UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 20-F
(Mark One)
[ ] REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES
EXCHANGE ACT OF 1934
OR
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the fiscal year ended October 31, 2004
---------------------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the transition period from to
Commission file number 0-30456
CHARTWELL TECHNOLOGY INC.
(Exact name of Registrant as specified in its charter)
None
(Translation of Registrant's name into English)
Alberta, Canada
(Jurisdiction of incorporation or organization)
Suite 400, 750 - 11th Street SW, Calgary, Alberta, Canada T2P 3N7
(Address of principal executive offices)
Securities registered or to be registered pursuant to Section 12(b) of the Act.
Title of each class Name of each exchange on which registered
None None
Securities registered or to be registered pursuant to Section 12(g) of the Act.
Common Shares without par value
(Title of Class)
Securities for which there is a reporting obligation pursuant to Section 15(d)
of the Act.
None
(Title of Class)
Indicate the number of outstanding shares of each of the issuer's classes of
capital or common stock as of the close of the period covered by the annual
report. 16,022,966 Common Shares without par value as at October 31, 2004.
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.
[X] Yes [ ] No
Indicate by check mark which financial statement item the registrant has elected
to follow.
[X] Item 17 [ ] Item 18
(APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PAST
FIVE YEARS)
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Sections 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court.
Yes No
NOTE REGARDING FORWARD LOOKING STATEMENTS
This Annual Report on Form 20-F contains forward-looking statements based on
beliefs of our management. Any statements contained in this Annual Report on
Form 20-F that are not historical facts are forward-looking statements as
defined in the U.S. Private Securities Litigation Reform Act of 1995. We have
based these forward-looking statements on our current expectations and
projections about future events, including, but not limited to:
o Registrant's limited operating history;
o under-capitalization;
o government regulations;
o risks involving new product development; unpredictability of future
revenues;
o risks of technological change; our dependence on key personnel;
o competition and low barriers to entry;
o dependence on continued growth in use of the Internet;
o our ability to protect its intellectual property rights and
uncertainty regarding infringing intellectual property rights of
others;
o general economic and business conditions;
o attracting and retaining personnel;
o competition in the software industry;
o implementing our business strategy;
o developing and introducing new products;
o regulatory and political conditions;
o obtaining and expanding market acceptance of our products; and
o other risks and uncertainties, some of which we describe under "Item
3. Key Information-- Risk Factors."
The words "anticipate," "believe," "continue," "counting on," "is confident,"
"estimate," "expect," "forecast," "intend," "may," "plan," "project," "predict,"
"should," "wants," "will," "would" and similar expressions as they relate to us
are intended to identify such forward-looking statements. Such statements
reflect our current views and assumptions and all forward-looking statements are
subject to various risks and uncertainties that could cause actual results to
differ materially from expectations. The factors that could affect our future
financial results are discussed more fully under "Item 3. Key Information --
Risk Factors," as well as elsewhere in this Annual Report on Form 20-F and in
our other filings with the U.S. Securities and Exchange Commission ("SEC").
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The Registrant's management has included projections and estimates in this
Annual Report, which are based primarily on management's assessment of the
Registrant's results of operations, discussions and negotiations with third
parties, management's experience and a review of information filed by its
competitors with the Securities and Exchange Commission.
The Registrant cautions readers not to place undue reliance on any such
forward-looking statements, which speak only as of the date made. The Registrant
disclaims any obligation subsequently to revise any forward-looking statements
to reflect events or circumstances after the date of such statements or to
reflect the occurrence of anticipated or unanticipated events.
NOTE REGARDING CURRENCY
In this Annual Report, unless otherwise specified, all dollar amounts are
expressed in Canadian Dollars. References in this document to "$" and "Cdn$"
refer to Canadian dollars, unless otherwise specified; references to "US$" refer
to US dollars.
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GLOSSARY
Some of the terms and abbreviations used throughout this Annual Report are
defined below:
"CGC" means Chartwell Games Corp. a wholly-owned subsidiary of the Company
(formerly Gaming Tech Corporation ("GT")).
"Common Shares" means one or more common shares in the authorized capital of
Chartwell Technology Inc.
"Company" or "Chartwell" or "Registrant" means Chartwell Technology Inc.
"Flash" is a bandwidth friendly and browser independent vector-graphic animation
technology. As long as different browsers are equipped with the necessary
plug-ins, Flash animations will look the same. With Flash, user can draw their
own animations or import other vector-based images.
"GT" means Gaming Tech Corporation, a wholly-owned subsidiary of the Company
(see also CGC).
"GTI" means Gateway Technology, Inc., a wholly-owned subsidiary of the Company.
"HTML" means the Hyper Text Markup Language which is the authoring language used
to create documents on the World Wide Web. HTML defines the structure and layout
of a Web document by using a variety of tags and attributes. There are hundreds
of tags used to format and layout the information on a Web Site and on
individual Web pages. Tags are also used to specify hypertext links. These allow
Web developers to direct users to other Web Sites or pages with only a click of
the mouse on either an image or word(s).
"Internet" is a global network connecting millions of computers. As of 1999, the
Internet has more than 200 million users worldwide, and that number is growing
rapidly. More than 100 countries are linked into exchanges of data, news and
opinions. Unlike online services, which are centrally controlled, the Internet
is decentralized by design. Each Internet computer, called the host, is
independent. Its operators can choose which Internet services to use and which
local services to make available to the global Internet community. There are a
variety of ways to access the Internet including online services such as America
Online or through a commercial Internet Service Provider.
"Intranet" is a network based on transmission control and Internet protocols (an
Internet) belonging to an organization, accessible only by such organization's
members, employee or others with authorization. An Intranet's Web Sites look and
act just like any other Web Sites, but the firewall surrounding an Intranet
prevents unauthorized access. Like the Internet itself, Intranets are used to
share information. Secure Intranets are a growing segment of the Internet
because they are much less expensive to build and manage than private networks
based on proprietary protocols.
"Java" is a high level programming language developed by Sun Microsystems.
Compiled Java code can be run on most computers because Java interpreters and
runtime environments, known as Java Virtual Machines (VMs), exist for most
operating systems, including UNIX, the Macintosh OS, and Windows. Bytecode can
also be converted directly into machine language instructions by a just-in-time
compiler (JIT). Java is a general purpose programming language with a number of
features that make the language well suited for use on the World Wide Web. Small
Java applications are called Java applets and can be downloaded from a Web
server and run on a computer by a Java-compatible Web browser, such as Netscape
Navigator or Microsoft Internet Explorer.
"server" means is a computer or device on a network that manages network
resources. For example, a file server is a computer and storage device dedicated
to storing files. Any user on the network can store files on the server. A print
server is a computer that manages one or more printers, and a network server is
a
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computer that manages network traffic. A database server is a computer system
that processes database queries. Servers are often dedicated, meaning that they
perform no other tasks besides their server tasks.
"Shockwave" is a technology developed by Macromedia, Inc. that enables Web pages
to include multimedia objects. To create a shockwave object, you use
Macromedia's multimedia authoring tool called DIRECTOR, and then compress the
object with a program called AFTERBURNER. You then insert a reference to the
"shocked" file in your Web page. To see a Shockwave object, you need the
Shockwave plug-in, a program that integrates seamlessly with your Web browser.
The plug-in is freely available from Macromedia's Web site as either a Netscape
Navigator plug-in or an ActiveX control. Shockwave supports audio, animation,
video and even processes user actions such as mouse clicks. It runs on all
Windows platforms as well as the Macintosh.
"software" means computer instructions or data and includes anything that can be
stored electronically. The storage devices and display devices are hardware.
Software is often divided into two categories: (i) system software which
includes the operating system and all the utilities that enable the computer to
function; and (ii) applications software which includes programs that assist
users such as word processors, spreadsheets and database management systems.
"TSX" or the "Exchange" means the Toronto Stock Exchange.
"Web Site" is a location on the World Wide Web. Each Web Site contains a home
page, which is the first document users see on entering the site. The site might
also contain additional documents and files.
"World Wide Web" or "Web" refers to a system of Internet servers that support
specially formatted documents. The documents are formatted in a language called
Hyper Text Mark-up Language ("HTML") that supports links to other documents as
well as graphics, audio and video files.
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TABLE OF CONTENTS
PART I.........................................................................1
Item 1. Identity of Directors, Senior Management and Advisers...............1
A. Directors and senior management........................................1
B. Advisers...............................................................1
C. Auditor................................................................1
Item 2. Offer Statistics and Expected Timetable.............................1
A. Offer statistics.......................................................1
B. Method and expected timetable..........................................1
Item 3. Key Information.....................................................2
A. Selected financial data................................................2
B. Capitalization and indebtedness........................................3
C. Reason for the offer and use of proceeds...............................4
D. Risk factors...........................................................4
Item 4. Information on the Company..........................................9
A. History and development of the company.................................9
B. Business Overview.....................................................11
C. Organizational structure..............................................20
D. Property, plants and equipment........................................21
Item 5. Operating and Financial Review and Prospects.......................21
A. Operating results.....................................................21
B. Liquidity and capital resources.......................................33
C. Research and development, patents and licenses, etc...................33
D. Trend information.....................................................34
E. Off balance sheet arrangements........................................34
F. Tabular disclosure of contractual obligations.........................34
G. Safe harbour..........................................................34
Item 6. Directors, Senior Management and Employees.........................35
A. Directors and senior management.......................................35
B. Compensation..........................................................37
C. Board practices.......................................................38
D. Employees.............................................................40
E. Share ownership.......................................................40
Item 7. Major Shareholders and Related Party Transactions..................42
A. Major shareholders....................................................42
B. Related party transactions............................................42
C. Interests of experts and counsel......................................42
Item 8. Financial Information..............................................42
A. Consolidated statements and other financial information...............42
B. Significant changes...................................................43
Item 9. The Offer and Listing..............................................43
A. Offer and listing details.............................................43
B. Plan of distribution..................................................44
C. Markets...............................................................44
D. Selling shareholders..................................................44
E. Dilution..............................................................44
F. Expenses of the issue.................................................44
Item 10. Additional Information............................................44
A. Share Capital.........................................................44
B. Memorandum and articles of association................................47
C. Material Contracts....................................................47
D. Exchange controls.....................................................47
E. Taxation..............................................................49
F. Dividends and paying agents...........................................55
G. Statement by experts..................................................55
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H. Documents on display..................................................55
I. Subsidiary information................................................56
Item 11. Quantitative and Qualitative Disclosures About Market Risk........56
Item 12. Description of Securities Other than Equity Securities............56
A. Debt securities.......................................................56
B. Warrants and rights...................................................56
C. Other securities......................................................56
D. American depositary shares............................................56
PART II.......................................................................57
Item 13. Defaults, Dividend Arrearages and Delinquencies...................57
Item 14. Material Modifications to the Rights of Security Holders
and Use of Proceeds...............................................57
Item 15. Controls and Procedures...........................................57
Item 16A. Audit Committee Financial Expert................................57
Item 16B. Code of Ethics..................................................57
Item 16C. Principal Accountant Fees and Services..........................58
Item 16D. Exemptions from the Listing Standards for Audit Committees......59
Item 16E. Purchases of Equity Securities by the Issuer and Affiliated
Purchasers......................................................59
PART III......................................................................60
Item 17. Financial Statements..............................................60
Item 18. Financial Statements..............................................61
Item 19. Exhibits..........................................................61
-vi-
PART I
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS
A. Directors and senior management.
Not applicable.
B. Advisers.
Not applicable.
C. Auditor.
Not applicable.
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE
A. Offer statistics.
Not applicable.
B. Method and expected timetable.
Not applicable.
-1-
ITEM 3. KEY INFORMATION
A. Selected financial data.
The following table sets forth selected financial data regarding our
consolidated operating results and financial position. The data has been derived
from our consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in Canada ("Canadian
GAAP"). For reconciliation to accounting principles generally accepted in the
United States ("U.S. GAAP"), see note 11 to the audited Consolidated Financial
Statements for the three fiscal years ended October 31, 2004, 2003, and 2002.
The following selected financial data is qualified in its entirety by, and
should be read in conjunction with the consolidated financial statements and
notes thereto included elsewhere this Annual Report. The selected financial data
is expressed in Canadian dollars (in accordance with Canadian GAAP and some in
U.S. GAAP where indicated).
--------------------------------------------------------------------
Fiscal year Ended October 31
(audited) (Cdn$)
--------------------------------------------------------------------
2004 2003 2002 2001 2000
--------------------------------------------------------------------
Operating Revenue
Software Set-up 798,343 919,892 896,560 803,990 640,253
--------------------------------------------------------------------
Software Licensing 11,268,494 6,300,335 2,646,766 908.876 172,463
--------------------------------------------------------------------
Interest and other 134,640 109,411 302,031 394,782 338,924
--------------------------------------------------------------------
Total Operating Revenue 12,201,477 7,329,638 3,845,357 2,107,648 1,151,640
--------------------------------------------------------------------
Total Expenses 8,594,660 6,278,100 5,166,164 3,912,300 4,011,581
--------------------------------------------------------------------
Income (Loss) from 3,606,817 1,051,538 (1,320,807) (1,804,652) (2,859,941)
Continuing Operations before income
taxes
Income taxes:
Future income tax reduction (414,964) (630,000) N/A N/A N/A
Net Income (Loss)
Canadian GAAP 4,021,781 1,681,538 (1,320,807) (1,804,652) (2,859,941)
--------------------------------------------------------------------
US GAAP 1,180,157 921,690 (1,338,087) (2,639,762) (2,978,726)
--------------------------------------------------------------------
Net Income (Loss) per diluted Share
from Continuing Operations
Canadian GAAP 0.24 $0.12 $(0.10) $(0.14) $(0.27)
US GAAP 0.07 $0.07 $(0.10) $(0.20) $(0.28)
--------------------------------------------------------------------
5,995,863 3,465,120 1,704,267 2,741,078 8,793,474
Cash and cash equivalents
Total Assets
Canadian GAAP 14,961,622 9,218,705 6,951,837 8,159,948 9,826,562
US GAAP 14,353,722 8,628,591 6,894,036 8,187,573 9,826,562
Total Liabilites 1,840,033 1,913,934 1,506,104 1,514,496 1,468,959
Net Assets 13,121,589 7,304,771 5,445,733 6,645,452 8,357,603
Shares Outstanding 16,022,966 15,987,701 15,817,701 15,628,501 15,550,501
--------------------------------------------------------------------
The Company paid no dividends during the past five fiscal years.
-2-
CURRENCY AND EXCHANGE RATES
Our financial statements are stated in Canadian Dollars and are prepared in
accordance with Canadian Generally Accepted Accounting Principles (GAAP), the
application of which, in our case, conforms in all material respects for the
periods presented with the US GAAP as noted in the footnotes to the financial
statements. In this Annual Report, unless otherwise specified, all dollar
amounts are expressed in Canadian Dollars. References in this document to "$"
and "Cdn$" refer to Canadian dollars, unless otherwise specified; references to
"US$" refer to US dollars.
The following table shows the rates derived from the noon buying rates in New
York City for cable transfers payable in Canadian dollars, as certified for
customs purposes by the Federal Reserve Bank of New York. The high and low
exchange rates for each month during the previous six months are as follows
(Canadian dollars per United States $1.00):
------------------------------------------------------------------
Month High Low
------------------------------------------------------------------
March 2005 1.2463 1.2017
February 2005 1.2562 1.2294
January 2005 1.2422 1.1982
December 2004 1.2401 1.1856
November 2004 1.2263 1.1775
October 2004 1.2726 1.2194
September 2004 1.3071 1.2648
------------------------------------------------------------------
The high, low, average and closing exchange rates for each of the Company's five
previous fiscal years are as follows (Canadian dollars per United States $1.00):
Company's Fiscal Year Ended October 31
- ------------------------------------------------------------------------------
2004 2003 2002 2001 2000
- ------------------------------------------------------------------------------
High $1.3970 $1.3043 $1.5108 $1.4933 $1.4350
Low 1.2194 1.5903 1.6128 1.5905 1.5311
Average 1.3195 1.4379 1.5718 1.5411 1.4771
Period End 1.2209 1.3195 1.5610 1.5905 1.5273
- ------------------------------------------------------------------------------
On April 8, 2005, the exchange rate of Canadian dollars into United States
dollars, based upon the noon buying rate in New York City for cable transfers
payable in Canadian dollars as certified for customs purposes by the Federal
Reserve Bank of New York, was U.S. $1.00 equals Cdn$1.2252.
B. Capitalization and indebtedness.
Not applicable.
-3-
C. Reason for the offer and use of proceeds.
Not applicable.
D. Risk factors.
The securities of the Registrant are highly speculative. In evaluating the
Registrant, it is important to consider that the Registrant is in the early
stage of its operations as a developer of gaming entertainment software. A
prospective investor or other person reviewing the Registrant should not
consider an investment unless the investor is capable of sustaining an economic
loss of the entire investment. All costs have been funded through equity and
related party advances. Certain risks are associated with the Registrant's
business including the following (the order in which they appear does not
necessarily reflect management's opinion of their order or priority):
OUR OPERATING RESULTS ARE DIFFICULT TO PREDICT, WHICH MAY AFFECT OUR BUSINESS.
Our operating results may fluctuate significantly due to a variety of factors,
many of which are outside of our control. Factors that may harm our business or
cause our operating results to fluctuate include the following:
- the ability of sublicensees of our Online Games technologies to obtain
new players and to encourage existing players to play Online Games;
- the mix of games and other products developed by us;
- CGC's inability to obtain additional licensees of our Online Games
technologies;
- our inability to adequately maintain, upgrade and develop our Online
Games technologies;
- the ability of our competitors to offer new or enhanced gaming
technologies, services or products;
- price competition;
- fluctuations in the demand for Internet wagering;
- an increase in the number of Internet wagering web sites;
- our failure to develop strategic marketing relationships;
- the amount and timing of operating costs and capital expenditures
relating to commercializing our Online Games technologies;
- changes in the regulatory and political environment that adversely
affect the Internet gaming industry, licensees and our business; and
- economic conditions specific to the Internet, online commerce and the
Internet gaming and entertainment industry.
A number of these factors are expected to affect our ability to generate
revenues and to continue to be commercially profitable. We cannot assure you
that we will sustain commercial profitability.
LACK OF CONTINUED ACCEPTANCE OF OUR PRODUCTS WILL AFFECT OUR BUSINESS.
Poor market acceptance of our products or other unanticipated events may result
in lower revenues than anticipated, making anticipated expenditures on
development, advertising and promotion not feasible. Initially, our success may
be limited by our lack of experience marketing Internet gaming technologies, our
limited international marketing experience and our lack of brand recognition. We
cannot assure you that our technologies will be accepted in the marketplace or
that we will earn sufficient revenues from sublicensing our products to earn any
profits.
OUR PRODUCTS WILL BECOME OBSOLETE IF WE DO NOT UPGRADE AND IMPROVE OUR PRODUCTS
AND DEVELOP NEW TECHNOLOGIES.
The success of our products and our ability to sublicense our technologies and
to develop a competitive advantage in the market will depend on our ability to
improve our products and develop new and innovative technologies. Our
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operations will be at risk if our products are not continually upgraded and
improved. The high technology industry is characterized by a consistent flow of
new product and service offerings, which may render existing products and
services obsolete. Without continued development, our products could be rendered
obsolete in 18 to 24 months.
WE EXPAND OUR GAME OFFERINGS AND ENTER NEW BUSINESS CATEGORIES THAT MAY NOT
ACHIEVE MARKET ACCEPTANCE.
Any new game, product or service that is developed by us, which is not favorably
received by sublicensees or end-users could damage our brand or reputation. This
damage could impair our ability to attract new customers, which could cause our
revenues to fall below expectations. An expansion of our business into other new
business categories or use applications will require significant additional
expenses, and strain our management, financial and operational resources. This
type of expansion would also subject us to increased business risks and could
aversely affect our levels of customer service. We may choose to expand our
operations by developing new games, services, products or applications for our
technologies, promoting new or complementary games, expanding the breadth and
depth of products and services offered or expanding our market presence through
relationships with third parties. If we allocate our resources to an expansion
strategy that fails to provide acceptable returns, our results of operation may
be materially adversely affected.
OUR SUCCESS IS DEPENDENT ON CERTAIN TECHNOLOGIES DEVELOPED BY THIRD-PARTY
VENDORS AND THE INTERNET, WHICH MAY FAIL AND HAVE A MATERIAL ADVERSE AFFECT ON
OUR BUSINESS.
We incorporate into our products certain software licensed to us by other
software developers, which are not licensed exclusively to us. Our business may
be materially adversely affected if the third party software developers in which
we rely upon are acquired by a competitor or terminate our ability to use their
software.
Our success is also dependent upon licensees who depend on the Internet.
Internet service providers who do not guarantee access to the Internet or the
reliability of Internet service. Accordingly, we could face materially adverse
consequences if Internet service providers chose not to permit Internet access
to licensees.
Because our products incorporate software developed and maintained by third
parties, we are also dependent to a certain extent upon such third parties'
abilities to enhance their current products, to develop new products on a timely
and cost-effective basis and to respond to emerging industry standards and other
technological changes. There can be no assurance that we would be able to
replace the functionality provided by the third-party software currently offered
in conjunction with our products in the event that such software becomes
obsolete or incompatible with future versions of our products, or is otherwise
not adequately maintained or updated. The absence of, or any significant delay
in, the replacement of that functionality could have a material adverse effect
on our sales.
OUR SUCCESS DEPENDS ON OUR ABILITY TO PREVENT OTHERS FROM INFRINGING ON OUR
TECHNOLOGIES.
Our success is heavily dependent upon proprietary technology. To protect our
proprietary technology, we rely principally upon copyright and trade secret
protection. All proprietary information which is capable of copyright is marked
as such. All employees and consultants are required to execute confidentiality
agreements with us. However, there can be no assurance that the steps taken by
us in this regard will be adequate to prevent misappropriation or independent
third-party development of our technology. Further, the laws of certain
countries in which we intend to license our technologies or products may not
protect software and intellectual property rights to the same extent as the laws
of Canada or the United States. We do not include in our software any mechanism
to prevent or inhibit unauthorized use, but we generally require the execution
of an agreement that restricts unauthorized copying and use of our products. If
unauthorized copying or misuse of our products were to occur, our business and
results of operations could be materially adversely affected.
While the disclosure and use of our proprietary technology, know-how and trade
secrets are generally controlled under agreements with the parties involved,
there can be no assurance that all confidentiality agreements will be honored,
that others will not independently develop similar or superior technology, that
disputes will not arise concerning the ownership of intellectual property, or
that illegal or unauthorized dissemination of our proprietary technology,
know-how and trade secrets will not occur.
-5-
INTELLECTUAL PROPERTY CLAIMS AGAINST US CAN BE COSTLY AND COULD IMPAIR OUR
BUSINESS.
We believe that our products and technology do not infringe patents or other
proprietary rights of third parties. However, there can be no assurance that
third parties will not claim that our current or future products infringe such
rights of third parties. We expect that software developers will increasingly be
subject to such claims as the number of products and competitors providing
Internet related software and services grows and overlaps occur. Any such claim,
with or without merit, could result in costly litigation or require us to enter
into royalty or licensing agreements in order to obtain a license to continue to
develop and market the affected products. There can be no assurance that we
would prevail in any such action or that any license (including licenses
proposed by third parties) would be made available on commercially acceptable
terms, if at all. If we become involved in litigation over proprietary rights,
it could consume a substantial portion of our managerial and financial
resources, which could have a material adverse effect on our business, financial
condition and operations.
OUR ABILITY TO LICENSE OUR TECHNOLOGY WILL BE ADVERSELY AFFECTED IF OUR
TECHNOLOGY'S SECURITY MEASURES FAIL.
Our technologies incorporate security and authentication protections designed to
allow licensees to protect certain personal information of players, such as
credit card numbers, player information and player account balances. We cannot
predict that whether events or developments will result in a compromise or
breach of the technology we use to protect a player's personal information. If
the security measures in our software fail, licensees may lose many customers
and our ability to license our technologies will be adversely affected.
Furthermore, the servers and computer systems of licensees may be vulnerable to
computer viruses, physical or electronic break-ins and similar disruptions,
which could disrupt their operations and their ability to pay us licensing fees.
Any material failure of such systems may have a material affect on our business.
We may need to expend significant additional capital and other resources to
protect against a security breach or to alleviate problems caused by any
breaches. We cannot assure you that we can prevent all security breaches.
OUR TARGET CUSTOMERS ARE CONCENTRATED AND MAY BASE THEIR BUYING DECISION ON THE
AVAILABILITY OF SERVICES THAT WE DO NOT OFFER, WHICH MAY AFFECT OUR ABILITY TO
MARKET AND SELL OUR PRODUCTS.
We believe that the customers for our Online Games Internet gaming software are
primarily individual entrepreneurs. These potential customers may make purchase
decisions on the availability of services that we do not offer, such as
management services, transaction clearing services, Internet gaming licensing
services and Internet casino marketing services. Several of our competitors may
offer these services in packages that may be more attractive to this target
market. This may affect our ability to successfully market and sell our
services.
The customers for our Internet entertainment and Intranet gaming software may be
primarily large corporations, Indian tribes and other entities that license our
technologies for their licensed casino operations or for entertainment purposes.
In order to effectively target and market to this target market, we will need to
develop specialized marketing programs and modifications to our software to meet
their specific business needs. We cannot assure you that we will successfully be
able to market and sell our technology to this target market or that such
efforts will be profitable.
If we cannot build and sustain a large customer base for our products and
services, our ability to upgrade, improve and develop new technologies will be
adversely affected and our ability to generate revenues and earn a profit will
be adversely affected.
THE LOSS OF OUR KEY MANAGEMENT PERSONNEL MAY ADVERSELY AFFECT OUR BUSINESS.
We will depend on a relatively small number of key employees including Darold H.
Parken, the President, Dave Acorn, the VP of Product & Client Management, Andrew
Smith, our Technical Director, and Lee Richardson, Chief Executive of Chartwell
Games, the loss of whom could have an adverse affect on the financial
performance of our business. We do not have employment agreements with these
individuals, and accordingly cannot assure you that they will continue their
service with the Company. We currently do not maintain key man life insurance on
any of our managers.
-6-
We rely on our management and if you are not prepared to do so should not invest
in our securities. All of the directors and officers of the Company may not
devote all of their time to the affairs of the company, but will be devoting
such time as is required to manage the company. The directors and officers are
engaged and will continue to be engaged in the search for business prospects on
behalf of themselves and others. See "Conflicts of Interest."
RAPID GROWTH MAY STRAIN OUR RESOURCES AND THE ABILITY FOR OUR PERSONNEL TO
EFFECTIVELY SUPPORT OUR BUSINESS.
We expect to grow rapidly, which may strain our resources. Limitations on our
personnel and resources may affect our ability to provide the quality of
service, technical support and marketing support needed to achieve and maintain
a competitive market position. There is a high demand for software development
and sales personnel, which may affect our ability to hire qualified personnel.
