> <C>
Write off of goodwill $8,142,000
Charge for Theatrix in-process research and development 2,036,000
Loss of gross margin due to lower sales 1,947,000
Loss on disposal of fixed assets, versus a gain in the year
ago periods 1,903,000
------------
TOTAL $14,028,000
------------
------------
</TABLE>
Each of these variances is further discussed below.
NET REVENUES
Net Revenues in for the quarter and nine months ended December 31, 1997 were
lower than the quarter and nine months ended December 31, 1996 by $645,000 or
53.7% and $2,735,000 or 63.6%, respectively. Net revenues for the quarter were
$557,000 versus $1,202,000 in the same period of the prior year. For the nine
month period net revenues were $1,563,000,as compared to $4,298,000 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 $315,000 versus $312,000 in the quarter
ended December 31, 1996, which is an increase of $3,000 or 1.0%. For the nine
months ended December 31, 1997 cost of revenues were $1,247,000 which were
$8,000 or .6% higher than the nine months ended December 31, 1996 of $1,239,000.
The primary increase in cost of revenues in both periods was an increase in the
Company's expense for royalties of $101,000 for the quarter and
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<PAGE>
$407,000 for nine months ended December 31, 1997. This increase in expense was
to recognize the Company's obligations under its royalty contracts.
Gross margin for the quarter and nine months ended December 31, 1997 were
$242,000 and $316,000 respectively. This resulted in gross margin being lower
than the comparable year ago periods by $648,000 and $2,743,000 for the quarter
and nine months ended December 31, 1997. As a result of the lower revenues, the
gross margin was negatively impacted by $478,000 for the quarter and $1,947,000
for the nine months ended December 31, 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 expensed in the second quarter ended September 30, 1997, were
$267,000 for the quarter and $1,079,000 for the nine months ended December 31,
1997. This resulted in decreases in these expenses of $160,000 or 37.5% for the
quarter and $153,000 or 12.4% in the nine month period ended December 31, 1997,
as compared to the respective comparable periods from the previous year. These
deincreases were primarily due to labor and overhead costs within the periods
for reductions in 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 $747,000 for the quarter
and $2,562,000 for the nine months ended December 31, 1997, which was an
decrease of $250,000 or 25.1% over the quarter ended December 31, 1996 and an
increase of $278,000 or 12.2%, over the nine months ended December 31, 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,
which resulted in the favorable decrease of these expenses within the third
quarter.
ADMINISTRATION. Administrative expenses were $390,000, for the quarter and
$1,329,000 for the nine months ended December 31, 1997. These results showed a
reduction of $391,000 for the quarter and a reduction of $514,000, as compared
to the respective comparable periods of nine months ended December 31, 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 second quarter ended September 30, 1997 and is included in the results for
the nine months then ended. The Company's financial situation indicated an
impairment of asset and it was expensed.
OTHER INCOME. Total Other Income was a gain in the quarter of $334,000 versus a
loss of $223,000 in the quarter ended December 31, 1996, and for the nine months
ended was a loss of $762,000 versus a gain of $685,000 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 $827,000 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
$124,000 for the quarter and $224,000 for the nine months ended December 31,
1997, when compared to the same periods of 1996, due to the conversion of the
subordinate debentures into common stock. The nine months results in the year
ago periods had a non-recurring benefit in other income of $124,000 nine months
ended December 31, 1997, respectively.
In addition, the Company realized a net gain from the forgiveness of debt from
its aggressive program of debt restructuring of $356,000 in the quarter and nine
months ended December 31, 1997.
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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 nine month period ended December 31, 1997 used
$3,281,000 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 shrink-wrap 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."
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<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.
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<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.
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<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 6 of the condensed interim financial statements).
CONVERTIBLE PROMISSORY NOTE FINANCING
From November, 1997 through January, 1998, 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
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<PAGE>
warrants priced at 15 cents. A permit was filed with the California Department
of Corporations on October 29, 1997 for 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,
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<PAGE>
significant delays in the collection of certain of its accounts receivable.
Product returns or price protection concessions 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.
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<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,
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<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
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<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
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<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.
On November 24, 1998, the Company announced that it had added two members to
their Board of Directors.
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<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a. Exhibits.
27.1 Financial Data Schedule
b. Reports on Form 8-K:
October 16, 1997 (Item 4 - Changes in Registrant's Certifying
Accountant).
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 30, 1998 By: /s/ Michelle Kraus
---------------------------------------
Michelle Kraus,
Chairman, President and
Chief Executive Officer
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<PAGE>
INDEX TO EXHIBITS
EXHIBIT
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> OCT-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 96,000
<SECURITIES> 0
<RECEIVABLES> 1,261,000
<ALLOWANCES> 853,000
<INVENTORY> 336,000
<CURRENT-ASSETS> 840,000
<PP&E> 762,000
<DEPRECIATION> 529,000
<TOTAL-ASSETS> 1,087,000
<CURRENT-LIABILITIES> 4,580,000
<BONDS> 0
0
0
<COMMON> 5,000
<OTHER-SE> (4,272,000)
<TOTAL-LIABILITY-AND-EQUITY> 1,087,000
<SALES> 557,000
<TOTAL-REVENUES> 557,000
<CGS> 315,000
<TOTAL-COSTS> 1,404,000
<OTHER-EXPENSES> 359,000
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (25,000)
<INCOME-PRETAX> (13,828,000)
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (13,828,000)
<EPS-PRIMARY> (3.16)
<EPS-DILUTED> (3.16)
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