The loss of qualified personnel, growth in the demand for qualified personnel or
our inability to recruit and train qualified personnel on a timely may adversely
affect the timeliness of the services we provide or the delivery of our
software.
Rapid growth may strain our resources and increase our cost of doing business by
reducing our efficiency. We cannot assure you that we will have the resources
necessary to develop and maintain a competitive market position.
OUR INABILITY TO GROW AND TO SUCCESSFULLY MANAGE OUR GROWTH MAY HARM OUR
BUSINESS.
To achieve our projected revenues and other targeted operating results, we will
be required to rapidly expand our systems, procedures, controls, employee base
and facilities. The success of the expansion plans will depend in part upon our
ability to continue to attract, retain and motivate key personnel. Failure to
make the required expansions and upgrades could have a material adverse effect
on our business, financial condition, results of operations and corporate
relationships. Our results of operations will also be adversely affected if
revenues do not increase sufficiently to compensate for the increase in
operating expenses resulting from any expansion and there can be no assurance
that any expansion will be profitable or will not adversely affect our results
of operations.
OUR OPERATIONS COULD BE AFFECTED BY CURRENCY FLUCTUATIONS.
Our profitability may also be adversely affected by fluctuations in currency
exchange rates. Our sublicensing agreements are denominated in United States
dollars. CGC's obligation and our obligations related to our license
arrangements are generally denominated in United States dollars. We hold our
funds in Canadian dollars. Fluctuating currency rates between the United States
dollar and the Canadian dollar may affect our results of operations. We do not
engage in hedging transactions to protect against such fluctuations.
BROKER-DEALERS MAY BE DISCOURAGED FROM EFFECTING TRANSACTIONS IN OUR SHARES
BECAUSE THEY ARE CONSIDERED PENNY STOCKS AND ARE SUBJECT TO THE PENNY STOCK
RULES.
Rules 15g-1 through 15g-9 promulgated under the Exchange Act impose sales
practice and disclosure requirements on NASD brokers-dealers who make a market
in "a penny stock." A penny stock generally includes any non-NASDAQ equity
security that has a market price of less than US$5.00 per share. Our shares are
quoted on the Toronto Stock Exchange and the closing price of our shares during
the fiscal year ended October 31, 2004 ranged from $1.60 to $4.36 per share. As
such, our shares will be deemed penny stock for the purposes of the Exchange
Act. The additional sales practice and disclosure requirements imposed upon
brokers-dealers may discourage broker-dealers from effecting transactions in our
shares, which could severely limit the market liquidity of the shares and impede
the sale of our shares in the secondary market.
Under the penny stock regulations, a broker-dealer selling penny stock to anyone
other than an established customer or "accredited investor," generally, an
individual with net worth in excess of US$1,000,000 or an annual income
exceeding US$200,000, or US$300,000 together with his or her spouse, must make a
special suitability determination for the purchaser and must receive the
purchaser's written consent to the transaction prior to sale, unless the
broker-dealer or the transaction is otherwise exempt. In addition, the penny
stock regulations require the broker-dealer to deliver, prior to any transaction
involving a penny stock, a disclosure schedule prepared by the Commission
relating to the penny stock market, unless the broker-dealer or the transaction
is otherwise exempt. A broker-dealer is also required to disclose commissions
payable to the broker-dealer and the registered representative
-7-
and current quotations for the securities. Finally, a broker-dealer is required
to send monthly statements disclosing recent price information with respect to
the penny stock held in a customer's account and information with respect to the
limited market in penny stocks.
DUE TO INTENSE COMPETITION, OUR FINANCIAL PERFORMANCE COULD SUFFER.
Although online gaming is a fast growing industry, it is becoming increasingly
competitive. There are currently several competitors for the licensing of play
for real Internet gaming software, including, among others, Realtime Gaming, Net
Entertainment, Parlay Entertainment, Playtech Inc., Wagerworks Inc. Microgaming,
Cryptologic Inc. and Boss Media AB. We believe that each of these competitors
offers Internet gaming technologies that compete directly with our Online Games
application. Many of these competitors have greater financial resources than us
and have established relationships with licensees or are operating Internet
gaming Web Sites.
Many of our competitors currently offer a full range of products and services,
including Internet gaming software, assistance in procuring licenses, electronic
funds transfer services, data management services, administrative services,
hosting of server software, credit card processing and other banking services,
marketing consulting services and turn-key Internet gaming systems.
We believe that our competitors may develop software and technologies that
compete with our technologies. These potential competitors include large
software development companies that develop a broad range of products as well as
Internet gaming companies that have developed technologies for their own
businesses.
Our competitors may be able to develop technologies more effectively or may be
able to license their technologies on more favorable terms based on the number
of sublicensees that license their products. Competitors may also adopt more
aggressive pricing or licensing policies than us, which may hinder our ability
to penetrate the market and license our technologies.
In addition, increased competition is likely to result in price reductions,
reduced gross margins and an increased number of competitors competing for
market share, any of which could seriously harm our ability to generate revenues
and our results of operations. We expect competition to intensify in the future
because current and new competitors can enter our market with little difficulty,
and our competitors may sell their software at reduced prices.
CONSOLIDATION IN THE SOFTWARE INDUSTRY MAY RESULT IN INSTABILITY OF SOFTWARE
DEMAND AND STRONGER PEER COMPANIES IN THE LONG TERM.
The entire IT sector, including the software industry, is currently experiencing
consolidation through mergers and acquisitions, particularly involving larger
companies. Large companies continue to expand into areas we target and thus
increasingly compete with us. Transactions in which we or our competitors
participate could have a material adverse effect on us in a variety of ways,
such as delaying sales due to customer uncertainty and subjecting us to
competition from stronger established or new peer group companies with more
resources, larger customer bases and a wider variety of products than we have.
THE GAMING INDUSTRY IS A VOLATILE INDUSTRY.
The gaming industry is a volatile industry, which is sensitive to economic
conditions. When economic conditions are prosperous, gaming industry revenues
increase. Conversely, when economic conditions are unfavorable, gaming industry
revenues decline. Any significant decline in general corporate conditions or the
economy that affect consumer spending could have a material adverse affect on
the Company's business, financial condition and results of operations.
CHANGES IN INTERNET GAMING REGULATIONS MAY HAVE AN ADVERSE EFFECT ON THE
BUSINESS OF THE COMPANY.
Historically, the gaming industry is subject to intense government regulation.
Many countries are currently struggling with issues surrounding wagering and
gambling over the Internet. More specifically, they are considering
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the merits, limitations and enforceability of prohibition, regulation or
taxation of wagering and gambling transactions that are transacted over the
Internet. There are significant differences of opinion and law between countries
such as the United Kingdom, United States, Canada, Australia, Liechtenstein and
Antigua. Nevertheless, several countries accept Internet gambling as legal and
some countries offer licenses for the operation of online casinos.
To the best of our knowledge, all of our licensees operate their interactive
Casinos from jurisdictions where Internet gaming is regulated or tolerated. All
licensees provide a representation in their license agreements to the effect
that such licensee will assume responsibility for determining the legality of
using our software, including, without limitation, accepting wagers in whichever
jurisdictions they choose to market to and receive wagers from.
As has been the case for several years, a significant debate exists whether the
laws of any country other than the country where the computer gaming servers are
physically located have jurisdiction over the operations of a licensee. We
license our software only to licensees that maintain an internet gaming license
issued by a jurisdiction in which internet gaming is legal.
We are unaware of any regulations or laws that prohibit the development and the
licensing of Internet gaming software, which may potentially be used in
violation of applicable statutes. However, it is possible that our planned
activities may be alleged to violate an applicable statute based on an
interpretation of the statute or based on a future change of law or
interpretation or enforcement policy. Such allegations could result in either
civil or criminal proceedings brought by governmental or private litigants. As a
result of such proceedings, we could incur substantial litigation expense,
fines, diversion of the attention of key employees, and injunctions or other
prohibitions preventing us from engaging in various anticipated business
activities. Such an outcome would have a material adverse effect on our business
and our results of operations.
CGC's strategy is to sublicense Online Games software to operators that are
licensed to operate Internet gaming web sites. As such, we believe CGC's
activities will conform to current gaming laws and regulations. However, there
is little case law authority related to the interpretation of gaming statutes as
they relate to they relate to the Internet and the wording of many of the
applicable statutes is ambiguous. Consequently, it is possible that sublicensees
of Online Games applications may be alleged to violate an applicable statute
based on an interpretation of the statute or based on a future change of law or
interpretation or enforcement policy.
CREDIT CARD COMPANIES MAY LIMIT CREDIT CARD USE IN INTERNET GAMING.
Licensees' revenues are generally collected through on-line credit card
processing. Recently some credit card companies, such as MasterCard, and certain
credit card issuing banks in the United States, have stopped processing
transactions from on-line gaming customers. Such further action by credit card
companies or issuers could have a material adverse effect on the Company's
business, revenues, operating results and financial condition.
ITEM 4. INFORMATION ON THE COMPANY
A. History and development of the company.
Introduction
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Chartwell Technology Inc. ("we," "us," "our," "Chartwell," the "Company" or the
"Registrant" as the context requires) and our wholly owned subsidiaries, Gateway
Technology Inc. ("GTI"), a Delaware corporation, and Chartwell Games Corp
("CGC"), formerly Gaming Tech Corporation ("GT"), a Belize corporation, are
engaged in the business of developing, marketing and licensing computer software
applications for gaming and entertainment on the Internet and internal intranet
systems. Our principal office is located at Chartwell House, 750 - 11th Street
SW, Suite 400, Calgary, Alberta, Canada, T2P 3N7. Our common stock trades on the
Toronto Stock Exchange under the symbol CWH:TSX.
-9-
Corporate History 1992 - 2004
- -----------------------------
We were incorporated as "Napier Explorations Inc." in British Columbia on
December 16, 1987 to engage in business as a mineral exploration company. We
changed our name to "Brockton Resources Inc." on May 1, 1989. From our inception
to April 1992, we conducted a program of mineral lease acquisition and
exploration activities. We abandoned our mineral properties in April 1992. On
November 19, 1992, we changed our name to "Chartwell Ventures Ltd."
We remained inactive until May 1994, when we acquired a 1.967% working interest
in a petroleum and natural gas property, the Harmattan East Viking Unit No. 1
located in Township 32, Ranges 2 and 3, W5M, known as the "Harmattan Property",
for $740,000. Mobil Oil (Canada) was the operator of the Harmattan Property and
we received revenues from production on the Harmattan Property through our
working interest. On December 18, 1995, we continued our incorporation into
Alberta, Canada under the Business Corporations Act of Alberta. From June 1994
through November 1998, our only asset and business was our working interest in
the Harmattan Property.
Effective November 1, 1998, we acquired GTI, which was engaged in the business
of developing software and integrating computer hardware and software for
Internet and Intranet based computer applications. GTI was a computer hardware
and software integrator that specialized in developing and licensing Internet
and Intranet based computing solutions, with a focus in the area of Internet
based commerce and Internet/Intranet gaming. After acquiring GTI, we shifted our
business strategy from the oil and gas industry to the software technology
development and licensing industry. On December 8, 1998, we changed our name to
"Chartwell Technology Inc." At this time, we changed our business to the
development of computer software.
In February 1999, we sold our entire interest in the Harmattan Property to an
arms'-length third party. Our sale of the Harmattan Property was effected to
divest our oil and gas operation and to focus our resources on the development
of our computer hardware and software integration business. We received approval
of the Alberta Stock Exchange related to our change in business in accordance
with its policies. During our fiscal year ended October 31, 1999, we raised
$500,000 through a private placement of convertible debentures and share
purchase warrants ("1999 Warrants") and $1,000,000 through a private placement
of special warrants ("1999 Special Warrants") completed on May 26, 1999. All of
the 1999 Special Warrants and 1999 Warrants were exercised resulting in the
issuance of 1,100,000 Common Shares in aggregate and resulting in a further cash
infusion of $1,375,000. Effective June 7, 1999, all of our convertible
debentures were converted into 500,000 Common Shares.
Under an agreement dated October 8, 1998, GTI acquired from Corel Corporation
all proprietary rights to certain software code, which formed the basis of our
Internet gaming product. Since our acquisition of GTI, we have completed a total
redevelopment of our Internet gaming software product.
On November 1, 1999, we sold certain parts of our interest in our gaming
software and assigned all our software sublicensing agreements related to our
gaming software to our wholly owned subsidiary Chartwell Games Corp. ("CGC"). We
organized CGC as an independent operating subsidiary to license and manage the
wagering version of our Online Games software application. Our business plan and
strategy is to focus primarily on the development, marketing and market
development of our entertainment software.
During the year ended October 31, 2000, we raised $10,075,000 through a private
placement of Special Warrants completed on March 10, 2000. During this fiscal
year the Company began to earn license fee revenue from the sales of its online
gaming software.
During the fiscal years ended October 31, 2001, 2002 and 2003 the Company
continued development and licensing of our software products. Marketing and
sales efforts were focused mainly on Europe and Asia due to the perceived demand
from this region. During this three year period the Company's licensing revenue
increased to $6,300,335 from $172,463 in fiscal 2000.
During the year ended October 31, 2004, the Company increased the size and scope
of its sales and marketing organization and established London, U.K. as the
Company's sales and marketing office. This resulted in our establishment of a
strong Corporate presence in a key market area. During the year we also
completed development of our newest core gaming system and product development
continued to be driven by our markets and our customers.
-10-
On December 7, 2004, the Company closed a private placement of 2,365,592 common
shares at a price of $4.65 for gross proceeds of approximately $11,000,000. The
underwriters were granted 141,936 compensation options exercisable at $5.10 per
share for 18 months.
See Item 4.B. and Item 5 below for important events in the development of the
Company's business for fiscal year ended October 31, 2004.
There has not been any indication of any public takeover offers by third parties
in respect of the Company's shares or by the Company in respect of other
company's shares during the last or current financial year.
B. Business Overview.
OUR BUSINESS
Chartwell is a leading software provider to the online gaming market.
Headquartered in Calgary, Chartwell has software development operations in
Canada and sales and markerting operations in London, U.K. We trade on the
Toronto Stock Exchange under the symbol CWH:TSX. Our business plan and strategy
is to focus on the continued development and marketing of our online suite of
games. We do not offer electronic funds transfer services, provide credit card
processing or banking services, conduct any gaming operations on our Web Site or
servers, provide gaming marketing or administrative services or provide services
related to obtaining gaming licnses or government approval for gaming
activities. Our business is developing and licensing gaming software and
software that is designed to assist operators with the administration and
management of a variety of game playing Web Sites. Our licensees must,
therefore, manage, support and administer their own Web Site servers and the
games offered on their sites and market their Web Site operations without our
assistance.
Development of Our Business - 2004
During the year ended October 31, 2004, we maintained our overall focus on
product development driven by our markets and our customers. We completed
development of our newest core gaming system release and the community
infrastructure system to support both the Poker and Bingo communities in 2005.
We also completed the commercial application of our mobile gaming system and the
alpha version of our kiosk gaming systems both of which are targeted for rollout
in 2005.
During fiscal 2004, we raised the profile of Chartwell in the financial
community through continued financial performance and the upgrading of our
public listing form the TSX Venture Exchange to the Toronto Stock Exchange.
Three firms initiated research coverage and market capitalization grew by
approximately 300%.
During fiscal 2004, we also increased the size and scope of our sales and
marketing organization and established London, U.K. as the Company's sales and
marketing office. This enabled us to create a strong Corporate presence in a key
market area with a closer proximity to current customers and prospects.
We will continue to develop and deliver new games and gaming options to our
licensees and will continue to deploy our gaming suite to new delivery channels
and platforms like kiosk and wireless.devices.
OUR PRODUCTS
Chartwell Gaming System
Chartwell does not operate any gaming sites, nor do we operate our clients'
sites. What we do is provide gaming systems to our clients, who then offer the
games to players. Players never place bets with Chartwell directly or
indirectly. Instead of competing with our clients, we enter into "technology
partnerships" with them, eliminating any potential for conflict of interest. We
offer a customized approach, creating a unique system for each individual client
that complements their current online operation and brand image. Cyberboss,
Chartwell's administration, marketing and reporting software, and Cyberbanx, our
proprietary e-commerce engine, provide our clients with all the tools
-11-
necessary for the successful operation and promotion of their Chartwell Gaming
System. Chartwell's gaming solution can also be provided under a third party
managed services solution.
Our entertainment software products consist of Online Casino, soft games,
multiplayer Bingo and multiplayer Poker games. The Online Casino comprises a
large selection of card games, table games, slots and video poker. The online
Casino suite is available in in-browser or download versions and a selection of
these games can also be played using Java enabled mobile devices and on
networked kiosks. All games can be operated in a wagering mode for real money
applications or a free mode for fun or entertainment applications. The software
can be deployed in either a standalone configuration or integrated into an
existing gaming site.
We continually upgrade our support software and technologies to increase their
functionality and capabilities. The ability of our licensees to maintain a
high-quality gaming environment is critical to the success of our Online Games
product and to our licensing revenue. The Online Games software is subject to
technological obsolescence and as technology advances, we will attempt to stay
ahead of the competition by upgrading the quality of our software with respect
to new gaming products, graphics, sound and other features to meet rising user
expectations.
We believe that maintaining a gaming environment, which includes security
measures to protect player information, confidentiality of player information,
responsible gaming features, variety of games, state of the art graphics, sounds
and processing speeds, will contribute to our ability to generate licensing
revenues. We have designed our Online Games software to feature the look and
feel of wagering games that are played in a physical environment by using our
proprietary technology.Our Online Games software provides the following built-in
security features that are designed to prevent hackers or licensees of our
software from manipulating games and systems, including:
Although we have implemented security measures to prevent tampering or
manipulating of our games, we cannot guarantee that such security measures will
not be breached or that future technologies will not render our systems
obsolete. If our Online Games security measures are breached, our business and
results of operations will be adversely affected.
-12-
Multiplayer Poker
Chartwell's multiplayer poker provides players with a selection of the most
popular poker games. Our multiplayer poker is licensed as part of a fully hosted
Poker community. Having players from multiple sites and using multiple
currencies all playing together allows more games, more game selection, and
larger pots, which in turn provides higher revenue potential for all
participating licensees. Community members can benefit from the critical mass of
the network and still be able to hold tables, tournaments or promotions for
their respective players. Each member of the community retains full control and
confidentiality of their own players and data, allowing them to use existing
payment systems and providing a secure environment or their players.
Multiplayer Bingo
Chartwell's in-browser, multiplayer North American (75-ball) and UK (90-ball)
bingo systems are Flash-based for smooth, state of the art graphics and can be
fully customized to match client's existing branding and themes. Clients have
the option of joining the Chartwell Bingo community, where bingo players from
multiple Chartwell clients can all play and chat together in the same games,
increasing game selection and accumulating larger jackpots. Like Chartwell
Poker, each bingo player enters the bingo community from a client-branded web
site and plays in a bingo hall branded with their particular site's colours,
logos and other design considerations. The Chartwell Bingo community also
supports deposits in any currency, allowing players from around the world to
play together. Alternately, Chartwell Bingo can be deployed as a stand-alone
product or integrated with a current online operation.
Soft Games
Along the traditional suite of casino games Chartwell also offers a range of
different "soft" or fixed odds games. Soft games include scratch cards, pull
tabs, lottery-style games and hi/lo games which are more chance-based than games
like poker or sports-betting which require higher levels of skills and strategy.
These games are gaining a widespread acceptance as a form inexpensive
entertainment, allowing us to expand the online gaming demographic by appealing
to a larger audience, including traditionally non-gaming markets.
Mobile Games
Chartwell has created a suite of casino and soft games for Java-enabled mobile
devices. Games feature custom branding and animation. Clients offering other
Chartwell products on their site can easily add mobile games, with players
accessing the mobile download using their existing user names, passwords and
player accounts. Chartwell is able to deploy its mobile casino suite across all
leading mobile phone manufacturers and wireless carrier networks. Our target is
to support the vast majority of phones in the UK and European marketplace at all
times.
We have also developed related applications, CyberBoss and CyberBanx, which
provide the back-end tools required for a completely integrated Internet gaming
system.
CyberBoss is a comprehensive administrative utility that provides licensees with
a suite of administrative, marketing, customer relations' management and
promotional tools. By using CyberBoss licensees are able to securely access and
classify server and transaction data from virtually anywhere via a web browser.
The CyberBoss system features password encryption features for data
transmissions and access by the licensee. We do not administer the CyberBoss
system or store licensee operations data.
CyberBanx is a proprietary e-commerce engine that facilitates secure, automated
player access to their account deposits and withdrawals through a number of
third party credit card and payment processors. The software features a
high-level security system that uses multiple level password encryption software
for data transmissions and can be programmed to require a variety of player
information including name, address, credit card number, maximum player
information that may be required by third party credit card and wire transfer
processing systems. CyberBanx also features technology that permits a licensee
to authenticate and verify the identity of the parties sending and receiving
data. As a security measure our licensees do not store credit card information
in the gaming system database.
Although we have implemented security measures to prevent tampering or
manipulating of our games, we cannot guarantee that such security measures will
not be breached or that future technologies will not render our systems
-13-
obsolete. If our Online Games security measures are breached, our business and
results of operations will be adversely affected.
We have also designed and developed a Site Development Kit (SDK), a Game
Development Kit (GDK) and an External Game Interface (EGI). These applications
are not licensed separately.
The SDK is a comprehensive integration interface that allows for seamless
integration of a customer's administration system to the Gaming System. The GDK
and EGI are interfaces that enable rapid development and deployment of online
games. The GDK is a standard interface to the back -end of the system and
supports rapid internal game development as well as providing a method for
independent third party game developers to add to the gaming suite. The EGI
allows for the addition of existing third party applications such as sports
books to be integrated into the Gaming System.
Managed Services Solution
Previously, the typical Chartwell client has been a large, sophisticated entity
with a solid IT infrastructure, an established player base, and payment
processing facilities. Many of these operators run sportsbooks or land-based
casinos, and as such appreciate the ability to run their Chartwell Gaming System
themselves. There is another market segment of operators who have an online
presence and large database of customers but are not currently involved in
gaming. They may recognize the benefit of adding ganes to their site but are not
currently involved in gamaing and may not have the industry experience necessary
to manage day-to-day operations of a gaming site. These operators are seeking a
service provider who can assist them in this regard while allowing them to
maintain ownership of their player database and brand. For these operators,
Chartwell now offers a managed services solution. Elite Club Managemnet N.V. is
an independent company acting as Chartwell's exclusive provider of managed
services. Elite Club holds the gaming license, hosts the game on behalf of the
licensees, provides player access, manages the operations of the gaming site,
supplies the hardware, connectivity and third party software. The client is
responsible for marketing and player acquisitions.
Online Games Licensing
CGC licenses Online Games play for real applications only to operators of
Internet gaming Web Sites who have been granted Internet gaming licenses by
jurisdictions that permit Internet gaming. We also license our Online Games
applications to a variety of entertainment Web Sites for entertainment and
promotional purposes. We modify our Online Games applications to meet our
licensees' specifications and marketing theme. We do not offer electronic funds
transfer services, provide credit card processing or banking services, conduct
any gaming operations on our Web Site or server, provide gaming marketing or
administrative services or provide services related to obtaining gaming licenses
or governmental approval for gaming activities. The material terms of CGC's
standard licensing agreement are as follows:
o The initial term is generally for a period of three years, renewable
for an additional two year period unless the licensee provides written
notice of termination at least 90 days prior to the expiration of a
term;
o The licenses are non-exclusive and non-transferable;
o CGC may terminate the license agreement if the licensee breaches any
material term of the license;
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o We will maintain and upgrade our software and retain all right, title
and interest in our technologies;
o The licensee paysa monthly licensing fee. The fee is calculated as a
percentage of the gross win of the licensee's online casino. whichis
on
o The licensee must be licensed in a jurisdiction that permits Internet
gaming and must remain in full compliance with the gaming laws and
regulatory requirements in the licensing jurisdiction.
CGC has reserved the right to cancel any license if certain standards are not
met.
As of March 31, 2005, CGC has licensing agreements with twenty-two (22)
licensees. Sixteen (16) of these licensees have launched licensed Internet
gaming Web Sites. The Company cannot confirm if or when the remaining licensees
will launch their Web Sites.
None of the Company, GTI or CGC intend to own or operate any Internet gaming
operations.
Internet Games and Gaming Software Market
The market for Internet gaming software how shown consoiderable growth over the
past two years with considerable growth potential ahead. Online casino continues
to be major growth area. Poker is emerging as a rapidly expanding game segment
and gaining popularity around the world. According to Poker Pulse, Global
Betting and Gaming Consultnats, online Poker has grown 20-fold since 2002, is
about 15% of the Internet gaming industry and is forecasted to double next year.
Mobile gaming, particlulary mobile lotteries, is now beginning to emerge as a
gaming option. Juniper Reseach believes that, regulatiory restrictions
notwithstanding, the total market for mobile gambling services could generate
revenues of more than US$19.3 billion in 2009, or nearly one-third of all mobile
entertainment revenues. The continued growth in the online casino market and
growth in these new game areas offer vast market potential and revenue
opportunities for Chartwell.
We cannot assure you that we will benefit from the increase size of the Internet
gaming market or the growth trend in the market in recent years. We also cannot
assure you that we will be able to successfully compete against established
companies that are in the business of licensing Internet gaming software.
Competition
Although online gaming is a fast growing industry, it is becoming increasingly
competitive and sophisticated. There are currently several competitors for the
licensing of play for real Internet gaming software, including, among others,
Realtime Gaming, Net Entertainment, Parlay Entertainment, Playtech Inc.,
Wagerworks Inc. Microgaming, Cryptologic Inc. and Boss Media AB. We believe that
each of these competitors offers Internet gaming technologies that compete
directly with our Online Games application. Many of these competitors have
greater financial resources than us and have established relationships with
licensees or are operating Internet gaming Web Sites.
Many of our competitors currently offer a full range of products and services,
including Internet gaming software, assistance in procuring licenses, electronic
funds transfer services, data management services, administrative services,
hosting of server software, credit card processing and other banking services,
marketing consulting services and turn-key Internet gaming systems.
We believe that our competitors may develop software and technologies that
compete with our technologies. These potential competitors include large
software development companies that develop a broad range of products as well as
Internet gaming companies that have developed technologies for their own
businesses.
-15-
Our competitors may be able to develop technologies more effectively or may be
able to license their technologies on more favorable terms based on the number
of sublicensees that license their products. Competitors may also adopt more
aggressive pricing or licensing policies than us, which may hinder our ability
to penetrate the market and license our technologies.
In addition, increased competition is likely to result in price reductions,
reduced gross margins and an increased number of competitors competing for
market share, any of which could seriously harm our ability to generate revenues
and our results of operations. We expect competition to intensify in the future
because current and new competitors can enter our market with little difficulty,
and our competitors may sell their software at reduced prices.
Barriers to Entry
Barriers to entry into the Internet/Intranet gaming and entertainment software
industry include significant capital costs relating to software development,
lead time relating to software development and scarcity of qualified software
programmers.
Set forth below are the market barriers we believe we face and our strategy for
addressing these issues:
Barrier Our Strategy
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Developing technology that is compatible with the Develop new technologies to improve the speed of play,
Internet and that transforms commonly played tangible graphics, sound and simplify the procedures for
games of chance into virtual games that are easy for playing our Online Games games.
players to play and understand
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Developing a web-site infrastructure that is secure and Improve and develop our CyberBanx and CyberBoss
that can process transactions on a timely and accurate software on a continual basis
basis
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Obtaining an experienced management and technical team to Recruit and maintain experienced software developers
develop an effective marketing, gaming and Internet and management with experience in software licensing
strategy
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Developing a solid reputation among licensees Provide software that incorporates current technology;
Provide games that are entertaining; and
Provide software support services to address licensee
requests.
- ------------------------------------------------------------------------------------------------------------------
We believe that each of these market barriers must be overcome to establish and
maintain a successful position in the Internet gaming software development
market. We cannot assure you that we will be able to overcome these barriers to
entry or that new competitors will not overcome them more quickly than us. If we
fail to overcome these barriers, we may be unable to compete or generate
sufficient revenues to earn profits, which will have a material affect on our
business and results of operations.
Technology
Although software development varies significantly in terms of the programming
languages used and operating systems on which such software runs, we view the
Internet games and gaming software markets as being divided between applications
which are developed in popular programming languages such as C++ which require
the user to install software prior to playing and those applications developed
in Java which require no installation. A significant part of our Online Games
software was developed in Java. The cross-platform nature of Java makes it
possible to play Online Games on all major operating systems without having to
install any part of the software prior to playing. We believe the browser based
capability of our software provides a competitive advantage over our competition
whose software requires installation.
We believe that our no install, Java and Flash based Online Games software will
provide licensees with the ability to present our players with the most current
version of our Online Games every time a user logs onto a system with no need to
install upgrades.
-16-
Our Online Games software is designed to run on all popular web browsers. The
server software was designed to operate in the Windows NT and 2000 operating
system and has been modified to operate on Linux and Unix systems.
Strategic Relationships
We intend to develop strategic relationships with licensees, which are
anticipated to use our Online Games technologies to develop virtual casinos on
the Internet. We anticipate we will receive ongoing license fees from these
licensing arrangements. We also anticipate our licensees will provide useful
feedback, such as the popularity of games, requested features, operational
suggestions to improve web site administration, customer comments, which are
expected to assist us in upgrading our technologies and developing the next
generation of products and gaming solutions.
We also anticipate we will enter into strategic relationships with potential
vendors and licensees of our Intranet gaming and entertaining solutions. These
vendors and licensees may allow us to offer our Intranet solutions for
applications in land based gaming establishments. We also believe that our
Intranet solutions may be successfully marketed as an entertainment product in
non-gaming environments. We anticipate that vendors and licensees of our
Intranet software solutions may provide useful feedback, which may assist us in
developing new technologies and in marketing our products.
Regulatory Environment - Internet Gaming Regulation
Historically, the gaming industry is subject to intense government regulation.
Many countries are currently struggling with issues surrounding wagering and
gambling over the Internet. More specifically, they are considering the merits,
limitations and enforceability of prohibition, regulation or taxation of
wagering and gambling transactions that are transacted over the Internet. There
are significant differences of opinion and law between countries such as the
United Kingdom, United States, Canada, Australia, Liechtenstein and Antigua.
Nevertheless, several countries accept Internet gambling as legal and some
countries offer licenses for the operation of online casinos.
To the best of our knowledge, all of our licensees operate their interactive
Casinos from jurisdictions where Internet gaming is regulated or tolerated. All
licensees provide a representation in their license agreements to the effect
that such licensee will assume responsibility for determining the legality of
using our software, including, without limitation, accepting wagers in whichever
jurisdictions they choose to market to and receive wagers from.
As has been the case for several years, a significant debate exists whether the
laws of any country other than the country where the computer gaming servers are
physically located have jurisdiction over the operations of a licensee. We
license our software only to licensees that maintain an internet gaming license
issued by a jurisdiction in which internet gaming is legal.
In the United States, the Federal Interstate Wire Act contains provisions which
make it a crime for anyone in the business of gaming to use an interstate or
international telephone line to transmit information assisting in the placing of
wagers, unless the wagering is legal in the jurisdictions from which and into
which the transmission is made. There are other federal laws impacting gaming
activities including the Interstate Wagering Paraphernalia Act, the Travel Act
and the Organized Crime Control Act. However, it remains unresolved whether
these other laws apply to gaming conducted over the Internet.
Various U.S. regulatory and legislative agencies are conducting studies of
interstate and interactive wagering and one, the National Gambling Impact Study
Commission, has recommended the prohibition of Internet gambling within the
United States and the development of enforcement strategies by the Department of
Justice.
We believe that any change in either the substance or the enforcement of the
applicable or proposed rules and regulations in these areas could have an
adverse effect on our business and prospects.
-17-
In the United States, all 50 states currently have statutes or regulations
regarding gaming activities, and three states have no gaming at all. In most
states it is illegal to place or accept a wager, with specific state-by-state
statutory exceptions.
In addition, as electronic commerce further develops, it may generally be the
subject of government regulation. As well, current laws, which pre-date or are
incompatible with Internet electronic commerce, may be enforced in a manner that
restricts the electronic commerce market. Any such developments could have a
material adverse effect on the Company's business, revenues, operating results
and financial condition.
We are unaware of any regulations or laws that prohibit the development and the
licensing of Internet gaming software, which may potentially be used in
violation of applicable statutes. It is possible that our planned activities may
be alleged to violate an applicable statute based on an interpretation of the
statute or based on a future change of law or interpretation or enforcement
policy. Such allegations could result in either civil or criminal proceedings
brought by governmental or private litigants. As a result of such proceedings,
we could incur substantial litigation expense, fines, diversion of the attention
of key employees, and injunctions or other prohibitions preventing us from
engaging in various anticipated business activities. Such an outcome would have
a material adverse effect on our business and our results of operations.
CGC's strategy is to sublicense Online Games software to operators that are
licensed to operate Internet gaming web sites. As such, we believe CGC's
activities will conform to current gaming laws and regulations. However, there
is little case law authority related to the interpretation of gaming statutes as
they relate to they relate to the Internet and the wording of many of the
applicable statutes is ambiguous. Consequently, it is possible that sublicensees
of Online Games applications may be alleged to violate an applicable statute
based on an interpretation of the statute or based on a future change of law or
interpretation or enforcement policy.
Marketing Strategies
The following summarizes our strategic focus and operating strategy:
PROVIDE HIGH QUALITY, INNOVATIVE AND SUPERIOR PRODUCTS AND SERVICES. We will
continue to position our product in the market based on the quality of our
customer support and the quality of our graphics, sounds, back office system and
security features and the speed of our software and systems. We intend to
continue to remain focused on designing technology that achieves efficiency for
licensees and that is innovative, easy to use and appealing to players.
PROVIDE MARKET-ORIENTED AND CUSTOMER FOCUSED SOLUTIONS. A key to our success
will be the success of our licensees. We intend to continue to obtain input from
our licensees on game content and features and to continue to design and develop
a wider variety of gaming products that will meet their needs and the
expectations of their customers. We intend to assist licensees by providing
customized software solutions featuring unique graphics, themes and features
that will allow licensees to differentiate their web sites and games in the
marketplace
PROVIDE OUR CUSTOMERS WITH A VARIETY OF GAMING PLATFORMS. The market for
electronic gaming is expanding to new platforms like mobile and networked
kiosks. During fiscal 2004, we completed the commercial application of our
mobile gaming system and the alpha version of our kiosk gaming systems. We to
market these new gaming offering to existing and new customers PROVIDE COMMUNITY
BASED POKER AND BINGO PRODUCTS. We intend to formally roll-out our community
based Poker and Bingo products in 2005 and we intend to integrate these into new
and existing licensees.
EUROPEAN FOCUS. We intend to continue and accelerate our established strategy of
focusing our new business development activities primarily in Europe. Our sales
team, operating from London, U.K. has over 25 years of combined experience in
the U.K. and European online gaming sector. We believe that our proximity to
existing and
-18-
prospective licensees and our broader and deeper industry experience can be
effectively utilized to develop new opportunities and add new licensees.
We cannot assure you that we will successfully differentiate our technologies
from our competitors or will develop a competitive advantage in the marketplace.
Product Development Strategy
We believe that the most significant factor influencing the licensing of
Internet gaming software is player appeal followed by a mix of elements
including price, service, reliability, technical capability, interface
capability, upgradeability, ability to customize and differentiate from other
web sites, management and administrative support tools and the financial
condition and reputation of the developer. We believe the factors affecting
player appeal is a combination of play features, game variety, ease of use,
appealing graphics, sound and special effects.
To increase the player appeal of Online Games games, we have designed them to be
easy to use and to play and to feature appealing graphics, sound and special
effects. Version 6.2 is our next product release. We intend to continue to make
significant investments in research and development in designing our next
generation of Online Games. We intend to develop new technologies and to license
the latest available technologies to improve the look, feel and speed of our
games. Our goal is to incorporate new games, graphics, sounds and features into
our games to differentiate our Online Games games from those of our competitors.
To appeal to licensees, we intend to develop technologies that allow operators
to market and differentiate their Internet casinos by featuring unique themes
and customized visual elements. We also intend to enhance our technologies to
provide data support and information systems that allow operators to develop and
manage marketing programs targeted at their customers and to manage the
administrative and financial aspects of their business efficiently through data
retention and analysis and accounting capabilities.
PLAN OF OPERATION
We are continuing to develop our business, expand our suite of games, deploy our
games across new platforms and sign new licensees. Fiscal year 2004 was our
second consecutive year of profitability and substantial revenue growth. During
the fiscal years ended October 31, 2004, and October 31, 2003, we had revenues
from continuing operations of $12,201,477 and $7,329,638 respectively. During
these same periods, we had operating income of $4,021,781 and $1,681,538
respectively. As of October 31, 2004, our accumulated deficit was reduced to
$3,483,171. At October 31, 2004, our cash and short term investments were
$9,314,149 and we had working capital of $10,549,056. Subsequent to October 31,
2004 on December 7, 2004, the Company completed a private placement of 2,365,592
common shares at $4.65 per share for gross proceeds of approximately $11,000,000
(net proceeds of $10.3 million after underwriters' fees and expenses). The
Company issued the underwriters 141,136 compensation options exercisable for a
period of 18 months at $5.10 per share. We believe we have sufficient working
capital to fund our operations through our fiscal year ending October 31, 2005.
See "Item 5.B - Liquidity and Capital Resources."
Our business plan through our fiscal year ending October 31, 2005 is to increase
our market share in the traditional internet casino market, establish our Poker
and Bingo Communities, roll out our Mobile and Kiosk offerings and establish
market share in these new market areas.
-19-
ONLINE GAMES SOFTWARE
Software Maintenance and Upgrades
During the year ended October 31, 2004, we released new versions of our Online
Games software. Through our fiscal year ending October 31, 2005, we plan to
maintain and upgrade software that is being used by our present licensees and to
integrate new and unique gaming applications into our customer base. We have
targeted to formally roll-out our Multi-player Poker and Multi-player Bingo and
new soft and lottery style games. We will also continue the deployment of our
expanding suite of games to alternate platforms like molbile and wireless
devices and networked kiosks. In addition, we are continuing to develop
localization of the software, which means developing the screens in various
languages to accommodate non-English-speaking players.
We will continue to offer customization to the current version of our Online
Games software, which allows licensees to differentiate its web site using
interfaces with unique graphic and sound effects and themes. The gaming engines
that run the Online Games are essentially the same for each sublicensee who
customize their individual web sites with graphic and sound interfaces that
provide the appearance of a unique web site. We also customize or upgrade the
back-end systems, which allow licensees to structure the layout of their
Internet casino web sites and operations, and accounting applications, which
permit licensees to administer and structure their accounting systems, to
provide different types and structures of reports upon the request of licensees.
Graphic Development and Creation
We have in-house graphics designers that design and create the HTML graphics
that are required to customize and distinguish licensees' gaming sites. Our
in-house graphic services work with licensees to develop web site interfaces
that feature unique themes designed to appeal to the licensee's target markets.
Present and Future Sales of Online Games Software
Our strategy for marketing and licensing our technology is to continue sales
efforts to present leads as well as exhibiting at trade shows, limited trade
publication advertising, online advertising and implementing a marketing
campaign targeted at existing Internet gaming companies. We have also
established a sales and marketing office in London, England that is staffed by
sales and marketing professionals with extensive industry experience. We expect
that the establishment of the London office will increase our visibility in
Europe and will generate more revenue opportunities for the Company.
Staffing
At March 31, 2005, we had ninety-three (93) employees and contractors including
subsidiaries. CGC had four (4) full time employees. None of the employees of the
Company or CGC are covered by a collective bargaining agreement.
C. Organizational structure.
CTI has two wholly-owned subsidiaries: GTI and CGC. CGC has one wholly-owned
subsidiary: Chartwell Games (Malta) Holding Limited and Chartwell Games (Malta)
Holding Limited has one wholly-owned subsidiary: Chartwell Games (Malta)
Limited.
GTI, our wholly owned subsidiary, was formed on June 27, 1997, as a Delaware
corporation. GTI was primarily responsible for the Company's marketing and sales
functions until May 31, 2000, from and after which time GTI has been inactive
and will be dissolved.
-20-
On November 5, 1999, we organized CGC (formerly GT) as an international business
corporation under the laws of Belize. CGC was organized as an independent
operating subsidiary to license our real money wagering software applications.
We own all the issued and outstanding shares of CGC.
In December of 2004, CGC organized the Malta companies for the purpose of
conducting all software licensing transactions.
We are headquartered in Calgary, Canada, and are primarily responsible for
technology and software development, software upgrade and maintenance, corporate
finance, strategic planning and other corporate functions related to the
development of our business. In March 2004, CGC established a sales and
marketing office in London, UK which is staffed by four sales and industry
professionals.
We, GTI and CGC have never been subject to any bankruptcy, receivership or
similar proceedings.
D. Property, plants and equipment.
Our executive offices are located in leased premises of approximately 11,072
square feet at Suite 400, 750 - 11th Street SW, Calgary, Alberta, Canada. The
lease is for a term of six years commencing December 1, 2003 at a base annual
rental rate of approximately $166,080 with operating costs of approximately
$130,405 annually. We consider these premises suitable for our current needs. We
have an office of approximately 838 square feet at 1166 Alberni Street, Suite
1400, Vancouver, British Columbia, Canada. The lease is for a term of five years
commencing January 1, 2004 at a base annual rental rate of approximately $9,380
with operating costs of approximately $9,965 annually.
CGC's principal offices are located in London, England.
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS
A. Operating results.
The following discussion and analysis of the results of operations and financial
condition of the Company for the fiscal years ending October 31, 2004, 2003 and
2002 should be read in conjunction with the Company's audited financial
statements and the related notes included with this annual report. The financial
statements have been prepared in accordance with accounting principles generally
accepted in Canada, which conform to accounting principles in the United States,
except as described in the notes to financial statements. Unless expressly
stated otherwise, all references to dollar amounts in this section are in
Canadian dollars (in accordance with Canadian GAAP). A description of the
material differences between Canadian GAAP and US GAAP is contained in Note 11
of the notes to financial statements.
OVERVIEW
Chartwell develops, markets, implements and supports gaming applications and
entertainment content for the internet and wireless platforms. Chartwell's JAVA
and Flash based software products and games are designed for deployment in
gaming, entertainment and promotional applications. Chartwell does not operate a
gaming site nor do we operate our clients gaming sites.
Business Model
Substantially all of Chartwell's revenue is of a recurring nature in the form of
software license fees. Chartwell's licensees pay an ongoing fee for the
licensing and support of our software. The license fee is calculated as a
percentage of each licensee's level of activity. Additional sales revenue is
derived from software setup-fees which are one time costs on new customer
installations. Subsequent to October 31, 2003, the Company revised its
accounting policy for the recognition of set-up fee revenue and related set-up
costs. The Company's contractual agreements with licensees provide for the
provision of graphics, web design, software implementation services, licensing
of the software and provision of software upgrades over the fixed term of the
contract. Set-up fee revenue
-21-
and related costs are recognized ratably over the term of the contract. Prior to
the revision of its policy, the Company recognized set-up fees and related
set-up costs using the completed contract method of accounting. The accounting
change was adopted retroactively. At October 31, 2004 the Company has $1.1
million of deferred set-up fees which will be taken into revenue over the next
five years.
Expenses are classified into five categories, software development and support;
sales, general and administrative ("SG&A"); depreciation and amortization, stock
compensation expense and foreign currency gains or losses. Software development
and support consists of personnel and related costs associated with the design
Fand development of new products, support of existing products, customer
implementation and quality assurance. SG&A expenses consist of personnel and
related costs associated with the Company's sales, marketing and business
development activities. In addition, SG&A expenses include the costs of all
administrative, financial and IT personnel, investor relations and professional
fees relating to our public company listing. Stock compensation expense consists
of the estimated fair value of options granted to consultants during the year.
Depreciation and amortization expenses are based on the estimated useful life of
our assets and include the amortization of deferred software development costs.
The company operates internationally with 100% of its revenue derived from
non-Canadian sources. Under the Company's licensing agreements, the majority of
the Company's revenue is received in U.S. dollars. Consequently, the Company is
exposed to currency fluctuations which result in foreign currency gains or
losses which are reported in this expense category.
FINANCIAL REVIEW
Chartwell realized strong top line and bottom line growth in fiscal 2004. Total
revenue increased to $12.2 million compared to $7.3 million in 2003; earnings
("net income") grew by 139.1% with diluted earnings per share of $0.24 compared
to $0.12 in 2003. The strong growth reflected incremental revenue from new games
and increased revenue from existing clients.
In 2004, 92.4% of Chartwell's revenue was of a recurring nature compared to
86.0% in 2003, and was generated from long term licensing agreements that
generally extend from three to five years. Our five largest licensees accounted
for approximately 91.3% of our recurring license fees in 2004 compared to 93.4%
in 2003. In 2004, we either renegotiated or extended contracts with four of our
major clients.
The Company continued to invest in key areas of our business, specifically
related to product development, sales and marketing and our European presence.
In March, the Company opened a sales office in the United Kingdom and added
three senior sales and marketing professionals to our sales team. Resources were
also added in the areas of software development, quality assurance and customer
support. Overall, headcount, including consultants, increased to seventy-seven
from fifty-six in 2003. These staffing additions are necessary to continue to
deliver on our product, revenue and customer support initiatives.
Increased expenditures will continue to be necessary in 2005 to sustain and
build for long-term growth.
Chartwell continued to strengthen its balance sheet in 2004. Cash and short-term
investments increased to $9.3 million compared to $5.2 million in 2003. The
Company's balance sheet was further strengthened by the completion of a private
placement of $10.5 million in the first quarter of 2005.
-22-
SELECTED ANNUAL FINANCIAL DATA
Comparison of the years ended October 31, 2004, 2003 and 2002:
Consolidated Statement of Operations and Deficit
% of % of % of
Year ended October 31, 2004 Revenue 2003 Revenue 2002 Revenue
-------------------------------------------------------------------------
(Amounts in Thousands,
Except Per Share Data)
Revenue
Software license fees $11,268 92.4% $ 6,300 86.0% $ 2,647 68.8%
Software set-up fees 798 6.5% 920 12.6% 896 23.3%
Interest & other 135 1.1% 109 1.5% 302 7.9%
-------------------------------------------------------------------------
12,201 100.0% 7,329 100.0% 3,845 100.0%
Expenses
Software development & support 4,418 36.2% 3,288 44.9% 2,648 68.9%
Sales, general & administrative 3,499 28.7% 1,948 26.6% 2,386 62.1%
Amortization of deferred software
development costs 98 0.8% 110 1.5% 110 2.9%
Stock-based compensation 103 0.8% - 0.0% - 0.0%
Depreciation & amortization 244 2.0% 137 1.9% 108 2.8%
Foreign currency loss (gain) 233 1.9% 795 10.8% (86) (2.2)%
-------------------------------------------------------------------------
8,595 70.4% 6,278 85.7% 5,166 134.4%
Net income (loss) before taxes 3,606 29.6% 1,051 14.3% (1,321) (34.4)%
Income taxes (415) (3.4)% (630) (8.6)% - 0.0%
Net income (loss) $ 4,021 33.0% $ 1,681 22.9% $ (1,321) (34.4)%
Net income (loss) per share
Basic $ 0.28 $ 0.12 $ (0.10)
Diluted $ 0.24 $ 0.12 $ (0.10)
October 31, 2004 2003 2002
(Amounts in CAD dollars, in Thousands) -----------------------------------------
Consolidated Balance Sheet Data
Cash & short-term investments $ 9,314 $ 5,178 $ 4,886
Working capital 10,549 6,545 5,484
Total assets 14,962 9,219 6,952
Deferred revenue 1,095 1,688 1,321
Total shoareholders equity 13,122 7,305 5,446
-23-
SELECTED QUARTERLY FINANCIAL DATA
The following table sets out selected unaudited financial information of the
Company on a consolidated basis for the last eight quarters. 2003 quarterly
results reflect the restated amounts resulting from the adoption of the change
in accounting policy for the recognition of set up fee revenue as previously
noted.
Fiscal 2004 Quarters
Q1 Q2 Q3 Q4 Annual
------------------------------------------------------------
Revenue
Software license fees $ 215 $ 191 $ 184 $ 208 $ 798
Software set-up fees 1,939 2,699 3,393 3,237 11,268
Interest & other 44 26 21 44 135
------------------------------------------------------------
2,198 2,916 3,598 3,489 12,201
Expenses
Software development & support 1,002 1,006 1,172 1,238 4,418
Sales, general & administrative 771 1,004 764 960 3,499
Amortization of deferred software
development costs -- -- 39 59 98
Stock-based compensation -- -- -- 103 103
Depreciation & amortization 35 53 103 53 244
Foreign currency loss (gain) (41) (76) 105 247 233
------------------------------------------------------------
1,767 1,985 2,183 2,660 8,595
Net income (loss) before taxes 431 931 1,415 829 3,606
Income taxes 45 (33) 204 (631) (415)
------------------------------------------------------------
Net income (loss) $ 386 964 $ 1,211 $ 1,460 $ 4,021
============================================================
Basic earnings per share $ 0.03 $ 0.07 $ 0.08 $ 0.10 $ 0.28
Diluted earnings per share $ 0.03 $ 0.06 $ 0.07 $ 0.08 $ 0.24
Fiscal 2003 Quarters
Q1 Q2 Q3 Q4 Annual
------------------------------------------------------------
Revenue
Software license fees $ 198 $ 234 $ 241 $ 246 $ 919
Software set-up fees 1,183 1,577 1,693 1,847 6,300
Interest & other 28 27 32 23 110
------------------------------------------------------------
1,409 1,838 1,966 2,116 7,329
Expenses
Software development & support 883 976 1,024 405 3,288
Sales, general & administrative 423 390 473 661 1,947
Amortization of deferred software
development costs 28 28 28 28 112
Stock-based compensation -- -- -- -- --
Depreciation & amortization 21 22 26 68 137
Foreign currency loss (gain) -- 383 201 211 795
------------------------------------------------------------
1,355 1,799 1,752 1,373 6,279
Net income (loss) before taxes 54 39 214 743 1,050
Income taxes -- -- -- (630) (630)
------------------------------------------------------------
Net income (loss) $ 54 39 $ 214 $ 1,373 $ 1,680
============================================================
Basic earnings per share $ -- $ -- $ 0.02 $ 0.10 $ 0.12
Diluted earnings per share $ -- $ -- $ 0.02 $ 0.10 $ 0.12
-24-
RESULTS OF OPERATIONS
YEAR ENDED OCTOBER 31, 2004 COMPARED TO THE YEAR ENDED OCTOBER 31, 2003.
REVENUE
Compared to the same period of 2003, total revenue in 2004 increased by 66.5%.
In 2004, Chartwell generated progressively stronger quarterly revenue due
primarily to the growing business of existing customers. The average quarterly
growth rate was 16.2% in 2004 compared to 13.6% in the year ended October 31,
2003.
Total revenues increased to $12.2 million for the year ended October 31, 2004
compared to $7.3 million for the year ended October 31, 2003. Revenue growth is
primarily attributable to the significant growth in recurring software license
fees which increased 78.9% to $11.3 million in the year ended October 31, 2004
compared to $6.3 million in the year ended October 31, 2003. Recurring license
fees remain the biggest contributor to revenue and represented 92.4% of total
revenue in fiscal 2004 compared to 86.0% of total revenue in fiscal 2003.
Looking forward, we expect that recurring license fees as a percentage of
revenue will continue to increase.
Set-up fee revenue decreased 13.2% to $798 thousand in the year ended October
31, 2004 compared to $920 thousand in the year ended October 31, 2003. The
decrease is primarily attributable to smaller set-up fees from new clients and
reflects the impact of the change in revenue recognition policy. We expect to
realize $479 thousand of deferred set-up fees as revenue in fiscal 2005.
Interest and other revenues increased 23.1% to $135 thousand in the year ended
October 31, 2004 compared to $109 thousand in the year ended October 31, 2003.
The increase in short-term investments to $3.3 million in 2004 compared to $1.7
million in 2003 accounted for the increase in interest income.
We anticipate that revenues will continue to increase during our fiscal year
2005, as we enter into new software licensing agreements and as we continue to
earn increasing revenues from our installed base of customers.
OPERATING EXPENSES
Compared to the same period of 2003, total operating expenses in 2004 increased
by 36.9%.
Total operating expenses increased to $8.6 million in the year ended October 31,
2004 compared to $6.3 million in the year ended October 31, 2003. Overall, the
increase in expenses in the current year is largely attributable to the increase
in headcount and related infrastructure costs, stock compensation expense and
depreciation and amortization.
As a percentage of total revenue, total operating expenses decreased to 70.4% in
fiscal 2004 compared to 85.7% in the prior year.
SOFTWARE DEVELOPMENT & SUPPORT
Software development and support costs continue to represent the Company's
largest expenditure area. In 2004, software development and support costs
increased by 34.3% to $4.4 million compared to $3.3 million in 2003. Costs
relating to the development of software are expensed as incurred unless they
meet the criteria for deferral and amortization under generally accepting
accounting principles. In 2004, the Company deferred costs of $175 thousand
compared to $531 thousand in 2003. This deferral had the effect of reducing
software development and support costs by the equivalent amount in the
respective years. Had the Company not deferred costs in both years, the year
over year increase would have been 20.2%. The Company commenced amortizing these
costs in the third quarter of 2004.
The Company's product development focus continues to be reflected in its
employee demographics as 80% of the total employee population were dedicated to
product design, development and support. Salaries and benefits accounted for
82.8% of software development costs in 2004 compared 81.2% in 2003.
-25-
As a percentage of revenue, software development and support expenses decreased
to 36.2% in 2004 compared to 44.9% in 2003.
Due to the increasing demands for new gaming products and the Company's product
development and support initiatives, we anticipate adding technical resources in
fiscal 2005 which will result in a corresponding increase in software
development expenses.
SALES, GENERAL & ADMINISTRATIVE
SG&A expenses increased by 79.6% to $3.5 million in 2004 compared to $1.9
million in 2003. The increase in 2004 was primarily attributable to increased
sales and marketing costs resulting from the opening of the London U.K. sales
office and the addition of sales and marketing personnel. Expenses also
increased in a number of other areas due to the general growth of the Company
and the upgrade of its public listing to the Toronto Stock Exchange from the TSX
Venture Exchange.
As a percentage of revenue, SG&A expenses increased slightly in 2004 to 28.7%
compared to 26.6% in 2003.
AMORTIZATION OF DEFERRED SOFTWARE DEVELOPEMNT COSTS
Amortization expenses decreased 11.0% to $98 thousand in 2004 compared to $110
thousand in 2003. The expense reflects two quarters of amortization of
previously deferred software development costs. The deferred costs will continue
to be amortized over an estimated remaining useful life of thirty months.
STOCK BASED COMPENSATION
In 2004, the Company recorded $103 thousand of stock based compensation expense
relating to the grant of options to consultants. There was no comparative
expense in 2003.
DEPRECIATION & AMORTIZATION
Depreciation and amortization expenses increased 77.9% to $244 thousand from
$137 thousand in 2003. The increase reflected additional investment in computer
hardware and software. As a percentage of revenue, depreciation and amortization
increased to 2.0% in 2004 compared to 1.9% in 2003. It is expected that
continued investment in computer hardware and software will be required as the
Company continues to grow but depreciation and amortization will remain constant
as a percentage of revenue.
FOREIGN CURRENCY LOSSES
Foreign currency losses decreased by 70.7% to $233 thousand compared to $795
thousand in 2003. The currency loss reflects the significant decline in the U.S.
dollar compared to its Canadian counterpart. The U.S. dollar exchange rate
declined from 1.2993 in November, 2003 to 1.2190 in October, 2004.
INCOME TAXES
Income tax assets relate to the Company's future tax benefits which arise from
loss carry forwards and research and development costs. The valuation of tax
assets is based on the amount of tax benefits available combined with the
determination as to when the tax benefits will be realized and the tax rate in
effect at that time. The tax assets are based on Management's best estimates of
the timing of the recovery of these assets. At October 31, 2004, the Company
recorded an additional future tax asset of $1.0 million. The recognition of this
future tax asset and the write off the corresponding asset of $630 thousand from
2003 resulted in a net tax recovery of $415 thousand in 2004. The net recovery
is treated as an expense recovery in the current year.
At October 31, 2004 the Company has no valuation allowance remaining and is
expected to be taxable in 2005.
NET INCOME
In 2004, net income increased 139.1% to $4.0 million compared to $1.7 million in
2003. Diluted earnings per share
-26-
increased to $0.24 compared to $0.12. Increased earnings in 2004 are
attributable to effectively managing expenses in proportion to revenue as well
as a significant reduction in foreign currency losses in 2004.
LIQUIDITY & CAPITAL RESOURCES
OPERATING ACTIVITIES
The Company's principal sources of cash were its cash on hand and cash flow from
operations. In 2004, the Company continued to increase its cash position to fund
its working capital needs.
In 2004, the Company generated cash flow from operations of $4.2 million
compared to $1.4 million in 2003. The increase in cash flow was due primarily to
the increase in net income.
Cash at October 31, 2004, including short term investments, increased to $9.3
million from $5.2 million and working capital increased to $10.5 million
compared to $6.5 million at October 31, 2003.
FINANCING ACTIVITIES
The Company's financing activities consisted primarily of the issuance of shares
resulting from the exercise of stock options. In 2004, the Company realized
proceeds of $856 thousand from the exercise of 702 thousand stock options at an
average price of $1.22. In 2003, the Company realized proceeds of $152 thousand
from the exercise of 145 thousand stock options at an average price of $1.05.
There were no other significant financing activities in either year.
In the first quarter of 2005, the Company closed a private placement consisting
of 2.4 million common shares which were sold at a price of $4.65 per share for
net proceeds of $10.3 million.
INVESTING ACTIVITIES
The Company's investing activities consist primarily of the purchase of short
term investments and property and equipment which included computers and
software for internal use and furniture, fixtures and telecommunications
technology relating to the relocation of the Company's office. In 2004, the
Company's net use of funds for investing purposes was $2.4 million compared net
proceeds of $730 thousand in 2003. The negative cash position from investing
activities was primarily attributable to the purchase of $1.6 million in short
term investments and $604 thousand of property and equipment.
We do not know of any trends, demands, commitments, events or uncertainty that
will result in, or that are reasonably likely to result in, our liquidity either
materially increasing or decreasing at present or in the foreseeable future.
Material increases or decreases in our liquidity are determined by the success
or failure of our software operations.
YEAR ENDED OCTOBER 31, 2003 COMPARED TO THE YEAR ENDED OCTOBER 31, 2002
REVENUE
Compared to the same period of 2002, total revenue in 2003 increased by 90.6%.
Total revenue increased by $3.5 million to $7.3 million for the year ended
October 31, 2003 compared to $3.8 million for the year ended October 31, 2002.
All of the Company's revenue was billed in U.S. dollars. As a result of the
continued strengthening of the Canadian dollar compared to its U.S. counterpart,
the amount of operating revenue reported in fiscal 2003 was approximately $600
thousand lower than would have been reported if the average exchange rate would
have remained at historical levels.
Revenue growth occurred in both set up fees and license fees. Recurring license
fees increased 138.0% to $6.3 million from $2.6 million in 2002. This increase
was attributable to the strong quarter over quarter revenue growth within our
installed base of clients. License fees represented 86.0% of total revenue in
2003, up from 68.8% in 2002.
-27-
Interest and other revenues for the fiscal year ended October 31, 2003 were $109
thousand compared to $302 thousand in 2002, a decrease of 63.8%. The decrease
was due to a reduction in earned interest resulting from a decrease in short
term investments of $1.4M.
OPERATING EXPENSES
Compared to the same period in 2002, operating expenses in 2003 grew by 21.5%.
The Company's expenses are classified into four categories: software development
and support, general and administrative, depreciation and amortization and
foreign currency losses.
In fiscal 2003, total operating expenses increased to $6.3million from $5.2
million in 2002. This increase is due solely to an increase in software
development and support expenses and foreign currency losses of $795 thousand.
SOFTWARE DEVELOPMENT & SUPPORT
Software development and support was the Company's largest expenditure area in
2003. In fiscal 2003, expenses increased by $600 thousand to $3.3 million from
$2.7million in 2002. In 2003, the Company deferred $531 thousand of costs
relating to the development of the Company's Community Poker product. Management
estimated that the appropriate amortization period would be three years and that
amortization would commence in 2004 with commercial availability of the product.
There was no deferral of costs in 2002.
In 2003, 75% of the total employee population was dedicated to product design,
development and support and the corresponding salaries and benefits accounted
for 93.0% of software development costs in 2003 compared to 81.2% in 2002.
As a percentage of operating revenue, software development expenses decreased to
44.9% from 68.9% in 2002.
SALES, GENERAL & ADMINISTRATIVE
SG&A expenses include salaries, benefits and expenses of corporate personnel in
addition to all sales, marketing, and business development expenses.
In fiscal 2003, SG&A expenses decreased by $438 thousand to $1.9 million from
$2.4million in 2002. The decrease was due primarily to a reduction in contract
termination expenses of $220 thousand and lower consulting fees.
As a percentage of operating revenue, SG&A expenses decreased to 26.6% in 2003
compared to 62.1% in 2002.
DEPRECIATION & AMORTIZATION
Amortization expense remained constant at $110 thousand in 2003. Costs related
to the acquisition of Gateway Technology Inc. were fully amortized in the year.
In fiscal 2003, depreciation expense increased by 27.1% to $137 thousand. The
increase is due to the Company's purchase of $208 thousand of computer systems.
FOREIGN CURRENCY (GAINS) LOSSES
In 2003, the Company incurred $795 thousand of foreign currency losses compared
to a foreign currency gain of $86 thousand in 2002. All of the Company's revenue
is received in U.S. dollars and the Company did not have any hedging programs to
mitigate the risk of downward fluctuations in the U.S. dollar. As a result of
the significant decline in the U.S dollar relative to its Canadian counterpart
the Company realized a significant foreign currency loss.
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NET INCOME (LOSS)
In 2003, net income increased to $1.7 million from a net loss of $1.3million in
2002. This was due to the combination of a significantly larger growth in
revenues (90.6%) than in expenses (21.5%) and the positive effect of the future
income tax recovery of $630 thousand on current income.
Earnings per share, fully diluted, for the year ended October 31, 2003 were
$0.12 compared to a loss per share, fully diluted, of $0.10 for the preceding
year.
LIQUIDITY & CAPITAL RESOURCES
OPERATING ACTIVITIES
The Company's principal sources of capital are its cash on hand and cash flow
from operations.
In 2003, the Company generated cash flow from operations of $1.4 million
compared to a utilization of $1.2 million in 2002. The improved cash flow was
due primarily to net income in 2003.
At October 31, 2003, the Company had cash, cash equivalents and short term
investments of $5.2 million compared to $4.9 million at the end of 2002.
Accounts receivable increased to $2.0 million from $1.1 million in 2002. A
significant portion of the receivables were collected in the first quarter of
2004. There was no significant change in accounts payable and accrued
liabilities in 2003 compared to 2002.
Deferred revenue at October 31, 2003 was $1.7 million compared to $1.3 million
at October 31, 2002. Deferred revenue is attributable to set-up fees which are
recorded as revenue ratably over the term of the software licensing agreement,
typically three to five years.
FINANCING ACTIVITIES
In 2003, the Company generated proceeds of $152 thousand from the exercise of
145 thousand stock options compared to proceeds of $121 thousand in 2002. There
were no other significant financing activities.
INVESTING ACTIVITIES
In 2003, the Company's net proceeds from investing activities were $730 thousand
compared to $71 thousand in 2002. The positive cash position was attributable to
proceeds of $1.5 million from the sale of short term investments. Investment in
new capital assets totaled $208 thousand, compared to $97 thousand in 2002 and
deferred development costs totaled $531 thousand. There was no deferral in 2002.
Related Party Transactions
SG&A expenses for the year ended October 31, 2004 include legal fees of $60
thousand and consulting fees of $165 thousand paid to certain officers of the
Company in the normal course of business. Amounts due from related parties of
$179 thousand consist of amounts due from certain Company officers and
directors. Of these amounts, $30 thousand is non-interest bearing, unsecured and
with no set terms of repayment. The remaining $149 thousand bears 6% interest,
is secured by 189 thousand common shares of the Company and has no set terms of
repayment.
Critical Accounting Policies and Estimates
Significant accounting policies and methods used in the preparation of the
Company's financial statements are described in note 1 to the financial
statements of the Company for the year ended October 31, 2004.
The preparation of financial statements in accordance with Canadian generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and the
disclosure of contingent assets and liabilities at the date of the consolidated
financial statements and the reported amounts of revenue and expenses during the
reporting period. Areas of significant estimates include the
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recoverability of deferred software development costs, amortization periods for
property and equipment, provision for doubtful accounts, the realization of
future tax assets, deferred set-up fee expenses and stock based compensation.
Actual results could differ from management's best estimates and underlying
assumptions as additional information becomes available in the future.
Deferred Software Development Costs
Research costs are expensed as incurred. Costs related to the development of
software are expensed as incurred. Costs related to the development of software
are expensed as incurred unless such costs meet the criteria for deferral and
amortization under Canadian generally accounting principles. The criteria
include identifiable costs attributable to a clearly defined product, the
establishment of technical feasibility, identification of a market for the
software, the Company's intent to market the software and the existence of
adequate resources to complete the project. In the year ended October 31, 2004
the Company deferred $175 thousand of software development costs which will be
amortized over an estimated useful life of three years commencing in the third
quarter of 2004.
Revenue Recognition
The Company enters into contractual agreements with licensees that provide for
the provision of graphics, web design and software implementation services, the
licensing of software, and the provision of unspecified software upgrades over
the fixed term of the contract. Revenue under such contractual arrangements is
not recognized before there exists persuasive evidence that an arrangement
exists, delivery has occurred, the fee is fixed and determinable, and the
collectibility of outstanding amounts is considered probable. The Company
considers persuasive evidence to exist when a formal contract or purchase order
is signed. Delivery occurs over the term of the arrangement as described further
below. The Company considers a fee to be fixed and determinable when it is for a
measurable amount and receivable over a period not to exceed twelve months.
Finally, the Company assesses collectibility relative to customer payment
histories, credit checks, the nature of the customer and other relevant
information. As the Company's contractual arrangements provide for the delivery
of multiple elements, the Company evaluates whether vendor-specific objective
evidence ("VSOE") exists to allow for the allocation of the arrangement fee
between the undelivered elements and the delivered elements for revenue
recognition purposes. To date, as the period provided for in contractual
arrangements for the provision of unspecified upgrades is consistent with the
license period, the Company has not been able to identify VSOE and allocate
revenue between delivered and undelivered elements. Accordingly, set-up fees are
recognized ratably over the term of the contract, commencing upon completed
delivery of the implementation and integration services. License fees, which are
contingent upon customer usage, are recognized on an accrual basis as earned
over the life of the contract.
Direct and incremental costs incurred with respect to the set-up contractual
arrangements have been deferred as deferred set-up expense and are recognized
ratably over the term of the contract consistent with that for the related
revenue recognition.
Accounts Receivable
The Company carries its accounts receivable at cost less a reserve for
unrealized foreign exchange losses and less an allowance for doubtful accounts.
On a periodic basis, the Company evaluates its accounts receivable and
establishes an allowance for doubtful accounts. The allowance is based on the
circumstances of each customer relationship together with an assessment of the
history of past write-offs and collections. The allowance for doubtful accounts
generally relates to unpaid license fees including amounts that may be owed
under minimum license obligations pursuant to the Company's license agreements.
Goodwill
The valuation of goodwill is based on the value of the reporting unit to which
goodwill is attributed. To the extent that the valuation exceeds the net book
value of the related reporting unit, no write-down is necessary. Goodwill is
tested for impairment annually, or more frequently if events or circumstances
indicate that the asset might be impaired.
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Accounting Policy to be Adopted - Stock-based Compensation
Effective November 1, 2004, the Company has elected to retroactively adopt,
without restatement, the new Canadian accounting standards for stock based
compensation to employees. In accordance with these standards, the Company
recognizes, at the grant date, the compensation costs of stock options granted
to employees and directors, measured at fair value and expensed over the period
of the employee related service, with a corresponding increase to contributed
surplus. Upon the exercise of the option, consideration received together with
the amount previously recognized in contributed surplus is recorded as an
increase to share capital. The Company will record a retroactive adjustment of
$431 thousand representing the estimated value of stock options issued to
employees in 2003 and 2004 which will be charged to deficit and credited to
contributed surplus on November 1, 2004.
Future Income Taxes
Income tax assets relate to the Company's future tax benefits which arise from
loss carry forwards and research and development costs. The valuation of tax
assets is based on the amount of tax benefits available combined with the
determination as to when the tax benefits will be realized and the tax rate in
effect at that time. At October 31, 2004 the Company had $1,044,964 of available
Canadian tax benefits to be utilized in future years should the Company remain
profitable. The tax assets are based on Managements' best estimates of the
timing of the recovery of these assets.
Risks and Uncertainties
Chartwell operates in a rapidly changing environment that involves numerous
risks and uncertainties, many of which are beyond our control and which could
have a material affect on our business, revenue, operating results and financial
condition. The following discussion highlights some of these risks and
uncertainties.
Government Regulation
Our licensees are subject to applicable laws in the jurisdictions in which they
operate. Some jurisdictions have introduced regulations attempting to restrict
or prohibit Internet gaming, while other jurisdictions have taken the position
that Internet gaming is legal and /or are in the process of considering
legislation to regulate Internet gaming. As companies and consumers involved in
Internet gaming are located around the world, including our licensees and their
players, there is uncertainty regarding the future legislative landscape for
Internet gaming. There is a risk that proposed legislation supporting Internet
gaming may not be passed or existing legislation supporting Internet gaming may
be changed. Changes to the regulatory framework could have an adverse material
affect on the Company's revenue and financial condition.
Competition
Some of the Company's competitors have significantly greater financial,
technical and marketing and sales resources and they may be able to respond more
quickly to changes in customer needs. In addition, these competitors may be able
devote a greater number of resources to the enhancement, promotion and sale of
their games and gaming systems. Our success is dependant on our ability to win
our share of sales against these larger competitors. Failure to do so could
result in an adverse material effect on the Company's revenue, results of
operation and financial condition.
Dependence on Market Growth
The online gaming market has experienced and is expected to continue to
experience significant growth. There can be no assurance that the, market for
the Company's gaming solutions will continue to grow, that customers will
continue to adopt the Company's solutions, or that the Company will be
successful in selling into new and existing markets. If the market in which the
Company's products compete fail to grow, or grow more slowly that the Company
currently anticipates, the Company's business, operating results and financial
condition could be materially adversely affected.
-31-
Renewal of Software License Agreements
Substantially all of the Company's revenue is of a recurring nature in the form
of software license fees. Licensees pay an ongoing fee for the licensing and
support of the Company's software under a software licensing agreement, which
typically has a three to five year term. The license fee, or royalty, is
calculated as a percentage of each licensee's level of activity. There is no
assurance that the company will be able to renew agreements with existing
clients or that the Company will be able to renew agreements under similar
financial and other terms. Failure to renew agreements or failure to renew
agreements under similar financial and other terms could have a significant
adverse effect on the Company's revenue, operating results and financial
condition.
Failure to Manage Growth Successfully
The company's business has grown rapidly in the last three years. The
accelerated growth of the Company's revenue places a strain on managerial and
financial resources. In addition, the Company's recent expansion has resulted in
a substantial growth in the number of its employees, the scope of its
infrastructure and the geographic area of its operation, resulting in increased
responsibility for existing and new management personnel. The Company's ability
to successfully manage this growth depends in large part upon our ability to:
o retain and attract qualified management
o attract and retrain technical personnel to continue to develop
reliable solutions that respond to evolving customer needs and;
o retrain, attract and train sales and marketing personnel to create an
expanding presence in the rapidly growing marketplace for the
Company's products.
Chartwell's inability to achieve any of these objectives could harm the
Company's business, financial condition and operating results.
Dependence on Key Personnel
The success of the Company is largely dependant on the performance of its key
management and technical personnel. Competition for highly skilled technical and
management personnel is intense. Failure to retain key employees and to attract
and retain additional key employees with the necessary skills could have an
adverse material effect upon the Company's growth and profitability.
Lengthy Sales Cycle
The Company's sales cycle, beginning with an interested customer and culminating
in entering into a commercial agreement with the customer, typically ranges from
6 to 12 months and may be longer. This lengthy sales cycle limits the Company's
ability to forecast the timing of new sales in a specific quarter. Any extension
in the length of the sales cycle could have a material adverse effect on
revenues and financial condition.
Risks Associated with Currency Fluctuations
The majority of the Company's revenue is realized in foreign currencies, while
the majority of the Company's expenses are incurred in Canadian dollars.
Fluctuations in the exchange rate between the Canadian dollar and other
currencies, particularly the U.S. dollar, may have a material adverse affect on
the Company's operating results and financial condition
-32-
Critical Accounting Policies & Estimates
Currency Translation & Inflation
The Company operates internationally, with 100% of its revenue derived from
non-Canadian sources. Under our licensing agreements, the majority of our
revenues will be received in U.S. dollars. Consequently, the Company will be
faced with currency fluctuations. We do not currently engage in currency
hedging. Product development, sales, marketing and administration is carried out
through our Canadian operations in Canadian dollars, our functional currency.
We do not anticipate that inflation will have a material adverse affect on our
future operations. Our material obligations are fixed based on capital leases
and real property leases.
Research and Development, Patents and Licenses
The Company's policy is to continuously perform research and development on new
products or versions of products. We also research new technologies that relate
to our products and use them to improve our products where appropriate. The
Company utilizes a licensing model with its customers, which provides protection
from unauthorized use. Our source code is not made available to licensees and we
utilize various security measures to prevent any unauthorized copying or viewing
of our source code. Research and development expenditures are included as
"Software Development" in our financial statements and are fully expensed in the
periods they are incurred unless such costs meet the criteria for deferral and
amortization under Canadian generally accepted accounting principles.
OUTLOOK
Fiscal 2004 was a year of significant growth and profitability for Chartwell.
The Company concluded the year with a 66.5% growth in revenue, achieved
profitability in four successive quarters and generated $0.24 in earnings per
diluted share and cash flow of $2.5 million. Profitability was achieved without
sacrificing or minimizing our product and business development initiatives.
During 2004, the Company continued to invest in product development, sales and
marketing and infrastructure to support the growth of the business. These
initiatives continue to drive significant revenue opportunities within the
installed base and in new vertical markets. The rollout of the Company's
community based products, planned for the third quarter of 2005, mobile and
kiosk games will provide additional sources of revenue that did not exist in
2004. In addition, the Company's significant corporate business development
presence in Europe will continue to drive more sales opportunities and extend
our marketing capabilities.
In fiscal 2005 the Company will continue to expand its international customer
base of brand name licensees by providing products that are market driven and
provide incremental revenue for our clients and accordingly for Chartwell.
B. Liquidity and capital resources.
See Item 5.A.
C. Research and development, patents and licenses, etc.
The Company's policy is to continuously perform research and development to
develop new products or versions of products. We also research new technologies
that relate to our products and use them to improve our products where
appropriate. The Company does not patent its products or technologies but
utilizes a licensing model with its customers, which provides protection from
unauthorized use. Our source code is not made available to licensees and we
utilize various security measures to prevent any unauthorized copying or viewing
of our source code. Research and development expenditures are included as
"Software Development" in our financial statements and are fully expensed in the
periods they are incurred unless such costs meet the criteria for deferral and
amortization under Canadian generally accepted accounting principles. For fiscal
2004 these expenditures amounted to $4,417,981, for fiscal 2003 these
expenditures amounted to $3,288,164 and for fiscal 2002 expenditures were
$2,648,223.
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D. Trend information.
Since the end of the last fiscal year the company released a new version of
casino software. Our recurring license fee revenue generated 86% of total
software revenue and should continue to increase as a percentage of the total.
The Company has added several new clients since the end of the last fiscal year
and existing clients are being upgraded to the new version.
E. Off balance sheet arrangements.
The Company has no off balance sheet arrangements.
F. Tabular disclosure of contractual obligations.
The following table lists as of October 31, 2004 information with respect to our
material contractual obligations.
Payments due by period
Contractual Obligations Total Less 1- 3 years 3 - 5 years More than
than 1 5 years
year
$ $ $ $ $
Long-Term Debt Obligations - - - - -
Capital (Finance) Lease Obligations 41,684 17,249 24,435 - -
Operating Lease Obligations 1,724,072 376,967 706,035 616,362 24,708
Purchase Obligations - - - - -
Other Long-Term Liabilities Reflected on the - - - - -
Company's Balance Sheet under the GAAP of the
primary financial statements
Total 1,765,756 394,216 730,470 616,362 24,708
1. Capital leases were incurred to purchase office equipment. There was one
lease outstanding at October 31, 2004 with monthly principal and interest
payments of $1,437.41 and termination date of August, 2005.
2. Operating lease obligations were incurred to lease facilities in Vancouver
and Calgary, Canada and London, U.K.
- --------------------------------------------------------------------------------
Location Lease Expiry Total Payments
- --------------------------------------------------------------------------------
Chartwell House November, 2009 $1,507,230
750 - 11th Street SW, Suite 400
Calgary, Alberta, Canada, T2P 3N7
- --------------------------------------------------------------------------------
1166 Albirni Street, Suite 1400 December, 2008 $ 81,922
Vancouver, BC, Canada, V6E 3Z3
- --------------------------------------------------------------------------------
Chartwell Games Corp. November, 2009 $ 134,920
8 The Square, Stockley park
Heathrow, Uxbridge, England U.K.
- --------------------------------------------------------------------------------
G. Safe harbour.
Certain statements contained in the foregoing Results of Operations and
elsewhere in this Form 20-F constitute forward-looking statements. Such
forward-looking statements involve a number of known and unknown risks,
uncertainties and other factors which may cause the actual results, performance
or achievements of the Company to be materially different from any future
results, performance or achievements expressed or implied by such
forward-looking statements. Readers are cautioned not to place undue reliance on
these forward-looking statements, which speak only as of the date the statements
were made and readers are advised to consider such forward-looking statements in
light of the risks set forth in the Item 3.D. above.
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ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
A. Directors and senior management.
All of our directors are elected annually by the shareholders and hold office
until the next annual general meeting of shareholders or until their successors
are duly elected and qualified, unless they sooner resign or cease to be
directors in accordance with our Articles. The Registrant's last annual regular
general meeting was held on March 22, 2005. Our executive officers are appointed
by and serve at the pleasure of the Board of Directors.
As at March 31, 2005, the following are the names and municipalities of
residence of our directors and officers, their positions and offices and their
principal occupations during the last five years.
- ---------------------------------------------------------------------------------------------------------
Name and Office held with the Principal Occupation
Municipality of Company
Residence
- ---------------------------------------------------------------------------------------------------------
Darold H. Parken** President, Chief President and Chief Executive Officer of the Company.
Calgary, AB Executive Officer and Prior thereto, Barrister & Solicitor, Parken & Company
Director since since February, 1989. Prior thereto, partner with Burnet,
October 26, 1994 Duckworth & Palmer, Barristers and Solicitors.
- ---------------------------------------------------------------------------------------------------------
Rene G. Carrier* Director since June President, Euro American Capital Corporation Inc. (a
Vancouver, BC 27, 1991 private investment company). Prior thereto, Vice
President of Pacific International Securities Inc. (a
brokerage firm) from 1982 to 1991.
- ---------------------------------------------------------------------------------------------------------
Darcy E. Krogh** Vice President, Vice President, Business Development of the Company.
Vancouver, BC Business Development Prior thereto, stock broker with several Canadian
and Director since investment dealers for 18 years.
June 7, 1999
- ---------------------------------------------------------------------------------------------------------
Donald Gleason Vice President, Vice President, Operations and Chief Financial Officer of
Calgary, AB Operations, Chief the Company. Prior thereto, Chief Financial Officer of
Financial Officer Agrimax Ltd., Agrimax Corporation and AGX Sulphur Ltd.
since June 9, 2003 from May 2002 to May 2003. Prior thereto, Chief Financial
Officer of EFA Software Services Ltd.
- ---------------------------------------------------------------------------------------------------------
David V. Acorn Vice President, Vice President, Client and Product Management of the
Calgary, AB Client and Product Company. Prior thereto, proprietor of eZ solutions (an
Management since June Internet and e-commerce application development company)
15, 1999. from May 1995 to June 1999.
- ---------------------------------------------------------------------------------------------------------
Roderick A. Ferguson* Director since July Partner, Fasken Martineau DuMoulin LLP, Barristers and
Calgary, AB 10, 2001. Solicitors since 2004. Prior thereto, Partner, Heenan
Blaikie LLP, Barristers and Solicitors since 2001 and prior
thereto, Partner, Burnet Duckworth & Palmer, Barristers
and Solicitors.
- ---------------------------------------------------------------------------------------------------------
Andrew Smith Vice President, Vice President, Software Development and Chief Technical
Calgary, AB Software Development Officer. Prior thereto, Senior Software Architect and
and Chief Technical Project Manager for Burnt Sand Solutions, a public
Officer since July e-business solutions integration firm.
10, 2000
- ---------------------------------------------------------------------------------------------------------
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- ---------------------------------------------------------------------------------------------------------
Name and Office held with the Principal Occupation
Municipality of Company
Residence
- ---------------------------------------------------------------------------------------------------------
Peter H. Kinash* Director since March CFO of Guest-Tek Interactive Entertainment Inc. from July
Calgary, AB 23, 2004. 12, 2004 to August 31, 2004. From September, 2001 to
present, consultant and advisor on financial matters to emerging
and established technology companies, including serving as
part-time CFO of Replicon Inc. from November, 2002 to present.
Prior thereto, CFO to Wi-LAN Inc. from January, 2000 to August,
2001 and Partner with KPMG LLP from September 1990 to January,
2000.
- ---------------------------------------------------------------------------------------------------------
Terence Shaunessy Director since March President, Shaunessy & Co. Ltd., Investment Counsel and
Calgary, AB 22, 2005. Portfolio Management since 2001, prior thereto, Vice
President, Institutions, HSBC Asset Management since 1999,
prior thereto, President and Managing Director, Gordon Capital
Corp.
- ---------------------------------------------------------------------------------------------------------
Notes:
* Audit Committee Member
** Compensation Committee Member
The following provides a brief biographical description of the officers and
senior management of the Company:
Darold H. Parken, B.A., LL.B.
President and Chief Executive Officer
Mr. Parken received his Bachelor of Arts Degree in Economics from the University
of Calgary in 1977 and his Bachelor of Laws Degree from the University of
Calgary in 1980. From 1980 to 1990, Mr. Parken practiced corporate securities
law with a major Canadian law firm of which he was a partner. He has public
company management experience and a wide range of experience in the areas of
corporate finance, mergers and acquisitions.
Donald Gleason, CGA
Vice President, Operations and Chief Financial Officer
Mr. Gleason has held senior level positions in the areas of operations and
finance with multinational software development and technology related companies
for the past 19 years. His most recent work experience in the technology sector
was in developing and implementing the financial plan for a growth oriented,
internationally focused provider of automated trading, clearing and settlement
software for the international capital markets. In addition Mr. Gleason had
direct management responsibilities for leading the finance and operations teams
in the areas of human resources, customer support, due diligence related to
mergers and acquisitions and strategic investments.
Darcy E. Krogh, B.A.
Vice President, Business Development
Mr. Krogh joined Chartwell's board and management team in June, 1999. His
responsibilities include strategic planning, corporate finance, expanding
operations, mergers and acquisitions. Mr. Krogh has experience as an investment
advisor and stock broker. Prior to joining Chartwell, Mr. Krogh was a stock
broker for 18 years with several Canadian investment dealers.
David V. Acorn
Vice President, Client and Product Management
Mr. Acorn received his Honours diploma in Internet Object Oriented Software
Engineering from the Southern Alberta Institute of Technology. He has an
extensive background in Internet and e-commerce development and design. Mr.
Acorn has management experience in the Information Technology industry,
specializing in Web development and owning and operating his own Web development
company from 1995 to 1999. His responsibilities in the Company include the
management of software, graphics and Web strategies. He leads a team of
programmers, designers and artists responsible for the development of the
Company's products and services.
-36-
Andrew Smith
Vice President, Software Development and Chief Technical Officer
Mr. Smith responsibilities include systems design, technical architecture and
technical direction. He has comprehensive and extensive software development
experience as well as over ten years in project management. Prior to joining
Chartwell, Mr. Smith was Senior Software Architect and Project Manager for Burnt
Sand Solutions, a public e-business solutions integration firm. Mr. Smith
received his Bachelor of Science (Computer Science) degree from the University
of Calgary in 1986.
None of our directors or executive officers has any family relationship with any
other officer or director of the Company.
B. Compensation.
Independent directors of the Corporation are compensated for their services as
directors, each receive $2,500 per quarter and $500 for each meeting attended.
Directors are entitled to reimbursement for reasonable travel and other
out-of-pocket expenses incurred in connection with attendance at meetings of the
Board of Directors. The Board of Directors makes separate remuneration to any
director undertaking services on behalf of us other than services ordinarily
required of a director.
We grant stock options to directors, executive officers and employees. See "Item
6.E - Share Ownership - Stock Option Plan".
Executive Officers
The following table sets forth certain information regarding the compensation
paid to Chartwell's Chief Executive Officer and the other executive officers of
Chartwell who had total annual salary and bonus exceeding $100,000 for the
fiscal year ended October 31, 2004 (collectively, the "Named Executive
Officers").
Compensation Summary Table
Annual Long-Term
Name and Principal Year Salary Bonus Other Stock All Other
Occupation Options
Granted
Darold H. Parken(1) 2004 $105,000 $2,000 nil nil nil
President and Chief 2003 $105,000 $2,000 nil nil nil
Executive Officer 2002 $105,000 $2,000 nil nil nil
Darcy E. Krogh, Vice 2004 $165,000 $2,000 nil nil nil
President, Business 2003 $165,000 $2,000 nil nil nil
Development 2002 $165,000 $2,000 nil nil nil
Donald Gleason, Chief 2004 $122,000 $2,000 nil nil nil
Financial Officer & 2003 $ 68,625 $2,000 nil 100,000 nil
V.P. Operations
David Acorn, Vice 2004 $125,000 $2,000 nil nil nil
President Client and 2003 $118,750 $2,000 nil nil nil
Product Management 2002 $100,000 $ 500 nil nil nil
Andrew Smith, Vice 2004 $150,000 $2,000 nil nil nil
President Software 2003 $142,708 $2,000 nil nil nil
Development & CTO 2002 $125,000 $2,000 nil nil nil
Notes:
(1) A law firm in which Mr. Parken is principal received fees and disbursements
for legal services of $60,000 during the last completed fiscal year,
$60,000 in fiscal 2003 and $60,000 in fiscal 2002.
-37-
Options Exercised and Granted During the Fiscal Year Ended October 31, 2004
The following Named Executive Officers exercised options during the year ended
Octobers 31, 2004
Name Number of Stock Options Price Date of Exercise
Exercised
- --------------------------------------------------------------------------------
Darcy E. Krogh 100,000 $1.06 March 22, 2004
Andrew Smith 5,000 $1.06 September 4, 2004
David V. Acorn 9,400 $1.17 October 29, 2004
Termination of Employment, Changes in Responsibility and Employment Contracts
Chartwell has no compensatory plan or arrangement in respect of compensation
received or that may be received by any Named Executive Officer in Chartwell's
most recently completed or current fiscal year to compensate such executive
officer in the event of the termination of employment (resignation, retirement,
change of control) or in the event of a change in responsibilities following a
change in control.
Aggregate cash compensation paid to directors and senior management for fiscal
2004 was $711,500.
No amounts have been set aside or accrued by us during fiscal 2003 to provide
pension retirements or similar benefits for our directors or executive officers
pursuant to any plan provided for or contributed to by us.
We have no plans or arrangements in respect of remuneration received or that may
be received by our executive officers in the current year to compensate such
officers in the event of termination of employment (as a result of resignation,
retirement, change of control) or a change of responsibilities following a
change of control, where the value of such compensation exceeds $60,000 U.S. per
executive officer.
None of our directors or executive officers received other compensation in
excess of the lesser of US$25,000 or 10% of such officer's cash compensation,
and all directors and executive officers, as a group, did not receive other
compensation which exceeded US$25,000 times the number of persons in the group
or 10% of group compensation.
Except as set out above, we have no material bonus or profit sharing plans
pursuant to which cash or non-cash compensation is or may be paid to our
directors or executive officers.
C. Board practices.
Members of the Board of Directors are elected by the holders of our Shares to
represent the interests of all shareholders. The Board of Directors meets
quarterly to review significant developments affecting the Registrant and to act
on matters requiring Board approval. Although the Board of Directors delegates
many matters to others, it reserves certain powers and functions to itself.
The only standing committees of our Board of Directors are the Audit Committee,
the Governance and Compliance Committee and the Compensation Committee.
-38-
Audit Committee
The Audit Committee of the Registrant's Board of Directors currently consists of
the following directors:
o Rene Carrier
o Rod Ferguson
o Peter Kinash
The functions of the Audit Committee include the review and recommendation to
the Board of Directors of the annual and interim financial statements and
related management's discussion and analysis of results. The Audit Committee has
Fdirect communication channels with internal personnel responsible for financial
statement preparation and with the Company's auditors. The Committee also meets
with the auditors independent of Management. Additional responsibilities include
monitoring the audit function, recommending the appointment of auditors,
reviewing and approving all non-audit services provided by the auditors to
Company, reviewing any auditors' reports to Management, and reviewing internal
controls and procedures relating to financial reporting and compliance with
material policies and laws.
Compensation Committee
The Compensation Committee of the Board of Directors currently consists of the
following directors:
o Darold H. Parken
o Darcy Krogh
The Compensation Committee is responsible for reviewing, on an annual basis, The
Company's compensation policies, practices and overall compensation philosophy,
including the granting of stock options to employees and the adequacy and form
of Directors' compensation. The Committee also discusses personnel and human
resources matters including recruitment and development and reviews and approves
all salary increases, with the exception of increases for certain members of
senior management.
None of our directors or executive officers are parties to any arrangement or
understanding with any other person pursuant to which said individual was
elected as a director or officer of the Registrant.
Governance and Compliance Committee
o The Company has recently established a Governance and Compliance
Committee. The mandate of the Committee is to review the Company's
corporate governance practices and provide reports and recommendations
to the Board.
The Governance and Compliance Committee of the Board of Directors currently
consists of the following directors:
o Roderick A. Ferguson
o Peter H. Kinash
Disclosure Committee
The Disclosure Committee of the Board of Directors currently consists of the
following directors:
o Darold H. Parken
o Darcy Krogh
o Roderick A. Ferguson
The mandate of the Disclosure Committee is as set out below.
o Determination of material information
o Establishing primary principles of disclosure policy
o Designation of Company spokespersons
-39-
o Establishing and monitoring timing and procedures for disclosure
o Review of Chartwell website content
o Establishing and monitoring rules of communications with financial
analysts and investors
o Approving forward looking information release
o Approving earnings guidance information
o Reviewing analysts' reports or models
o Responding to market rumors
o Maintaining confidentiality and restrictions on trading
None of our directors and/or executive officers has been the subject of any
order, judgment, or decree of any governmental agency or administrator or of any
court of competent jurisdiction, revoking or suspending for cause any license,
permit or other authority of such person or of any corporation of which he is a
director and/or executive officer, to engage in the securities business or in
the sale of a particular security or temporarily or permanently restraining or
enjoining any such person or any corporation of which he is an officer or
director from engaging in or continuing any conduct, practice, or employment in
connection with the purchase or sale of securities, or convicting such person of
any felony or misdemeanor involving a security or any aspect of the securities
business or of theft or of any felony.
There are no arrangements or understandings among any of the directors regarding
their election as director.
D. Employees.
The Company had 93 employees and contractors as at March 31, 2005 in the
following departments:
o Software Development, Product Development and Client Support: 76
o Sales: 4
o General Administration: 7
o Management: 6
Of the total of 93 employees and contractors, 89 are based in Canada and 4 are
based in London, U.K.
Our employees are not members of any labor union or organization.
E. Share ownership.
Beneficial Ownership of Directors and Senior Management
The following table lists, as of March 31, 2005, Directors and Senior Management
of the Company who beneficially owned our voting securities and any amount of
our voting securities owned by the Directors and Senior Management as a group,
based on 18,647,089 common shares outstanding at March 31, 2005.
Amount of Beneficial Percent of
Title of Class Name of Beneficial Owner Ownership Class
- ---------------- ------------------------ -------------------- ----------
Common Darold H. Parken (1) 838,100 4.49%
Common Darcy E. Krogh (2) 35,000 0.18%
Common Rene G. Carrier 74,500 0.39%
Common David V. Acorn (3) 9,400 0.05%
Common Roderick A. Ferguson (4) 15,000 0.08%
Common Andrew Smith (5) nil 0.00%
-40-
Amount of Beneficial Percent of
Title of Class Name of Beneficial Owner Ownership Class
- ---------------- ------------------------ -------------------- ----------
Common Donald Gleason (6) 21,333 0.11%
Common Lee Richardson (7) nil 0.00%
Common Peter Kinash (8) nil 0.00%
Common Terence Shaunessy 5,000 0.02%
1) Includes options (exercisable within 60 days of March 31, 2005) to purchase
250,000 common shares at a price of $1.06 per share, expiring September 17,
2005; and options to purchase 300,000 common shares at a price of $1.06 per
share, expiring April 22, 2006.
2) Includes options (exercisable within 60 days of March 31, 2005) to purchase
100,000 common shares at a price of $1.06 per share, expiring September 17,
2005.
3) Includes options (exercisable within 60 days of March 31, 2005) to purchase
40,600 common shares at a price of $1.06 per share, expiring June 6, 2005
and options to purchase 33,333 common shares at a price of $1.05 per share,
expiring June 4, 2008.
4) Includes options (exercisable within 60 days of March 31, 2005) to purchase
35,000 common shares at a price of $1.63 per share, expiring April 18,
2007.
5) Includes options (exercisable within 60 days of March 31, 2005) to purchase
55,000 common shares at a price of $1.06 per share, expiring July 10, 2005;
and options to purchase 50,000 common shares at a price of $2.00 per share,
expiring September 5, 2006.
6) Includes options (exercisable within 60 days of March 31, 2005) to purchase
33,333 common shares at a price of $1.05 per share, expiring June 5, 2005.
7) Includes options (exercisable within 60 days of March 31, 2005) to purchase
66,667 common shares at a price of $2.58, expiring February 28, 2009.
8) Includes options (exercisable within 60 days of March 31, 2005) to purchase
16,666 common shares at a price of $3.00, expiring March 22, 2009.
Stock Option Plan
Stock Options to purchase securities from the Registrant are granted to
Directors, Officers, employees and consultants of the Registrant on terms and
conditions acceptable to the regulatory authorities in Canada, notably the
Toronto Stock Exchange ("the TSX"). The Stock Option Plan approved by the
Shareholders of the Company on July 31, 2000 was repealed and replaced by a new
Stock Option Plan which was approved by our shareholders at an Annual General
Meeting held on April 28, 2004. Options under the Stock Option Plan are granted
by the Compensation Committee of the Board of Directors.
Under the Stock Option Plan, stock options for up to 3,264,000 common shares may
be granted from time to time, provided that stock options in favor of any one
individual may not exceed 10% of the total issued and outstanding common shares.
No stock option granted under the stock option program is transferable by the
optionee other than by will or the laws of descent and distribution, and each
stock option is exercisable during the lifetime of the optionee only by such
optionee.
The exercise price of all stock options granted under the stock option program
must be at least equal to the fair market value of such common shares on the
date of grants, less the permitted discount under the TSX policies and
-41-
the maximum term of each stock option may not exceed five years. The exercise
prices for stock options are determined in accordance with TSX guidelines.
On June 5, 2001, we repriced certain employee stock options with an original
exercise price ranging from $1.77 to $4.20, to a new exercise price ranging from
$1.06 to $1.17 per share.
Refer to the Notes to the Consolidated Financial Statements for further
information regarding stock options.
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
A. Major shareholders.
We are currently a publicly-held corporation, with our common shares held by
residents of Canada, the United States and other countries. To the best of our
knowledge, we are not controlled, directly or indirectly, by another corporation
or any government, as at March 31, 2005. Except as otherwise set forth below, no
person or corporation or other entity owns, directly or indirectly, or controls
more than 5% of our common shares, the only class of securities with voting
rights.
- --------------------------------------------------------------------------------------------
Identity of Persons or Group Number of Common Shares Owned Percentage of Class
Oak Bay Investments 1,000,000 5.36%
- --------------------------------------------------------------------------------------------
The major shareholders do not have different voting rights than other holders of
our common shares, and there are no arrangements, known to us which may at a
subsequent date result in a change in control of the corporation.
B. Related party transactions.
Except for the ownership of our securities and the compensation described
herein, none of our directors, executive officers, holders of ten percent of our
outstanding Shares, or any associate or affiliate of such person, have, to our
knowledge, had a material interest, direct or indirect, during the three fiscal
years ended October 31, 2002, 2003 and 2004, or in any proposed transaction
which may materially affect us.
Steven Latham, a former director of Chartwell, owes the company $29,907 without
interest on a demand note. This loan is payable upon demand. This arrangement is
not on similar terms as arrangements we would otherwise negotiate with unrelated
third parties. The loans to Stephen Latham were grabted in April, 1998 and June,
1999.
Darold Parken, a director and the President of Chartwell, owes the company
$151,235 as of January 31, 2005. Interest on the promissory note issued with
respect to Company stock options that he exercised is set at 6% annually. This
loan is payable upon demand. This arrangement is not on similar terms as
arrangements we would otherwise negotiate with unrelated third parties. The loan
to Darold Parken was granted in April, 2001.Interests of experts and counsel.
Not applicable.
ITEM 8. FINANCIAL INFORMATION
A. Consolidated statements and other financial information.
See Item 17 for a list of the financial statements filed as part of this Annual
Report.
We are aware of no pending or threatened legal proceedings to which the
Corporation is a party, or of which any of its properties is the subject.
-42-
We have never declared or paid any cash dividends on our common shares. We
currently expect to retain future earnings, if any, for use in the operation and
expansion of our business and do not anticipate paying any cash dividends in the
foreseeable future.
B. Significant changes.
On December 7, 2004 the Company closed a private placement consisting of 2,
365,592 common shares which were sold at a price of $4.65 per share for net
proceeds of approximately $10.3 million before underwriter expenses and related
Company legal expenses. The underwriters were granted 141,936 compensation
options exercisable at an exercise price of $5.10 per common share for a period
of 18 months from the date of the closing of the private placement. All of the
securities sold pursuant to the private placement are subject to a four month
hold period. Net proceeds of the financing will be used for general corporate
purposes.
There have been no other significant subsequent events since October 31, 2004 to
the date of this Annual Report.
ITEM 9. THE OFFER AND LISTING
A. Offer and listing details.
Our Common Shares are listed for trading on the Toronto Stock Exchange ("TSX")
under the symbol "CWH:TSX" The following tables set forth the reported high and
low closing bid prices of the Corporation's Common Shares on the designated
exchanges for (a) the five most recent fiscal years; (b) each quarterly period
for the past two fiscal years and (c) for the last six months ending March 31,
2004.
TSX
Fiscal Year ended October 31 High Low
- ---------------------------- ---- ---
2000 7.50 1.50
2001 2.60 0.75
2002 2.05 0.67
2003 1.80 0.71
2004 4.36 1.60
Quarter Ended High Low
- ------------- ---- ---
October 31, 2004 4.36 3.37
July 31, 2004 3.75 3.07
April 30, 2004 3.95 2.45
January 31, 2004 2.45 1.60
October 31, 2003 1.80 0.99
July 31, 2003 1.25 0.95
April 30, 2003 1.40 0.90
January 31, 2003 1.15 0.71
Month High Low
- ----- ---- ---
March, 2005 9.25 8.72
February, 2005 9.35 7.00
January, 2005 6.90 5.97
December, 2004 6.70 4.90
November, 2004 5.40 4.25
October, 2004 4.36 3.70
-43-
The closing price of our Common Shares on March 31, 2005 was $8.75 on the TSX.
B. Plan of distribution.
Not applicable.
C. Markets.
Our Common Shares are listed for trading on the Toronto Stock Exchange ("TSX")
under the symbol "CWH:TSX."
D. Selling shareholders.
Not applicable.
E. Dilution.
Not applicable.
F. Expenses of the issue.
Not applicable.
ITEM 10. ADDITIONAL INFORMATION
A. Share Capital.
Not applicable.
B. Memorandum and articles of association.
Purposes
We are a corporation continued from British Columbia to Alberta under the
Business Corporations Act (Alberta) on December 18, 1995. There are no
restrictions on the business which we may carry on. The Corporation's objectives
and purposes are not described in its Articles of Continuance or constating
documents. The Corporation is governed by the Business Corporations Act
(Alberta), (the "Act"). Under the Act the Corporation is not required to define
or state its objectives and purposes, rather, it is granted an unrestricted
right to carry on business.
Conflicts
- ---------
Pursuant to the Corporation's Articles, a director or officer who is a party to
a material contract or proposed material contract, or who has a material
interest in any person who is a party to a material contract or proposed
material contract with the Corporation or a subsidiary must disclose such
interest. Subject to the provisions of the Act, a director will not by reason
only of his office be accountable to the Corporation or to the Corporation's
shareholders for any profit or gain realized from such a contract or
transaction, and such contract or transaction will not be void or voidable by
reason only of the director's interest therein, of the Corporation provided that
the required declaration and disclosure of interest is properly made, the
contract or transaction is approved by the directors or shareholders, if
necessary, and it was fair and reasonable to the Corporation at the time it was
approved and, if required by the Act, the director refrains from voting as a
director on the contract or transaction. Under the Act, such a director must not
vote on any resolution to approve the contract unless the contract is:
An arrangement by way of security for money lent to or obligations undertaken by
him, or by a body corporate in which he has an interest, for the benefit of the
Corporation or an affiliate of the Corporation;
-44-
(a) a contract relating primarily to his remuneration as a director,
officer, employee or agent of the Corporation or an affiliate of the
Corporation;
(b) a contract for indemnity or insurance under the Act; or
(c) a contract with an affiliate of the Corporation.
These rules would allow the full board to vote on compensation of directors
generally, but would require a director to abstain on a vote relating to
compensation unique to him.
Quorum
- ------
The quorum for the transaction of business at any meeting of its board of
directors must consist of a majority of the directors holding office or such
greater number of directors as the Corporation's board determines.
Borrowing Powers
- ----------------
Pursuant to the Corporation's Articles of Continuance dated December 18, 1995,
its directors may without the authorization of its shareholders, (a) borrow
money on in such manner and amount, on such security, from such sources and upon
such terms and conditions as they see fit; (b) issue bonds, debentures, and
other debt obligations either outright or as security for any liability or
obligation of the Corporation or any other person; (c) mortgage, charge, whether
by way of specific or floating charge, or give other security on the undertaking
or on the whole or any part of the property and assets of the Corporation, both
present and future; and (d) give financial assistance to any person, directly or
indirectly, by way of loan, guarantee, the provision of security, or otherwise.
The Corporation's directors may also, by resolution, delegate the borrowing
powers referred to above to one of its directors, a committee of directors or
one of its officers.
Directors' Qualifications
- -------------------------
Pursuant to the Act, the Corporation's directors must be at least 18 years of
age and are not required to hold shares issued by the Corporation.
The Corporation's Articles of Continuance provide that the Board of Directors
shall consist of a minimum of three and a maximum of six Directors. The Board of
Directors may, between annual meetings, appoint one or more additional directors
to serve until the next annual meeting, but the number of additional directors
shall not at any time exceed 1/3 of the number of directors who held office at
the expiration of the last annual meeting of the corporation.
Common Shares
- -------------
The authorized share capital of the Company consists of 100,000,000 Common
Shares, without par value. The holders of Common Shares are entitled to
dividends, if as and when declared by the directors, to one vote per Common
Share at meetings of the holders of Common Shares of the Company and, upon
liquidation, to receive such assets of the Company as are distributable to the
holders of the Common Shares.
The common shares have no preemptive or conversion rights or other subscription
rights. There are no redemption or sinking fund provisions applicable to the
common shares. All outstanding common shares are fully paid and non-assessable.
According to the Act, the Corporation may not declare or pay a dividend if there
are reasonable grounds for believing that:
(a) before or after the payment of the dividend it would be unable to pay
its liabilities as they become due; and
-45-
(b) the realizable value of its assets would be less than its liabilities
plus its stated capital. The Corporation cannot predict what the
realizable value of its assets or the amount of its liabilities will
be in the future.
Amendment of Articles
- ---------------------
Under the Act, the Corporation's directors, or shareholders who are entitled to
vote at its annual meeting of shareholders, may make a proposal to amend its
Articles of Incorporation. A resolution to amend its Articles of Incorporation
must be passed by a majority of not less than two-thirds of the votes cast by
the Corporation's shareholders who vote in respect of the resolution. In certain
cases, where they are affected differently from other shareholders, a class or
series of shares will be entitled to a separate vote on a proposal to amend the
Corporation's Articles.
Annual Meeting
- --------------
The Corporation's directors must call an annual meeting of shareholders no later
than 15 months after its last preceding annual meeting of shareholders, and may
at any time call a special meeting of shareholders. A notice of the time and
place of a meeting of shareholders must be sent not less than 21 days and not
more than 50 days before the meeting and must be sent to each shareholder who is
entitled to vote, to each director and to its auditor.
The Corporation's directors may fix a date, that is not less than 21 days and
not more than 50 days before the meeting, as a record date for the determination
of the shareholders entitled to notice of the meeting. If a record date is not
fixed, the record date must be the close of business on the date immediately
preceding the date on which notice is given, or if notice is not given, the date
on which the meeting is held.
All business transacted at a special meeting of shareholders and all business
transacted at an annual meeting of shareholders, except consideration of the
financial statements and auditors report, fixing the number of directors for the
following year, election of directors and re-appointment of the incumbent
auditor is deemed to be special business. A notice of a meeting of shareholders
at which special business is to be transacted must state the nature of that
business in sufficient detail to allow the Corporation's shareholders to form a
reasonable judgment on that business and the text of any special resolution to
be submitted to the meeting.
The only persons entitled to be present at a meeting of its shareholders are
those persons who are entitled to vote thereat, the directors and auditors of
the Corporation and others who, although not entitled to vote, are entitled or
required under any provision of the Act or the articles to be present at the
meeting. Any other person will be admitted only on the invitation of the
chairman of the meeting or with the consent of the meeting.
Limitations on Ownership of Securities
- --------------------------------------
There are no limitations on the right to own securities imposed by foreign law
or by the Articles of Continuance or other constituent documents.
Change of Control
- -----------------
Except for the restrictions set out above that attach to the Corporation's
shares, there are no provisions in the Corporation's Articles of Continuance or
other constituent documents that would delay, defer or prevent a change of
control and that would operate only with respect to a merger, acquisition or
corporate restructuring involving the Corporation.
Shareholder Ownership Disclosure
- --------------------------------
The Corporation's constituent documents do not contain provisions that govern an
ownership threshold above which its shareholder ownership must be disclosed.
However, we are governed by the Securities Act (Alberta) and under that Act, a
person or company that becomes an "insider" (as that term is defined in such
FAct), must file a report with the applicable securities commission disclosing
any direct or indirect beneficial ownership or control or direction
-46-
over the Corporation's securities. An "insider" includes all of the
Corporation's directors and senior officers, every director or senior officer of
a company that is itself an insider of the Corporation, all its subsidiaries,
any person or corporation that, beneficially owns, directly or indirectly,
voting securities of the Corporation, exercises control or direction over its
voting securities, or beneficially owns, directly or indirectly, certain voting
securities of the Corporation and exercises control or direction over certain
voting securities of the Corporation that carry more than 10% of the voting
rights attached to all of its voting securities, excluding voting securities
held by a person or company as underwriter in the course of a distribution.
Capital Changes
- ---------------
The Corporation's Articles of Incorporation and other constituent documents do
not contain provisions that govern changes in its capital that are more
stringent than those required by Canadian securities laws.
C. Material Contracts.
There are no contracts other than normal course of business agreements.
D. Exchange controls.
Exchange Controls and Investment Canada Act
Canada has no system of exchange controls. There are no exchange restrictions on
borrowing from foreign countries nor on the remittance of dividends, interest,
royalties and similar payments, management fees, loan repayments, settlement of
trade debts, or the repatriation of capital. Any such remittances to United
States residents, however, may be subject to a withholding tax pursuant to the
Canadian Income Tax Act as modified by the reciprocal tax treaty between Canada
and the United States. See "Item 10E., Taxation".
The Investment Canada Act (the "Act"), enacted on June 20, 1985, requires prior
notification to the Government of Canada on the "acquisition of control" of
Canadian businesses by non-Canadians, as defined in the Act. Certain
acquisitions of control, discussed below, are reviewed by the Government of
Canada. The term "acquisition of control" is defined as any one or more
non-Canadian persons acquiring all or substantially all of the assets used in
the Canadian business, or the acquisition of the voting shares of a Canadian
corporation carrying on the Canadian business or the acquisition of the voting
interests of an entity controlling or carrying on the Canadian business. The
acquisition of the majority of the outstanding shares is deemed to be an
"acquisition of control" of a corporation. The acquisition of less than a
majority, but one-third or more, of the voting shares of a corporation is
presumed to be an "acquisition of control" of a corporation unless it can be
established that the purchaser will not control the corporation.
Investments requiring notification and review are all direct acquisitions of
Canadian businesses with assets of CDN$5,000,000 or more (subject to the
comments below on WTO investors), and all indirect acquisitions of Canadian
businesses (subject to the comments below on WTO investors) with assets of more
than CDN$50,000,000 or with assets of between CDN$5,000,000 and CDN$50,000,000
which represent more than 50% of the value of the total international
transaction. In addition, specific acquisitions or new businesses in designated
types of business activities related to Canada's cultural heritage or national
identity could be reviewed if the Government of Canada considers that it is in
the public interest to do so.
The Act was amended with the implementation of the Agreement establishing the
World Trade Organization ("WTO") to provide for special review thresholds for
"WTO investors", as defined in the Act. "WTO investor" generally means (i) an
individual, other than a Canadian, who is a national of a WTO member (such as,
for example, the United States), or who has the right of permanent residence in
relation to that WTO member, (ii) governments of WTO members, and (iii) entities
that are not Canadian controlled, but which are WTO investor controlled, as
determined by rules specified in the Act. The special review thresholds for WTO
investors do not apply, and the general rules described above do apply, to the
acquisition of control of certain types of businesses specified in the Act,
including a business that is a "cultural business". If the WTO investor rules
apply, an investment in the shares of the Company by or from a WTO investor will
be reviewable only if it is an investment to acquire control of the Company and
the value of the assets of the Company is equal to or greater than a specified
amount (the "WTO
-47-
Review Threshold"). The WTO Review Threshold is adjusted annually by a formula
relating to increases in the nominal gross domestic product of Canada. The 2004
WTO Review Threshold is CDN$237,000,000.
If any non-Canadian, whether or not a WTO investor, acquires control of the
Company by the acquisition of shares, but the transaction is not reviewable as
described above, the non-Canadian is required to notify the Canadian government
and to provide certain basic information relating to the investment. A
non-Canadian, whether or not a WTO investor, is also required to provide a
notice to the government on the establishment of a new Canadian business. If the
business of the Company is then a prescribed type of business activity related
to Canada's cultural heritage or national identity, and if the Canadian
government considers it to be in the public interest to do so, then the Canadian
government may give notice in writing within 21 days requiring the investment to
be reviewed.
For non-Canadians (other than WTO investors), an indirect acquisition of
control, by the acquisition of voting interests of an entity that directly or
indirectly controls the Company, is reviewable if the value of the assets of the
Company is then CDN$50,000,000 or more. If the WTO investor rules apply, then
this requirement does not apply to a WTO investor, or to a person acquiring the
entity from a WTO investor. Special rules specified in the Act apply if the
value of the assets of the Company is more than 50% of the value of the entity
so acquired. By these special rules, if the non-Canadian (whether or not a WTO
investor) is acquiring control of an entity that directly or indirectly controls
the company, and the value of the assets of the Company and all other entities
carrying on business in Canada, calculated in the manner provided in the Act and
the regulations under the Act, is more than 50% of the value, calculated in the
manner provided in the Act and the regulations under the Act, of the assets of
all entities, the control of which is acquired, directly or indirectly, in the
transition of which the acquisition of control of the Company forms a part, then
the thresholds for a direct acquisition of control as discussed above will
apply, that is, a WTO Review Threshold of CDN$237,000,000, (in 2004) for a WTO
investor or a threshold of CDN$5,000,000 for a non-Canadian other than a WTO
investor. If the value exceeds that level, then the transaction must be reviewed
in the same manner as a direct acquisition of control by the purchase of shares
of the Company.
If an investment is reviewable, an application for review in the form prescribed
by the regulations is normally required to be filed with the Director appointed
under the Act (the "Director") prior to the investment taking place and the
investment may not be consummated until the review has been completed. There
are, however, certain exceptions. Applications concerning indirect acquisitions
may be filed up to 30 days after the investment is consummated and applications
concerning reviewable investments in culture-sensitive sectors are required upon
receipt of a notice for review. In addition, the Minister (a person designated
as such under the Act) may permit an investment to be consummated prior to
completion of the review, if he is satisfied that delay would cause undue
hardship to the acquiror or jeopardize the operations of the Canadian business
that is being acquired. The Director will submit the application to the
Minister, together with any other information or written undertakings given by
the acquiror and any representation submitted to the Director by a province that
is likely to be significantly affected by the investment.
The Minister will then determine whether the investment is likely to be of net
benefit to Canada, taking into account the information provided and having
regard to certain factors of assessment where they are relevant. Some of the
factors to be considered are (i) the effect of the investment on the level and
nature of economic activity in Canada, including the effect on employment, on
resource processing, and on the utilization of parts, components and services
produced in Canada; (ii) the effect of the investment on exports from Canada;
(iii) the degree and significance of participation by Canadians in the Canadian
business and in any industry in Canada of which it forms a part; (iv) the effect
of the investment on productivity, industrial efficiency, technological
development, product innovation and product variety in Canada; (v) the effect of
the investment on competition within any industry or industries in Canada; (vi)
the compatibility of the investment with national industrial, economic and
cultural policies taking into consideration industrial, economic and cultural
objectives enunciated by the government or legislature of any province likely to
be significantly affected by the investment; and (vii) the contribution of the
investment to Canada's ability to compete in world markets.
The Act sets certain time limits for the Director and the Minister. Within 45
days after a completed application has been received, the Minister must notify
the acquiror that (a) he is satisfied that the investment is likely to be of net
benefit to Canada, or (b) he is unable to complete his review, in which case he
shall have 30 additional days to complete his review (unless the acquiror agrees
to a longer period), or (c) he is not satisfied that the investment is likely to
be of net benefit to Canada.
Where the Minister has advised the acquiror that he is not satisfied that the
investment is likely to be of net benefit to Canada, the acquiror has the right
to make representations and submit undertakings within 30 days of the date of
the
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notice (or any further period that is agreed upon between the acquiror and the
Minister). On the expiration of the 30 day period (or the agreed extension), the
Minister must quickly notify the acquiror (i) that he is now satisfied that the
investment is likely to be of net benefit to Canada or (ii) that he is not
satisfied that the investment is likely to be of net benefit to Canada. In the
latter case, the acquiror may not proceed with the investment or, if the
investment has already been consummated, must divest itself of control of the
Canadian business.
The Act provides civil remedies for non-compliance with any provision. There are
also criminal penalties for breach of confidentiality or providing false
information.
E. Taxation.
U.S. Federal Income Tax Consequences
The following is a summary of the anticipated material U.S. federal income tax
consequences to a U.S. Holder (as defined below) arising from and relating to
the acquisition, ownership, and disposition of Common Shares.
This summary is for general information purposes only and does not purport to be
a complete analysis or listing of all potential U.S. federal income tax
consequences that may apply to a U.S. Holder as a result of the acquisition,
ownership, and disposition of Common Shares. In addition, this summary does not
take into account the individual facts and circumstances of any particular U.S.
Holder that may affect the U.S. federal income tax consequences of the
acquisition, ownership, and disposition of Common Shares. Accordingly, this
summary is not intended to be, and should not be construed as, legal or U.S.
federal income tax advice with respect to any U.S. Holder. Each U.S. Holder
should consult its own financial advisor, legal counsel, or accountant regarding
the U.S. federal, U.S. state and local, and foreign tax consequences of the
acquisition, ownership, and disposition of Common Shares.
Scope of this Disclosure
Authorities
- -----------
This summary is based on the Internal Revenue Code of 1986, as amended (the
"Code"), Treasury Regulations (whether final, temporary, or proposed), published
rulings of the Internal Revenue Service ("IRS"), published administrative
positions of the IRS, the Convention Between Canada and the United States of
America with Respect to Taxes on Income and on Capital, signed September 26,
1980, as amended (the "Canada-U.S. Tax Convention"), and U.S. court decisions
that are applicable and, in each case, as in effect and available, as of the
date of this Annual Report. Any of the authorities on which this summary is
based could be changed in a material and adverse manner at any time, and any
such change could be applied on a retroactive basis. This summary does not
discuss the potential effects, whether adverse or beneficial, of any proposed
legislation that, if enacted, could be applied on a retroactive basis.
U.S. Holders
- ------------
For purposes of this summary, a "U.S. Holder" is a beneficial owner of Common
Shares that, for U.S. federal income tax purposes, is (a) an individual who is a
citizen or resident of the U.S., (b) a corporation, or any other entity
classified as a corporation for U.S. federal income tax purposes, that is
created or organized in or under the laws of the U.S. or any state in the U.S.,
including the District of Columbia, (c) an estate if the income of such estate
is subject to U.S. federal income tax regardless of the source of such income,
or (d) a trust if (i) such trust has validly elected to be treated as a U.S.
person for U.S. federal income tax purposes or (ii) a U.S. court is able to
exercise primary supervision over the administration of such trust and one or
more U.S. persons have the authority to control all substantial decisions of
such trust.
Non-U.S. Holders
- ----------------
For purposes of this summary, a "non-U.S. Holder" is a beneficial owner of
Common Shares other than a U.S. Holder. This summary does not address the U.S.
federal income tax consequences of the acquisition, ownership, and disposition
of Common Shares to non-U.S. Holders. Accordingly, a non-U.S. Holder should
consult its own financial advisor, legal counsel, or accountant regarding the
U.S. federal, U.S. state and local, and foreign tax
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consequences (including the potential application of and operation of any tax
treaties) of the acquisition, ownership, and disposition of Common Shares.
U.S. Holders Subject to Special U.S. Federal Income Tax Rules Not Addressed
- ---------------------------------------------------------------------------
This summary does not address the U.S. federal income tax consequences of the
acquisition, ownership, and disposition of Common Shares to U.S. Holders that
are subject to special provisions under the Code, including the following U.S.
Holders: (a) U.S. Holders that are tax-exempt organizations, qualified
retirement plans, individual retirement accounts, or other tax-deferred
accounts; (b) U.S. Holders that are financial institutions, insurance companies,
real estate investment trusts, or regulated investment companies; (c) U.S.
Holders that are broker-dealers, dealers, or traders in securities or currencies
that elect to apply a mark-to-market accounting method; (d) U.S. Holders that
have a "functional currency" other than the U.S. dollar; (e) U.S. Holders that
are liable for the alternative minimum tax under the Code; (f) U.S. Holders that
own Common Shares as part of a straddle, hedging transaction, conversion
transaction, constructive sale, or other arrangement involving more than one
position; (g) U.S. Holders that acquired Common Shares in connection with the
exercise of employee stock options or otherwise as compensation for services;
(h) U.S. Holders that hold Common Shares other than as a capital asset within
the meaning of Section 1221 of the Code; or (i) U.S. Holders that own, directly
or indirectly, 10% or more, by voting power or value, of the outstanding shares
of the Company. U.S. Holders that are subject to special provisions under the
Code, including U.S. Holders described immediately above, should consult their
own financial advisor, legal counsel or accountant regarding the U.S. federal,
U.S. state and local, and foreign tax consequences of the acquisition,
ownership, and disposition of Common Shares.
If an entity that is classified as partnership (or "pass-through" entity) for
U.S. federal income tax purposes holds Common Shares, the U.S. federal income
tax consequences to such partnership (or "pass-through" entity) and the partners
of such partnership (or owners of such "pass-through" entity) generally will
depend on the activities of the partnership (or "pass-through" entity) and the
status of such partners (or owners). Partners of entities that are classified as
partnerships (or owners of "pass-through" entities) for U.S. federal income tax
purposes should consult their own financial advisor, legal counsel or accountant
regarding the U.S. federal income tax consequences of the acquisition,
ownership, and disposition of Common Shares.
Tax Consequences Other than U.S. Federal Income Tax Consequences Not Addressed
- ------------------------------------------------------------------------------
This summary does not address the U.S. state and local, U.S. federal estate and
gift, or foreign tax consequences to U.S. Holders of the acquisition, ownership,
and disposition of Common Shares. Each U.S. Holder should consult its own
financial advisor, legal counsel, or accountant regarding the U.S. state and
local, U.S. federal estate and gift, and foreign tax consequences of the
acquisition, ownership, and disposition of Common Shares. (See
"Taxation--Canadian Federal Income Tax Considerations" below).
U.S. Federal Income Tax Consequences of the Acquisition, Ownership, and
Disposition of Common Shares
Distributions on Common Shares
- ------------------------------
General Taxation of Distributions
A U.S. Holder that receives a distribution, including a constructive
distribution, with respect to the Common Shares will be required to include the
amount of such distribution in gross income as a dividend (without reduction for
any Canadian income tax withheld from such distribution) to the extent of the
current or accumulated "earnings and profits" of the Company. To the extent that
a distribution exceeds the current and accumulated "earnings and profits" of the
Company, such distribution will be treated (a) first, as a tax-free return of
capital to the extent of a U.S. Holder's tax basis in the Common Shares and, (b)
thereafter, as gain from the sale or exchange of such Common Shares. (See more
detailed discussion at "Disposition of Common Shares" below).
Reduced Tax Rates for Certain Dividends
For taxable years beginning after December 31, 2002 and before January 1, 2009,
a dividend paid by the Company generally will be taxed at the preferential tax
rates applicable to long-term capital gains if (a) the Company is a
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"qualified foreign corporation" (as defined below), (b) the U.S. Holder
receiving such dividend is an individual, estate, or trust, and (c) such
dividend is paid on Common Shares that have been held by such U.S. Holder for at
least 61 days during the 121-day period beginning 60 days before the
"ex-dividend date" (i.e., the first date that a purchaser of such Common Shares
will not be entitled to receive such dividend).
The Company generally will be a "qualified foreign corporation" under Section
1(h)(11) of the Code (a "QFC") if (a) the Company is incorporated in a
possession of the U.S., (b) the Company is eligible for the benefits of the
Canada-U.S. Tax Convention, or (c) the Common Shares are readily tradable on an
established securities market in the U.S. However, even if the Company satisfies
one or more of such requirements, the Company will not be treated as a QFC if
the Company is a "passive foreign investment company" (as defined below) for the
taxable year during which the Company pays a dividend or for the preceding
taxable year. In 2003, the U.S. Department of the Treasury (the "Treasury") and
the IRS announced that they intended to issue Treasury Regulations providing
procedures for a foreign corporation to certify that it is a QFC. Although these
Treasury Regulations were not issued in 2004, the Treasury and the IRS have
confirmed their intention to issue these Treasury Regulations. It is expected
that these Treasury Regulations will obligate persons required to file
information returns to report a distribution with respect to a foreign security
issued by a foreign corporation as a dividend from a QFC if the foreign
corporation has, among other things, certified under penalties of perjury that
the foreign corporation was not a "passive foreign investment company" for the
taxable year during which the foreign corporation paid the dividend or for the
preceding taxable year.
As discussed below, the Company does not believe that it was a "passive foreign
investment company" for the taxable year ended October 31, 2004, and does not
expect that it will be a "passive foreign investment company" for the taxable
year ending October 31, 2005. (See more detailed discussion at "Additional Rules
that May Apply to U.S. Holders" below). However, there can be no assurance that
the IRS will not challenge the determination made by the Company concerning its
"passive foreign investment company" status or that the Company will not be a
"passive foreign investment company" for the current or any future taxable year.
Accordingly, although the Company believes that it should be a QFC, there can be
no assurances that the IRS will not challenge the determination made by the
Company concerning its QFC status, that the Company will be a QFC for the
current or any future taxable year, or that the Company will be able to certify
that it is a QFC in accordance with the certification procedures issued by the
Treasury and the IRS.
If the Company is not a QFC, a dividend paid by the Company to a U.S. Holder,
including a U.S. Holder that is an individual, estate, or trust, generally will
be taxed at ordinary income tax rates (and not at the preferential tax rates
applicable to long-term capital gains). The dividend rules are complex, and each
U.S. Holder should consult its own financial advisor, legal counsel, or
accountant regarding the dividend rules.
Distributions Paid in Foreign Currency
The amount of a distribution paid to a U.S. Holder in foreign currency generally
will be equal to the U.S. dollar value of such distribution based on the
exchange rate applicable on the date of receipt. A U.S. Holder that does not
convert foreign currency received as a distribution into U.S. dollars on the
date of receipt generally will have a tax basis in such foreign currency equal
to the U.S. dollar value of such foreign currency on the date of receipt. Such a
U.S. Holder generally will recognize ordinary income or loss on the subsequent
sale or other taxable disposition of such foreign currency (including an
exchange for U.S. dollars).
Dividends Received Deduction
Dividends paid on the Common Shares generally will not be eligible for the
"dividends received deduction." The availability of the dividends received
deduction is subject to complex limitations that are beyond the scope of this
discussion, and a U.S. Holder that is a corporation should consult its own
financial advisor, legal counsel, or accountant regarding the dividends received
deduction.
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Disposition of Common Shares
- ----------------------------
A U.S. Holder will recognize gain or loss on the sale or other taxable
disposition of Common Shares in an amount equal to the difference, if any,
between (a) the amount of cash plus the fair market value of any property
received and (b) such U.S. Holder's tax basis in the Common Shares sold or
otherwise disposed of. Any such gain or loss generally will be capital gain or
loss, which will be long-term capital gain or loss if the Common Shares are held
for more than one year. Gain or loss recognized by a U.S. Holder on the sale or
other taxable disposition of Common Shares generally will be treated as "U.S.
source" for purposes of applying the U.S. foreign tax credit rules. (See more
detailed discussion at "Foreign Tax Credit" below).
Preferential tax rates apply to long-term capital gains of a U.S. Holder that is
an individual, estate, or trust. There are currently no preferential tax rates
for long-term capital gains of a U.S. Holder that is a corporation. Deductions
for capital losses and net capital losses are subject to complex limitations.
For a U.S. Holder that is an individual, estate, or trust, capital losses may be
used to offset capital gains and up to U.S.$3,000 of ordinary income. An unused
capital loss of a U.S. Holder that is an individual, estate, or trust generally
may be carried forward to subsequent taxable years, until such net capital loss
is exhausted. For a U.S. Holder that is a corporation, capital losses may be
used to offset capital gains, and an unused capital loss generally may be
carried back three years and carried forward five years from the year in which
such net capital loss is recognized.
Foreign Tax Credit
- ------------------
A U.S. Holder who pays (whether directly or through withholding) Canadian income
tax with respect to dividends paid on the Common Shares generally will be
entitled, at the election of such U.S. Holder, to receive either a deduction or
a credit for such Canadian income tax paid. Generally, a credit will reduce a
U.S. Holder's U.S. federal income tax liability on a dollar-for-dollar basis,
whereas a deduction will reduce a U.S. Holder's income subject to U.S. federal
income tax. This election is made on a year-by-year basis and applies to all
foreign taxes paid (whether directly or through withholding) by a U.S. Holder
during a year.
Complex limitations apply to the foreign tax credit, including the general
limitation that the credit cannot exceed the proportionate share of a U.S.
Holder's U.S. federal income tax liability that such U.S. Holder's "foreign
source" taxable income bears to such U.S. Holder's worldwide taxable income. In
applying this limitation, a U.S. Holder's various items of income and deduction
must be classified, under complex rules, as either "foreign source" or "U.S.
source." In addition, this limitation is calculated separately with respect to
specific categories of income (including "passive income," "high withholding tax
interest," "financial services income," "general income," and certain other
categories of income). Dividends paid by the Company generally will constitute
"foreign source" income and generally will be categorized as "passive income"
or, in the case of certain U.S. Holders, "financial services income." However,
for taxable years beginning after December 31, 2006, the foreign tax credit
limitation categories are reduced to "passive income" and "general income" (and
the other categories of income, including "financial services income," are
eliminated). The foreign tax credit rules are complex, and each U.S. Holder
should consult its own financial advisor, legal counsel, or accountant regarding
the foreign tax credit rules.
Information Reporting; Backup Withholding Tax
- ---------------------------------------------
Payments made within the U.S., or by a U.S. payor or U.S. middleman, of
dividends on, and proceeds arising from certain sales or other taxable
dispositions of, Common Shares generally will be subject to information
reporting and backup withholding tax, at the rate of 28%, if a U.S. Holder (a)
fails to furnish such U.S. Holder's correct U.S. taxpayer identification number
(generally on Form W-9), (b) furnishes an incorrect U.S. taxpayer identification
number, (c) is notified by the IRS that such U.S. Holder has previously failed
to properly report items subject to backup withholding tax, or (d) fails to
certify, under penalty of perjury, that such U.S. Holder has furnished its
correct U.S. taxpayer identification number and that the IRS has not notified
such U.S. Holder that it is subject to backup withholding tax. However, U.S.
Holders that are corporations generally are excluded from these information
reporting and backup withholding tax rules. Any amounts withheld under the U.S.
backup withholding tax rules will be allowed as a credit against a U.S. Holder's
U.S. federal income tax liability, if any, or will be refunded, if such U.S.
Holder furnishes required information to the IRS. Each U.S. Holder should
consult its own financial advisor, legal counsel, or accountant regarding the
information reporting and backup withholding tax rules.
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Additional Rules that May Apply to U.S. Holders
If the Company is a "controlled foreign corporation" or a "passive foreign
investment company" (each as defined below), the preceding sections of this
summary may not describe the U.S. federal income tax consequences to U.S.
Holders of the acquisition, ownership, and disposition of Common Shares.
Controlled Foreign Corporation
- ------------------------------
The Company generally will be a "controlled foreign corporation" under Section
957 of the Code (a "CFC") if more than 50% of the total voting power or the
total value of the outstanding shares of the Company is owned, directly or
indirectly, by citizens or residents of the U.S., domestic partnerships,
domestic corporations, domestic estates, or domestic trusts (each as defined in
Section 7701(a)(30) of the Code), each of which own, directly or indirectly, 10%
or more of the total voting power of the outstanding shares of the Company (a
"10% Shareholder").
If the Company is a CFC, a 10% Shareholder generally will be subject to current
U.S. federal income tax with respect to (a) such 10% Shareholder's pro rata
share of the "subpart F income" (as defined in Section 952 of the Code) of the
Company and (b) such 10% Shareholder's pro rata share of the earnings of the
Company invested in "United States property" (as defined in Section 956 of the
Code). In addition, under Section 1248 of the Code, any gain recognized on the
sale or other taxable disposition of Common Shares by a U.S. Holder that was a
10% Shareholder at any time during the five-year period ending with such sale or
other taxable disposition generally will be treated as a dividend to the extent
of the "earnings and profits" of the Company that are attributable to such
Common Shares. If the Company is both a CFC and a "passive foreign investment
company" (as defined below), the Company generally will be treated as a CFC (and
not as a "passive foreign investment company") with respect to any 10%
Shareholder.
The Company does not believe that it has previously been, or currently is, a
CFC. However, there can be no assurance that the Company will not be a CFC for
the current or any future taxable year.
Passive Foreign Investment Company
- ----------------------------------
The Company generally will be a "passive foreign investment company" under
Section 1297 of the Code (a "PFIC") if, for a taxable year, (a) 75% or more of
the gross income of the Company for such taxable year is passive income or (b)
50% or more of the assets held by the Company either produce passive income or
are held for the production of passive income, based on the fair market value of
such assets (or on the adjusted tax basis of such assets, if the Company is not
publicly traded and either is a "controlled foreign corporation" or makes an
election). "Passive income" includes, for example, dividends, interest, certain
rents and royalties, certain gains from the sale of stock and securities, and
certain gains from commodities transactions.
For purposes of the PFIC income test and assets test described above, if the
Company owns, directly or indirectly, 25% or more of the total value of the
outstanding shares of another foreign corporation, the Company will be treated
as if it (a) held a proportionate share of the assets of such other foreign
corporation and (b) received directly a proportionate share of the income of
such other foreign corporation. In addition, for purposes of the PFIC income
test and asset test described above, "passive income" does not include any
interest, dividends, rents, or royalties that are received or accrued by the
Company from a "related person" (as defined in Section 954(d)(3) of the Code),
to the extent such items are properly allocable to the income of such related
person that is not passive income.
If the Company is a PFIC, the U.S. federal income tax consequences to a U.S.
Holder of the acquisition, ownership, and disposition of Common Shares will
depend on whether such U.S. Holder makes an election to treat the Company as a
"qualified electing fund" or "QEF" under Section 1295 of the Code (a "QEF
Election") or a mark-to-market election under Section 1296 of the Code (a
"Mark-to-Market Election"). A U.S. Holder that does not make either a QEF
Election or a Mark-to-Market Election will be referred to in this summary as a
"Non-Electing U.S. Holder."
Under Section 1291 of the Code, any gain recognized on the sale or other taxable
disposition of Common Shares, and any "excess distribution" (as defined in
Section 1291(b) of the Code) paid on the Common Shares, must be ratably
allocated to each day in a Non-Electing U.S. Holder's holding period for the
Common Shares. The amount of any such gain or excess distribution allocated to
prior years of such Non-Electing U.S. Holder's holding period for the Common
Shares generally will be subject to U.S. federal income tax at the highest tax
applicable to ordinary
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income in each such prior year. A Non-Electing U.S. Holder will be required to
pay interest on the resulting tax liability for each such prior year, calculated
as if such tax liability had been due in each such prior year.
A U.S. Holder that makes a QEF Election generally will not be subject to the
rules of Section 1291 of the Code discussed above. However, a U.S. Holder that
makes a QEF Election generally will be subject to U.S. federal income tax on
such U.S. Holder's pro rata share of (a) the "net capital gain" of the Company,
which will be taxed as long-term capital gain to such U.S. Holder, and (b) and
the "ordinary earnings" of the Company, which will be taxed as ordinary income
to such U.S. Holder. A U.S. Holder that makes a QEF Election will be subject to
U.S. federal income tax on such amounts for each taxable year in which the
Company is a PFIC, regardless of whether such amounts are actually distributed
to such U.S. Holder by the Company.
A U.S. Holder that makes a Mark-to-Market Election generally will not be subject
to the rules of Section 1291 of the Code discussed above. A U.S. Holder may make
a Mark-to-Market Election only if the Common Shares are "marketable stock" (as
defined in Section 1296(e) of the Code). A U.S. Holder that makes a
Mark-to-Market Election will include in gross income, for each taxable year in
which the Company is a PFIC, an amount equal to the excess, if any, of (a) the
fair market value of the Common Shares as of the close of such taxable year over
(b) such U.S. Holder's tax basis in such Common Shares. A U.S. Holder that makes
a Mark-to-Market Election will, subject to certain limitations, be allowed a
deduction in an amount equal to the excess, if any, of (a) such U.S. Holder's
adjusted tax basis in the Common Shares over (b) the fair market value of such
Common Shares as of the close of such taxable year.
The Company does not believe that it was a PFIC for the taxable year ended
October 31, 2004, and does not expect that it will be a PFIC for the taxable
year ending October 31, 2005. There can be no assurance, however, that the IRS
will not challenge the determination made by the Company concerning its PFIC
status or that the Company will not be a PFIC for the current or any future
taxable year.
The PFIC rules are complex, and each U.S. Holder should consult its own
financial advisor, legal counsel, or accountant regarding the PFIC rules and how
the PFIC rules may affect the U.S. federal income tax consequences of the
acquisition, ownership, and disposition of Common Shares.
Canadian Federal Income Tax Considerations
The summary below is restricted to the case of a holder (a "Holder") of one or
more common shares who for the purposes of the Income Tax Act (Canada) (the
"Act") is a non-resident of Canada, holds his common shares as capital property
and deals at arm's length with the Company.
Dividends
A Holder will be subject to Canadian withholding tax ("Part XIII Tax") equal to
25%, or such lower rate as may be available under an applicable tax treaty, of
the gross amount of any dividend paid or deemed to be paid on these common
shares. Under the 1995 Protocol amending the Canada-U.S. Income Tax Convention
(1980) (the "Treaty") the rate of Part XIII Tax applicable to a dividend on
common shares paid to a Holder who is a resident of the United States is limited
to 15% reduced to 5% if the shareholder is a corporation owning at least 10% of
the outstanding common shares of the Company. These treaty limits do not apply
to dividends paid on common shares held by a holder resident in the U.S. where
the holding is effectively connected to a permanent establishment in Canada
through which a business is carried on. The Company will be required to withhold
the applicable amount of Part XIII Tax from each dividend so paid and remit the
withheld amount directly to the Receiver General for Canada for the account of
the Holder.
Disposition of Common Shares
A Holder who disposes of a common share, including by deemed disposition on
death, will not be subject to Canadian tax on any capital gain (or capital loss)
thereby realized unless the common share constituted "taxable Canadian property"
as defined by the Act. A capital gain occurs when proceeds from the disposition
of a share or other capital property exceeds the original cost. A capital loss
occurs when the proceeds from the disposition of a
-54-
share are less than the original cost. Under the Act, a capital gain is
effectively taxed at a lower rate as only 50% of the gain is effectively
included in the Holder's taxable income.
Generally, a common share will not constitute taxable Canadian property of a
Holder unless he held the common shares as property used or held by him in a
business (other than an insurance business) carried on in Canada, or he or
persons with whom he did not deal at arm's length alone or together held or held
options to acquire, at any time within the five year period immediately
preceding the disposition, 25% or more of the shares of any class of the capital
stock of the Company. The disposition of a common share that constitutes
"taxable Canadian property" of a Holder could also result in a capital loss
which can be used to reduce taxable income to the extent that such Holder can
offset it against a capital gain. A capital loss cannot be used to reduce all
taxable income (only that portion of taxable income derived from a capital
gain).
A Holder who is a resident of the United States and realizes a capital gain on
disposition of a common share that was taxable Canadian property will
nevertheless, by virtue of the Treaty, generally be exempt from Canadian tax
thereon unless (a) more than 50% of the value of the common share is derived
from, or forms an interest in, Canadian real estate, including rights to exploit
Canadian minerals and resources, (b) the common share formed part of the
business property of a permanent establishment that the Holder has or had in
Canada within the 12 months preceding disposition, or (c) the Holder (i) was a
resident of Canada at any time within the ten years immediately preceding the
disposition and for a total of 120 months during any consecutive 20 year period
ending before the disposition, and (ii) owned the common share (or property for
which it was substituted in a rollover transaction) when he ceased to be
resident in Canada.
A Holder who is subject to Canadian tax in respect of a capital gain realized on
disposition of a common share must include 50% of the capital gain (taxable
capital gain) in computing his taxable income earned in Canada. The Holder may,
subject to certain limitations, deduct 50% of any capital loss (allowable
capital loss) arising on disposition of taxable Canadian property from taxable
capital gains realized in the year of disposition in respect to taxable Canadian
property and, to the extent not so deductible, from such taxable capital gains
of any of the three preceding years or of any subsequent year. For losses
carried back to years prior to 2000, the amount is adjusted to reflect the
former 75% inclusion rate. For losses applied to capital gains in 2000, the
amount is adjusted to reflect the average inclusion rate for the year.
F. Dividends and paying agents.
Not applicable.
G. Statement by experts.
Not applicable.
H. Documents on display.
The Company is a reporting company under the Securities Exchange Act of 1934, as
amended (the "Exchange Act") and is a "foreign private issuer" as defined in the
Exchange Act. A foreign private issuer is exempt from the provisions of the
Exchange Act which prescribe the furnishing and content of proxy statements to
shareholders and relating to short swing profits reporting and liability.
Readers may review a copy of the Company's filings with the U.S. Securities and
Exchange Commission ("the "SEC"), including exhibits and schedules filed with
it, at the SEC's public reference facilities in Room 1024, Judiciary Plaza, 450
Fifth Street, N.W., Washington, D.C. 20549. Readers may also obtain copies of
such materials from the Public Reference Section of the SEC, Room 1024,
Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, at prescribed
rates. Readers may call the SEC at 1-800-SEC-0330 for further information on the
public reference rooms. The SEC maintains a Web site (http://www.sec.gov) that
contains reports, submissions and other information regarding registrants that
file electronically with the SEC. The Company has only recently become subject
to the requirement to file electronically through the EDGAR system most of its
securities documents, including registration statements under the Securities Act
of 1933, as amended and registration statements, reports and other documents
under the Securities Exchange Act of 1934, as amended.
-55-
The Company is required to file financial statements and other information with
all of the Securities Commissions in Canada electronically through the Canadian
System for Electronic Document Analysis and Retrieval (SEDAR) which can be
viewed at www.sedar.com.
Copies of any documents referred to in this Annual Report and filed with the SEC
can be viewed at the Company's head office during normal business hours.
Documents referred to in this annual report may be viewed at the head office of
the Company.
I. Subsidiary information.
Not applicable.
ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our financial results are quantified in Canadian dollars and a majority of our
obligations and expenditures with respect to our operations are incurred in
Canadian dollars, while revenues are generally received in U.S. dollars. In the
past, we have raised equity funding through the sale of securities denominated
in Canadian dollars, and we may in the future raise additional equity funding or
financing denominated in Canadian dollars. We currently do not believe we
currently have any materially significant market risks relating to our
operations resulting from foreign exchange rates. However, if we enter into
financing or other business arrangements denominated in currency other than the
Canadian dollar, variations in the exchange rate may give rise to foreign
exchange gains or losses that may be significant.
We currently have no long-term debt obligations. We do not use financial
instruments for trading purposes and we are not a party to any leverage
derivatives. In the event we experience substantial growth in the future, our
business and results of operations may be materially affected by changes in
interest rates and certain other credit risk associated with our operations.
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
A. Debt securities.
Not applicable.
B. Warrants and rights.
Not applicable.
C. Other securities.
Not applicable.
D. American depositary shares.
Not applicable.
-56-
PART II
ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES
None.
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS
AND USE OF PROCEEDS
None.
ITEM 15. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
The Company maintains disclosure controls and procedures that are designed to
ensure that the information required to be disclosed in our Exchange Act reports
is recorded, processed, summarized and reported within the time periods
specified in the SEC's rules and forms, and that such information is accumulated
and communicated to management, including the Company's Chief Executive Officer
and Chief Financial Officer, as appropriate, to allow timely decisions regarding
required disclosure. After evaluating the effectiveness of the Company's
disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e)
and 15d-15(e)) as of the end of the period covered by this report, the Chief
Executive Officer and Chief Financial Officer have concluded that as of such
date, the Company's disclosure controls and procedure were adequate and
effective to ensure that material information relating to the Company and its
consolidated subsidiaries would be made known to them by others within those
entities.
Report on Internal Control Over Financial Reporting
There were no significant changes in the Company's internal controls or in other
factors that could significantly affect these disclosure controls and procedures
during the fiscal year, including any significant deficiencies or material
weaknesses of internal controls that would require corrective action.
ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT
All of the members of the Audit Committee are financially literate and the Board
has determined that Peter H. Kinash of the Audit Committee meets the
requirements of an "audit committee financial expert" as defined in Item 16A of
Form 20-F. Mr. Kinash is independent in accordance with the independence
requirements for audit committee members under the rules of the American Stock
Exchange
ITEM 16B. CODE OF ETHICS
The Company developed a code of ethics to reflect SEC rules and other proposed
regulations, which code of ethics was adopted by the board of directors. The
Code of ethics governs the actions of and is applicable to all of the directors
and officers of the Company and its subsidiaries, and their affiliates. The code
of ethics deals with the following issues:
o compliance with all the laws and regulations identified in the code of
ethics;
o corporate opportunities and conflicts of interest;
o the quality of the public disclosures;
-57-
o the protection and appropriate use of the Company's properties;
o the protection of confidential information and property;
o fair behavior; and
o compliance with insider trading and corrupt practices legislation.
All interested investors may acquire a copy of our code of ethics free of charge
by written request.
There have been no waivers to the code of ethics since its adoption.
ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES
KPMG acted as the Company's independent auditor for the fiscal years ended
October 31, 2004 and 2003. The chart below sets forth the total amount billed
the Company by KPMG for services performed in the years 2004 and 2003, and
breaks down these amounts by category of service in Cdn$:
- ----------------------------------------------------------------------
Years ended October 31
- ----------------------------------------------------------------------
2004 2003
$ $
- ----------------------------------------------------------------------
Audit Fees: 71,500 66,000
- ----------------------------------------------------------------------
Audit Related Fees: 14,900
- ----------------------------------------------------------------------
Tax Fees: 40,047 13,500
- ----------------------------------------------------------------------
All Other Fees: -- --
- ----------------------------------------------------------------------
Total 111,547 94,400
- ----------------------------------------------------------------------
"Audit Fees" are the aggregate fees billed by KPMG for the audit of the
Company's consolidated annual financial statements, reviews of interim financial
statements and attestation services that are provided in connection with
statutory and regulatory filings or engagements.
"Audit-Related Fees" are fees charged by KPMG for assurance and related services
that are reasonably related to the performance of the audit or review of the
Company's financial statements and are not reported under "Audit Fees." This
category comprises fees billed for independent accountant review of the interim
financial statements and Management Discussion and Analysis, as well as advisory
services associated with the Company's financial reporting.
"Tax Fees" are fees for professional services rendered by KPMG for tax
compliance, tax advice on actual or contemplated transactions.
-58-
Audit Committee's pre-approval policies and procedures
The Audit Committee nominates and engages the independent auditors to audit the
financial statements, and approves all audit, audit-related services, tax
services and other services provided by KPMG. Any services provided by KPMG that
are not specifically included within the scope of the audit must be pre-approved
by the audit committee prior to any engagement. The audit committee is permitted
to approve certain fees for audit-related services, tax services and other
services pursuant to a de minimus exception before the completion of the
engagement.
ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES.
Not Applicable.
ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND
AFFILIATED PURCHASERS.
None.
-59-
PART III
ITEM 17. FINANCIAL STATEMENTS
Our financial statements are stated in Canadian Dollars (Cdn$) and are prepared
in accordance with Canadian Generally Accepted Accounting Principles (GAAP),
which, in our case, conforms in all material respects for the periods presented
with United States GAAP, except as disclosed in the footnotes to the financial
statements.
The financial statements as required under Item No. 17 are attached hereto and
found immediately following the text of this Annual Report.
Audited Consolidated Financial Statements of Chartwell Technology Inc.
for the fiscal years ended October 31, 2002, 2003 and 2004.
-60-
ITEM 18. FINANCIAL STATEMENTS
Not applicable.
ITEM 19. EXHIBITS
Exhibit
Number Description
------ -----------
1.1(1) Certificate of Incorporation of Napier Explorations Inc.
1.2(1) Certificate of Name Change from Napier Explorations Inc. to
Brockton Resources Inc., dated October 13, 1988
1.3(1) Special Resolution, dated July 21, 1992
1.4(1) Directors Resolution, dated November 4, 1992
1.5(1) Certificate of Name Change from Brockton Resources Inc. to
Chartwell Ventures Ltd., dated November 19, 1992
1.6(1) Certificate of Registration as an Extra-Provincial Corporation in
Alberta, Chartwell Ventures Ltd., dated June 21, 1994
1.7(1) Certificate of Continuance from British Columbia to Alberta,
Chartwell Ventures Ltd., dated December 18, 1995
1.8(1) Certificate of Name Change from Chartwell Ventures Ltd. to
Chartwell Technology Inc., dated December 8, 1998
1.9(1) Amended Articles of Brockton Resources Inc.
1.10(3) Revised Company By-Laws, approved July 31, 2000 (previously filed
as Exhibit 4.2)
4.1(1) Stock Option Plan, dated June 22, 1998 (previously filed as
Exhibit 3.8)
4.2(1) Form of Software Licensing Agreement (previously filed as Exhibit
3.14)
4.3(1) Contractual Rights and Software Purchase and Sale Agreement dated
November 1, 1999 By and Among Chartwell Technology Inc., Gateway
Technology Inc. and Gaming Tech Corporation (previously filed as
Exhibit 3.15)
4.4(2) ????
4.5(3) Revised Stock Option Plan, dated June 23, 2000 (previously filed
as Exhibit 4.1)
4.5 Revised Stock Option Plan, dated March 22, 2004
8.1 List of subsidiaries
11.1 Code of Ethics
12.1 Certification of CEO required by Rule 13a-14(a) or Rule 15d-14(a)
12.2 Certification of CFO required by Rule 13a-14(a) or Rule 15d-14(a)
-61-
Exhibit
Number Description
------ -----------
13.1 Certification of CEO pursuant to 18 U.S.C. Section 1350 as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
13.2 Certification of CFO pursuant to 18 U.S.C. Section 1350 as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
- ---------------
(1) Previously filed on December 17, 1999
(2) Previously filed on July 31, 2000.
(3) Previously filed on April 19, 2001
-63-
SIGNATURES
Pursuant to the requirements of Section 12 of the Securities Exchange Act
of 1934, the registrant certifies that it meets all of the requirements for
filing on Form 20-F and has duly caused this Annual Report to be signed on its
behalf by the undersigned, thereunto duly authorized.
Date: May 16, 2005 By: /s/ Don Gleason
----------------------------------------
Don Gleason, Chief Financial Officer
-63-
kpmg
Consolidated Financial Statements of
CHARTWELL TECHNOLOGY INC.
Years ended October 31, 2004, 2003 and 2002.
Auditors' Report to the shareholders
We have audited the consolidated balance sheets of Chartwell Technology Inc. as
at October 31, 2004 and 2003 and the consolidated statements of operations and
deficit and cash flows for each of the years in the three-year period ended
October 31, 2004. These financial statements are the responsibility of the
Corporation's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with Canadian generally accepted auditing
standards. Those standards require that we plan and perform an audit to obtain
reasonable assurance whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
In our opinion, these consolidated financial statements present fairly, in all
material respects, the financial position of the Corporation as at October 31,
2004 and 2003 and the results of its operations and its cash flows for each of
the years in the three year period ended October 31, 2004 in accordance with
Canadian generally accepted accounting principles.
/s/ KPMG LLP
KPMG LLP
Chartered Accountants
Calgary, Canada
December 21, 2004
CHARTWELL TECHNOLOGY INC.
Consolidated Balance Sheets
As at October 31
(stated in Canadian dollars)
- -------------------------------------------------------------------------------------------------
2004 2003
- -------------------------------------------------------------------------------------------------
Assets
Current assets:
Cash $ 5,995,863 $ 3,465,120
Short term investments 3,318,286 1,712,890
Accounts receivable 1,916,309 1,991,725
Deferred set-up expense 58,585 47,452
Prepaid expenses and deposits 230,632 148,699
Notes receivable 117,873 -
Future income tax asset (note 7) 115,000 110,000
- -------------------------------------------------------------------------------------------------
Total current assets 11,752,548 7,475,886
Due from related parties (note 6) 178,961 190,512
Property and equipment (note 2) 431,824 338,969
Goodwill (note 4(c)) 811,666 -
Deferred software development costs (note 3) 607,900 530,948
Deferred set-up expense 68,186 162,390
Notes receivable 180,573 -
Future income tax asset (note 7) 929,964 520,000
- -------------------------------------------------------------------------------------------------
$ 14,961,622 $ 9,218,705
- -------------------------------------------------------------------------------------------------
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable and accrued liabilities $ 708,900 $ 217,012
Current portion of obligations under capital lease 15,640 5,956
Deferred revenue 478,952 707,433
- -------------------------------------------------------------------------------------------------
Total Current liabilities 1,203,492 930,401
Deferred revenue 615,748 980,502
Obligations under capital lease 20,793 3,031
Shareholders' equity:
Share capital (note 4) 16,502,188 14,809,723
Contributed surplus 102,572 -
Deficit (3,483,171) (7,504,952)
-------------------------------------------------------------------------------------------
Total Shareholders equity 13,121,589 7,304,771
Commitments (note 9)
Subsequent event (note 12)
- -------------------------------------------------------------------------------------------------
$ 14,961,622 $ 9,218,705
- -------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
On behalf of the Board:
Signed "Darold H. Parken" Signed "Rod A. Ferguson"
- ---------------------------- ------------------------
Director Director
CHARTWELL TECHNOLOGY INC.
Consolidated Statements of Operations and Deficit
Years ended October 31
(stated in Canadian dollars)
- -----------------------------------------------------------------------------------------------
2004 2003 2002
- -----------------------------------------------------------------------------------------------
Revenue:
Software license fees $ 11,268,494 $ 6,300,335 $ 2,646,766
Software set-up fees 798,343 919,892 896,560
Interest and other 134,640 109,411 302,031
- -----------------------------------------------------------------------------------------------
12,201,477 7,329,638 3,845,357
Expenses
Software development and support 4,417,981 3,288,164 2,648,223
Sales, general and administrative 3,498,607 1,947,372 2,385,652
Amortization of deferred software
development costs 98,048 110,068 110,076
Stock-based compensation 102,572 - -
Depreciation and amortization 244,251 137,310 108,008
Foreign currency loss (gain) 233,201 795,186 (85,795)
- -----------------------------------------------------------------------------------------------
8,594,660 6,278,100 5,166,164
- -----------------------------------------------------------------------------------------------
Net income (loss) before income taxes 3,606,817 1,051,538 (1,320,807)
Income taxes:
Future income tax reduction (note 7) (414,964) (630,000) -
- -----------------------------------------------------------------------------------------------
Net income (loss) 4,021,781 1,681,538 (1,320,807)
Deficit, beginning of year (7,504,952) (9,186,490) (7,865,683)
- -----------------------------------------------------------------------------------------------
Deficit, end of year $ (3,483,171) $ (7,504,952) $ (9,186,490)
- -----------------------------------------------------------------------------------------------
Net income (loss) per share:
Basic $ 0.28 $ 0.12 $ (0.10)
Diluted 0.24 0.12 (0.10)
- -----------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
CHARTWELL TECHNOLOGY INC.
Consolidated Statements of Cash Flows
Years ended October 31
(stated in Canadian dollars)
- --------------------------------------------------------------------------------------------------------
2004 2003 2002
- --------------------------------------------------------------------------------------------------------
Cash provided by (used in):
Operations:
Net income (loss) $ 4,021,781 $ 1,681,538 $ (1,320,807)
Depreciation and amortization 244,251 137,310 108,008
Unrealized foreign exchange losses 268,327 550,234 -
Amortization of deferred software
development costs 98,048 110,068 110,076
Stock-based compensation 102,572 - -
Interest income capitalized (11,413) (27,947) (11,570)
Issue of shares as finders fee - 25,000 -
Future income tax reduction (414,964) (630,000) -
Write-down of long-term securities - - 42,882
Gain on disposal of Property and Equipment (9,213) - 24,258
Contracts acquired on acquisition 25,000 - -
- --------------------------------------------------------------------------------------------------------
4,324,389 1,846,203 (1,047,153)
Change in non-cash working capital:
Accounts receivable (34,819) (863,086) (79,598)
Due from related parties 20,000 - -
Deferred set-up expense 83,071 107,441 (94,741)
Prepaid expenses (100,904) (69,552) 720
Accounts payable and accrued liabilities 491,888 47,858 109,257
Deferred revenue (593,235) 366,813 (107,363)
- --------------------------------------------------------------------------------------------------------
(133,999) (410,526) (171,725)
- --------------------------------------------------------------------------------------------------------
4,190,390 1,435,677 (1,218,878)
Financing:
Issue of shares for cash 855,799 152,500 121,088
Repayment of lease obligations 27,446 (6,841) (10,286)
- --------------------------------------------------------------------------------------------------------
883,245 145,659 110,802
Investing:
Sale (purchase) of short term investments (1,605,396) 1,468,604 168,513
Purchase of property and equipment (604,404) (207,905) (97,248)
Deferred software development costs (175,000) (530,948) -
- --------------------------------------------------------------------------------------------------------
(2,384,800) 729,751 71,265
Effect of foreign exchange rate changes on cash (158,092) (550,234) -
- --------------------------------------------------------------------------------------------------------
Increase (decrease) in cash 2,530,743 1,760,853 (1,036,811)
Cash, beginning of year 3,465,120 1,704,267 2,741,078
- --------------------------------------------------------------------------------------------------------
Cash, end of year $ 5,995,863 $ 3,465,120 $ 1,704,267
- --------------------------------------------------------------------------------------------------------
Supplemental cash flow information:
Interest received $ 123,228 $ 101,464 $ 290,462
Interest paid (2,048) (1,955) (2,201)
- --------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
CHARTWELL TECHNOLOGY INC.
Notes to Consolidated Financial Statements
Years ended October 31, 2004, 2003 and 2002
(stated in Canadian dollars)
- --------------------------------------------------------------------------------
Chartwell Technology Inc. (the "Company") is incorporated under the Business
Corporations Act (Alberta). The Company specializes in the development of games
and entertainment content for Internet and Intranet deployment. The Company's
software products and games are designed for use in gaming, entertainment,
advertising and promotional applications.
1. Significant accounting policies:
(a) Basis of presentation:
The consolidated financial statements include the accounts of the
Company and its wholly owned subsidiaries, Gateway Technology Inc.
("GTI"), a United States company, and Chartwell Games Corp. ("CGC")
(formerly Gaming Tech Corporation), a Belize company. GTI is a US
incorporated company, which was acquired on November 1, 1998, and CGC
was incorporated in Belize and commenced operations November 1, 1999.
The accounting policies of the Company are in accordance with
generally accepted accounting principles in Canada and Canadian
dollars is the functional currency. Except for the information
disclosed in note 11 there are no material differences between
Canadian and United States generally accepted accounting principles in
these consolidated financial statements.
(b) Property and equipment:
Property and equipment are recorded at cost and amortization is
provided for on a declining balance basis using the following rates:
----------------------------------------------------------------
Capital assets under lease 30%
Computer equipment 30%
Furniture and equipment 20%
----------------------------------------------------------------
(c) Deferred software development costs:
Research costs are expensed as incurred. Costs related to the
development of software are expensed as incurred unless such costs
meet the criteria for deferral and amortization under Canadian
generally accepted accounting principles. The criteria include
identifiable costs attributable to a clearly defined product, the
establishment of technical feasibility, identification of a market for
the software, the Company's intent to market the software, and the
existence of adequate resources to complete the project. In the year
ended October 31, 2004, the Company deferred $175,000 of software
development costs which will be amortized over an estimated useful
life of three years, commencing in the year when commercial sales of
the products commence. Capitalized software development is evaluated
in each reporting period to determine whether it continues to meet the
criteria for continued deferral and amortization.
CHARTWELL TECHNOLOGY INC.
Notes to Consolidated Financial Statements
Years ended October 31, 2004, 2003 and 2002
(stated in Canadian dollars)
- --------------------------------------------------------------------------------
1. Significant accounting policies (continued):
(d) Foreign currency translation:
Accounts of foreign operations, all of which are considered
financially and operationally integrated, are translated to Canadian
dollars using average exchange rates for the year for revenue and
expenses. Monetary assets and liabilities are translated at the
year-end current exchange rate and non-monetary assets and liabilities
are translated using historical rates of exchange. Gains or losses
resulting from these translation adjustments are included in net
income.
Transactions in foreign currencies are translated at rates in effect
at the time of the transaction. Monetary assets and liabilities are
translated at current rates. Gains and losses are included in income.
(e) Revenue recognition:
The Company enters into contractual agreements with licensees that
provide for the provision of graphics, web design and software
implementation services, the licensing of software, and the provision
of unspecified software upgrades over the fixed term of the contract.
Revenue under such contractual arrangements is not recognized before
there exists persuasive evidence that an arrangement exists, delivery
has occurred, the fee is fixed and determinable, and the
collectibility of outstanding amounts is considered probable. The
Company considers persuasive evidence to exist when a formal contract
or purchase order is signed. Delivery occurs over the term of the
arrangement as described further below. The Company considers a fee to
be fixed and determinable when it is for a measurable amount and
receivable over a period not to exceed twelve months. Finally, the
Company assesses collectibility relative to customer payment
histories, credit checks, the nature of the customer and other
relevant information. As the Company's contractual arrangements
provide for the delivery of multiple elements, the Company evaluates
whether vendor-specific objective evidence ("VSOE") exists to allow
for the allocation of the arrangement fee between the undelivered
elements and the delivered elements for revenue recognition purposes.
To date, as the period provided for in contractual arrangements for
the provision of unspecified upgrades is consistent with the license
period, the Company has not been able to identify VSOE and allocate
revenue between delivered and undelivered elements. Accordingly,
set-up fees are recognized ratably over the term of the contract,
commencing upon completed delivery of the implementation and
integration services. License fees, which are contingent upon customer
usage, are recognized on an accrual basis as earned over the life of
the contract.
Direct and incremental costs incurred with respect to the set-up
contractual arrangements have been deferred as deferred set-up expense
and are recognized ratably over the term of the contract consistent
with that for the related revenue recognition.
CHARTWELL TECHNOLOGY INC.
Notes to Consolidated Financial Statements
Years ended October 31, 2004, 2003 and 2002
(stated in Canadian dollars)
- --------------------------------------------------------------------------------
1. Significant accounting policies (continued):
(f) Per share amounts:
Basic per share amounts are calculated using the weighted average
number of shares outstanding during the year. Diluted per share
amounts are calculated based on the treasury stock method, which
assumes that any proceeds obtained on exercise of options would be
used to purchase common shares at the average market price during the
period. The weighted average number of shares outstanding is then
adjusted by the net change.
(g) Income taxes:
The Company follows the liability method of accounting for income
taxes, whereby future tax assets and liabilities are recognized for
the future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and
liabilities and their respective tax bases. Future tax assets and
liabilities are measured using substantively enacted tax rates
expected to apply when the asset is realized or the liability settled.
A valuation allowance is recorded against future income tax assets if
it is more likely than not that all or a portion of the assets will
not be realized.
(h) Stock-based compensation:
Effective November 1, 2002, the Company adopted the Canadian standards
for accounting for stock-based compensation and other stock-based
payments. The new recommendations require equity instruments awarded
to employees and non-employees and the cost of the service received as
consideration to be measured and recognized based on the fair value of
the equity instruments issued. Compensation expense is recognized over
the period of related employee service, usually the vesting period of
the equity instrument awarded. In addition, the new standards require
that equity instruments issued to non-employees be recorded at their
fair value at the date they are earned. The new recommendations permit
the measurement of compensation expense for stock options granted to
employees and directors that are not direct awards of stock, stock
appreciation rights or otherwise call for settlement in cash or other
assets by an alternative method and to provide pro forma disclosure of
the financial results using the fair value method.
The Company has elected to follow an alternative method of accounting
for stock options awarded to employees and recognize no compensation
expense when stock options are granted. On November 1, 2004, as a
result of a change in accounting standards, the Company is no longer
able to follow this alternate method and must recognize the fair value
of options issued to employees as an expense over the period of the
related employee service. The Company has elected to adopt this new
policy retroactively without restatement of prior periods. As a
result, $430,563, representing the estimated value of stock options
issued to employees in 2003 and 2004, will be charged to deficit and
credited to contributed surplus on November 1, 2004.
CHARTWELL TECHNOLOGY INC.
Notes to Consolidated Financial Statements
Years ended October 31, 2004, 2003 and 2002
(stated in Canadian dollars)
- --------------------------------------------------------------------------------
1. Significant accounting policies (continued):
(i) Use of estimates:
The preparation of consolidated financial statements in conformity
with generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of
assets and disclosure of contingent assets and liabilities at the date
of the consolidated financial statements and the reported amounts of
revenue and expenses during the reporting period. Areas of significant
estimate include the recoverability of deferred software development
costs, amortization periods for property and equipment, provision for
doubtful accounts, the realization of future tax assets, deferred
set-up fee expenses, and stock-based compensation. Actual results
could differ from management's best estimates and underlying
assumptions as additional information becomes available in the future.
(j) Goodwill:
Goodwill is the residual amount that results when the purchase price
of an acquired business exceeds the sum of the amounts allocated to
the assets acquired, less liabilities assumed, based on their fair
values. Goodwill is allocated as of the date of the business
combination to the Company's reporting units that are expected to
benefit from the synergies of the business combination. Goodwill is
not amortized and is tested for impairment annually, or more
frequently if events or changes in circumstances indicate that the
asset might be impaired. The impairment test is carried out in two
steps. In the first step, the carrying amount of the reporting unit is
compared with its fair value. When the fair value of a reporting unit
exceeds its carrying amount, goodwill of the reporting unit is
considered not to be impaired and the second step of the impairment
test is unnecessary. The second step is carried out when the carrying
value amount of a reporting unit exceeds its fair value, in which case
the implied fair value of the reporting unit's goodwill is compared
with its carrying amount to measure the amount of the impairment loss,
if any. The implied fair value is determined in the same manner as the
value of goodwill is determined in a business combination described in
the preceding paragraph, using the fair value of the reporting unit as
if it was the purchase price. When the carrying amount of reporting
unit goodwill exceeds the implied fair value of the goodwill, an
impairment loss is recognized in an amount equal to the excess and is
presented as a separate line item in the statement of operations
before extraordinary items and discontinued operations.
(k) Comparative figures:
Certain comparative figures have been reclassified to conform with the
current year financial statement presentation.
(l) Cash and short term investments:
Cash consists of bank deposits. Short-term investments consist of
maturities of three months or less and are recorded at cost which does
not differ materially from fair value.
2. Property and equipment:
---------------------------------------------------------------------------------------------
Accumulated Net book
2004 Cost amortization value
---------------------------------------------------------------------------------------------
Property and equipment under lease $ 90,152 $ 52,279 $ 37,873
Computer equipment 732,740 514,523 218,217
Furniture and equipment 264,627 88,893 175,734
---------------------------------------------------------------------------------------------
$ 1,087,519 $ 655,695 $ 431,824
---------------------------------------------------------------------------------------------
2003
---------------------------------------------------------------------------------------------
Property and equipment under lease $ 47,005 $ 36,047 $ 10,958
Computer equipment 730,773 447,361 283,412
Furniture and equipment 89,558 44,959 44,599
---------------------------------------------------------------------------------------------
$ 867,336 $ 528,367 $ 338,969
---------------------------------------------------------------------------------------------
3. Deferred software development costs:
---------------------------------------------------------------------------
2004 2003
---------------------------------------------------------------------------
Software development costs $ 1,230,097 $ 1,055,097
Less: accumulated amortization (622,197) (524,149)
---------------------------------------------------------------------------
Net book value $ 607,900 $ 530,948
---------------------------------------------------------------------------
CHARTWELL TECHNOLOGY INC.
Notes to Consolidated Financial Statements
Years ended October 31, 2004, 2003 and 2002
(stated in Canadian dollars)
- --------------------------------------------------------------------------------
4. Share capital:
(a) Authorized:
100,000,000 common shares without par value
(b) Issued:
------------------------------------------------------------------------------------------------
Number
of shares Amount
------------------------------------------------------------------------------------------------
Balance, October 31, 2001 15,628,501 $ 14,511,135
Issued for cash on exercise of stock options 189,200 121,088
------------------------------------------------------------------------------------------------
Balance, October 31, 2002 15,817,701 14,632,223
Issued for cash on exercise of stock options 145,000 152,500
Issued as finders fee 25,000 25,000
------------------------------------------------------------------------------------------------
Balance, October 31, 2003 15,987,701 14,809,723
Issued for cash on exercise of stock options 701,932 855,799
Release of shares from escrow - 836,666
Shares cancelled from escrow and returned to treasury (666,667) -
------------------------------------------------------------------------------------------------
Balance, October 31, 2004 16,022,966 $ 16,502,188
------------------------------------------------------------------------------------------------
CHARTWELL TECHNOLOGY INC.
Notes to Consolidated Financial Statements
Years ended October 31, 2004, 2003 and 2002
(stated in Canadian dollars)
- --------------------------------------------------------------------------------
4. Share capital (continued):
(c) Release of escrowed shares and goodwill:
On November 1, 1998, the Company acquired all of the issued and
outstanding shares of Gateway Technology Inc. ("GTI") for
consideration of 1,000,000 common shares. Under the terms of the
Purchase Agreement, the shares were placed in escrow and were
releasable from time to time as one escrowed share for each $1.00 of
cash flow generated by GTI subsequent to its acquisition by the
Company. Shares remaining in escrow at October 31, 2003 were to be
returned to the Company and cancelled. The escrowed shares were
considered contingent consideration and valued at $nil in the
financial statements at November 1, 1998.
At October 31, 2003 application was made to the TSX Venture Exchange
for the release of 333,333 shares in accordance with the terms of the
escrow agreement. On February 12, 2004 the Exchange provided approval
for the release of the shares and on April 27, 2004 the shares were
released from escrow. The release of the shares have been accounted
for as an additional cost of the purchase of GTI, equal to the fair
value of the shares on February 12, 2004 of $836,666. The remaining
666,667 shares were cancelled and returned to treasury.
The additional consideration of $836,666 has been assigned to license
contracts acquired, in the amount of $25,000 and the remaining
$811,666 to goodwill. The contracts expired in 2001 and the assigned
consideration of $25,000 was written off as a current period expense.
On August 18, 2004 application was made to the Alberta Securities
Commission for the release of 955,400 shares held in escrow on behalf
of the principles of the Company and others, subject to the direction
and determination of the regulatory authorities in the Province of
Alberta. On October 5, 2004 consent was given by the Alberta
Securities Commission to the release of all shares held pursuant to
that agreement
375,000 shares remain in escrow on behalf of the principals of the
Company and are subject to the direction and determination of the
securities regulatory authorities in the Province of British Columbia.
(d) Stock option plan:
The Company has a stock option plan for its directors, officers,
employees and key consultants whereby an amount of options to acquire
a maximum of 3,264,000 shares may be granted subject to certain terms
and conditions. Stock option vesting privileges are at the discretion
of the Board. The exercise price for stock options granted is no less
than the quoted market price on grant date.
CHARTWELL TECHNOLOGY INC.
Notes to Consolidated Financial Statements
Years ended October 31, 2004, 2003 and 2002
(stated in Canadian dollars)
- --------------------------------------------------------------------------------
4. Share capital (continued):
(e) Continuity of options issued under the plan:
A summary of the status of the plan as of October 31, 2004, 2003 and
2002 and the changes during the years is presented below:
--------------------------------------------------------------------------------------------------------
October 31, October 31, October 31,
--------------------------------------------------------------------------------------------------------
2004 2003 2002
--------------------- --------------------- ----------------------
Weighted Weighted Weighted
average average average
exercise exercise exercise
Shares price Shares price Shares price
--------------------------------------------------------------------------------------------------------
Outstanding, beginning
of year 2,616,100 $ 1.19 2,388,866 $ 1.21 2,011,566 $ 1.15
Granted 600,000 $ 2.45 503,900 1.08 426,400 1.54
Exercised (701,932) $ 1.22 (145,000) 1.05 - -
Forfeited (158,334) $ 1.31 (131,666) 1.38 (49,100) 1.80
--------------------------------------------------------------------------------------------------------
Outstanding, end of
year 2,355,834 $ 1.49 2,616,100 $ 1.19 2,388,866 $ 1.21
--------------------------------------------------------------------------------------------------------
(f) Summary of the balances of options issued under the plan:
------------------------------------------------------------------------------------------------------
Options Outstanding Options Exercisable
------------------------------------------------------------------------------------------------------
Weighted
average Weighted Weighted
remaining average average
Range of contractual exercise exercise
exercise prices Number life (years) price Number price
------------------------------------------------------------------------------------------------------
$ 1.00-1.50 1,530,067 1.7 $ 1.06 1,230,975 $ 1.07
1.51-2.00 250,767 2.2 1.72 173,596 1.77
2.01-2.50 175,000 3.6 2.35 50,000 2.09
2.51-3.00 400,000 4.3 2.63 37,500 2.58
------------------------------------------------------------------------------------------------------
$ 1.00-3.00 2,355,834 2.3 $ 1.49 1,492,071 $ 1.22
------------------------------------------------------------------------------------------------------
The weighted average grant date fair value of stock options granted
during 2004 was $1.55.
CHARTWELL TECHNOLOGY INC.
Notes to Consolidated Financial Statements
Years ended October 31, 2004, 2003 and 2002
(stated in Canadian dollars)
- --------------------------------------------------------------------------------
4. Share capital (continued):
(g) Per share amounts:
The weighted average number of shares outstanding for the year was
14,249,151 (2003 - 13,504,890; 2002 - 13,485,109). Diluted shares of
16,709,931 for 2004 reflect the dilutive effect of the exercise of the
options outstanding. Diluted loss per share was not disclosed
separately in 2002 as the exercise of options outstanding would have
had an anti-dilutive effect on net loss per share. Contingently
returnable and issuable shares held in escrow have been excluded from
the calculations.
5. Stock-based compensation:
The Company has calculated the fair value of stock options granted in 2004
to employees, directors, and officers using the Black Scholes option
pricing model, assuming a dividend yield of 0%, a risk-free interest rate
of 4%, weighted average expected volatility of 67%, and an expected option
life of 5 years. Had compensation expense been determined based on the fair
value of the 2004 employee stock option awards at the grant dates, the
Company's net income and loss per share for 2004 would have been changed to
the following pro forma amounts:
----------------------------------------------------------------------------------
2004 As reported Pro Forma
----------------------------------------------------------------------------------
Net income $ 4,021,781 $ 3,671,031
----------------------------------------------------------------------------------
Net income per share:
Basic $ 0.28 $ 0.26
Diluted $ 0.24 $ 0.22
----------------------------------------------------------------------------------
----------------------------------------------------------------------------------
2003 As reported Pro Forma
----------------------------------------------------------------------------------
Net income $ 1,681,538 $ 1,601,725
----------------------------------------------------------------------------------
Net income per share:
Basic $ 0.12 $ 0.12
Diluted $ 0.12 $ 0.12
Of the 600,000 stock options granted in 2004, 125,000 were issued to
consultants. The estimated fair value of those options of $102,572 has been
charged to operations.
CHARTWELL TECHNOLOGY INC.
Notes to Consolidated Financial Statements
Years ended October 31, 2004, 2003 and 2002
(stated in Canadian dollars)
- --------------------------------------------------------------------------------
6. Related party transactions:
For the year ended October 31, 2004, the Company incurred legal fees of
$60,000 (2003 - $60,000; 2002 - $60,000) and consulting fees of $165,000
(2003 - $165,000; 2002 - $162,000) to certain directors of the Company in
the normal course of business. These transactions were measured at the
exchange amount and recorded in general and administrative expenses.
Amounts due from related parties of $178,961 (2003 - $190,512) consist of
amounts due from certain Company officers, directors and employees. Of
these amounts, $29,907 is non-interest bearing, unsecured and with no set
terms of repayment. The remaining $149,054 bears 6% interest, is secured by
189,200 common shares of the Company and has no set terms of repayment.
CHARTWELL TECHNOLOGY INC.
Notes to Consolidated Financial Statements
Years ended October 31, 2004, 2003 and 2002
(stated in Canadian dollars)
- --------------------------------------------------------------------------------
7. Income taxes:
Income tax recovery differs from the amount that would be computed by
applying the basic combined Canadian federal and provincial statutory
income tax rate to the net income (loss) for the year. The reasons for the
differences are as follows:
----------------------------------------------------------------------------------------------------
2004 2003 2002
----------------------------------------------------------------------------------------------------
Net income (loss) before income taxes $ 3,606,817 $ 1,051,538 $ (1,320,807)
----------------------------------------------------------------------------------------------------
Combined Canadian federal and provincial
statutory rate 34.4% 37.2% 39.7%
Computed provision (recovery) $ 1,240,746 $ 391,173 $ (524,360)
Non-tax-based amortization - 40,945 43,653
Difference in foreign tax rates, net of
foreign property accrual income (218,301) 8,743 35,596
(Realization) benefit of future tax assets
not recognized (444,602) (451,767) 436,825
Stock-based compensation 35,284 - -
Non deductible expenses 16,873 10,906 8,287
Reduction of valuation allowance (1,044,964) (630,000) -
----------------------------------------------------------------------------------------------------
Actual recovery $ (414,964) $ (630,000) $ -
----------------------------------------------------------------------------------------------------
The adjustment in respect of differences in foreign tax rates includes
amounts arising from the differences in taxable income in the various
jurisdictions in which the Company operates.
The components of the Company's net future income tax asset at October 31,
2004 and 2003 are as follows:
------------------------------------------------------------------------------------------
2004 Canada United States Total
------------------------------------------------------------------------------------------
Non-capital/net operating losses $ - $ 19,393 $ 19,393
Property and equipment 114,097 - 114,097
Share issue costs 297 - 297
Resource deductions 75,785 - 75,785
Deferred development costs 658,860 - 658,860
Deferred revenue 238,545 - 238,545
Deferred set-up expense (42,620) - (42,620)
------------------------------------------------------------------------------------------
1,044,964 19,393 1,064,357
Less: valuation allowance - (19,393) (19,393)
------------------------------------------------------------------------------------------
$ 1,044,964 $ - $ 1,044,964
------------------------------------------------------------------------------------------
CHARTWELL TECHNOLOGY INC.
Notes to Consolidated Financial Statements
Years ended October 31, 2004, 2003 and 2002
(stated in Canadian dollars)
- --------------------------------------------------------------------------------
7. Income taxes (continued):
------------------------------------------------------------------------------------------
2003 Canada United States Total
------------------------------------------------------------------------------------------
Non-capital/net operating losses $ 64,930 $ 20,995 $ 85,925
Property and equipment 81,337 - 81,337
Share issue costs 57,140 - 57,140
Resource deductions 78,039 - 78,039
Deferred development costs 1,284,846 - 1,284,846
Deferred revenue 465,508 - 465,508
Deferred set-up expense (72,647) - (72,647)
- ------------------------------------------------------------------------------------------------
1,959,153 20,995 1,980,148
Less: valuation allowance (1,329,153) (20,995) (1,350,148)
- ------------------------------------------------------------------------------------------------
$ 630,000 $ - $ 630,000
- ------------------------------------------------------------------------------------------------
At October 31, 2004, the Company has non-capital loss carry-forwards for
Canadian income tax purposes of $nil (2003 - $187,550) available for
deduction against future years' taxable income. In addition, the Company
has net operating losses carry-forward for United States income tax
purposes of approximately $57,038 (2003 - $61,750) available for deduction
against future year's taxable income. These losses expire between 2018 and
2019.
8. Financial instruments:
The Company's financial instruments consist of cash, short term
investments, accounts receivable, amounts due from related parties,
accounts payable and accrued liabilities and capital lease obligations. The
fair value of these financial instruments approximate their carrying
values. It is management's opinion that the Company is not exposed to
significant interest and or credit risk. The Company's credit risk lies in
its accounts receivable where the balance is due from a small number of
customers. The Company's short term investments consist of investments in
low risk, fixed interest, corporate and government bonds. A substantial
portion of the Company's revenue is exposed to currency fluctuations.
CHARTWELL TECHNOLOGY INC.
Notes to Consolidated Financial Statements
Years ended October 31, 2004, 2003 and 2002
(stated in Canadian dollars)
- --------------------------------------------------------------------------------
9. Commitments:
Leases:
Future minimum annual payments under operating and capital leases are as
follows:
----------------------------------------------------------------------
2005 $ 394,216
2006 $ 406,878
2007 $ 323,593
2008 $ 316,520
2009 $ 299,840
Thereafter $ 24,708
----------------------------------------------------------------------
10. Segmented information:
The Company has aggregated its Canadian and Belize operating segments into
one reporting segment as management has determined that the nature of the
operations in each segment meets the aggregation criteria specified by
Canadian accounting standards.
The Company's software set-up and license fees are from domestic and
foreign entities and originate from the following countries of operation:
--------------------------------------------------------------------------------------
2004 Canada Belize Total
--------------------------------------------------------------------------------------
Software set-up fees $ - $ 798,343 $ 798,343
Software license fees $ 204,154 $ 11,064,340 $ 11,268,494
Total assets $ 7,186,451 $ 7,775,171 $ 14,961,622
--------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------
2003
--------------------------------------------------------------------------------------
Software set-up fees $ - $ 919,892 $ 919,892
Software license fees $ 227,538 $ 6,072,797 $ 6,300,335
Total assets $ 7,731,868 $ 1,486,837 $ 9,218,705
--------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------
2002
--------------------------------------------------------------------------------------
Software set-up fees $ 51,832 $ 844,728 $ 896,560
Software license fees $ 231,071 $ 2,415,695 $ 2,646,766
Total assets $ 4,660,842 $ 2,290,995 $ 6,951,837
--------------------------------------------------------------------------------------
During the year ended October 31, 2004, four licensees (2003 - four; 2002 -
three), each of which provided more than 10% of the Company's total sales
revenue, accounted for 79.4% (2003 - 72.6%; 2002 - 68.5%) of the Company's
2004 total sale revenue.
CHARTWELL TECHNOLOGY INC.
Notes to Consolidated Financial Statements
Years ended October 31, 2004, 2003 and 2002
(stated in Canadian dollars)
- --------------------------------------------------------------------------------
11. Differences in generally accepted accounting principles between Canada and
the United States:
The financial statements have been prepared in accordance with Canadian
generally accepted accounting principles ("Canadian GAAP"). Any differences
in United States generally accepted accounting principles ("U.S. GAAP") as
they pertain to the Company's financial statements are not material except
as follows:
(a) Reconciliation of Canadian GAAP to U.S. GAAP net income (loss):
The effect on the net income (loss) for each of the years in the three
year period ended October 31, 2004 of the differences between Canadian
GAAP and U.S. GAAP is summarized as follows:
------------------------------------------------------------------------------------------------------
Years ended October 31,
------------------------------------------------
2004 2003 2002
------------------------------------------------------------------------------------------------------
Net income (loss) for the year as reported
in accordance with Canadian GAAP $ 4,021,781 $ 1,681,538 $ (1,320,807)
Compensation (expense) reduction - repricing
of stock options (2,474,811) (228,900) 95,820
Compensation expense - escrowed shares (289,862) - -
Software development costs (175,000) (530,948) -
Amortization of software development costs 98,049 - -
Stock based compensation expense:
APB 25 - - (7,981)
FAS 123 - - (105,119)
------------------------------------------------------------------------------------------------------
Net income (loss) - U.S. GAAP 1,180,157 921,690 (1,338,087)
Deficit, beginning of year - U.S. GAAP (9,449,247) (10,370,937) (9,032,850)
------------------------------------------------------------------------------------------------------
Deficit, end of year - U.S. GAAP $ (8,269,090) $ (9,449,247) $ (10,370,937)
------------------------------------------------------------------------------------------------------
Net income (loss) per share:
Basic $ 0.08 $ 0.07 $ (0.10)
Diluted $ 0.07 $ 0.07 $ (0.10)
--------------------------------------------------------------------------------------------------------
For U.S. GAAP purposes, the amounts of interest income would not be
included in the subtotal of revenue.
CHARTWELL TECHNOLOGY INC.
Notes to Consolidated Financial Statements
Years ended October 31, 2004, 2003 and 2002
(stated in Canadian dollars)
- --------------------------------------------------------------------------------
11. Differences in generally accepted accounting principles between Canada and
the United States (continued):
(a) Reconciliation of Canadian GAAP to U.S. GAAP net income (loss)
(continued):
The components of comprehensive income are as follows:
-----------------------------------------------------------------------------------------------
2004 2003 2002
-----------------------------------------------------------------------------------------------
Net income (loss) - U.S. GAAP $ 1,180,157 $ 921,690 $ (1,338,087)
Other comprehensive (loss) income:
Change in fair value of available
for sale securities 59,166 (1,365) (85,426)
-----------------------------------------------------------------------------------------------
Comprehensive income (loss) $ 1,239,323 $ 920,325 $ (1,423,513)
-----------------------------------------------------------------------------------------------
Balance sheet items which vary in conformity with U.S. GAAP and SEC
requirements:
---------------------------------------------------------------------------------------
2004 2003
---------------------------------------------------------------------------------------
Assets:
Deferred software development costs $ - $ -
---------------------------------------------------------------------------------------
$ - $ -
---------------------------------------------------------------------------------------
Shareholders' equity:
Accumulated other comprehensive income $ - $ (59,166)
Deficit (8,269,090) (9,449,247)
---------------------------------------------------------------------------------------
$ (8,269,090) $ (9,508,413)
---------------------------------------------------------------------------------------
There are no variations between the carrying values of liabilities and
those amounts measured using U.S. GAAP.
CHARTWELL TECHNOLOGY INC.
Notes to Consolidated Financial Statements
Years ended October 31, 2004, 2003 and 2002
(stated in Canadian dollars)
- --------------------------------------------------------------------------------
11. Differences in generally accepted accounting principles between Canada and
the United States (continued):
(b) Stock based compensation:
The Company applies the intrinsic value-based method of accounting
prescribed by Accounting Principles Board ("APB") Opinion No. 25,
"Accounting for Stock Issued to Employees", and related
interpretations, in accounting for its stock options issued to
employees, directors and officers of the Company for purposes of
reconciliation to U.S. GAAP. As such, compensation expense would be
recorded on the date of grant only if the current market price of the
underlying stock exceeded the exercise price. SFAS No. 123,
"Accounting for Stock-Based Compensation", established accounting and
disclosure requirements using a fair value-based method of accounting
for stock-based employee compensation plans. As allowed by SFAS No.
123, the Company has elected to continue to apply the intrinsic
value-based method of accounting described above and has adopted the
disclosure requirements of SFAS No. 123. Stock options issued to
consultants and other third parties are accounted for at their fair
values in accordance with SFAS No. 123 which is consistent to the
policy applied for Canadian GAAP purposes since November 1, 2002.
During 2004, there were 125,000 options granted to consultants or
other third parties (2003 - nil; 2001 - 100,000). There was $102,572
(2003 - $nil; 2002 - $105,119) charged to income for those options in
2004.
All options granted to date have been fixed and granted to employees,
directors and officers of the Company. The Company has calculated the
fair value of stock options granted using the Black Scholes option
pricing model with the following weighted-average assumptions:
---------------------------------------------------------------------
2004 2003 2002
---------------------------------------------------------------------
Risk free interest rate 4% 4% 5%
Expected Volatility 67% 99% 72%
Expected option life (in years) 5 5 5
Dividend yield 0% 0% 0%
---------------------------------------------------------------------
CHARTWELL TECHNOLOGY INC.
Notes to Consolidated Financial Statements
Years ended October 31, 2004, 2003 and 2002
(stated in Canadian dollars)
- --------------------------------------------------------------------------------
11. Differences in generally accepted accounting principles between Canada and
the United States (continued):
(b) Stock based compensation (continued):
Had the Company determined employee compensation costs based on the
fair value at the date of grant for its stock options under SFAS 123,
net earnings in accordance with US GAAP would have been as reported in
the following table. The Company has not recognized in income any
amount under SFAS 123 for stock-based employee compensation expense.
These pro forma earnings reflect compensation cost amortized over the
vesting periods of the options.
---------------------------------------------------------------------------------------------------
Years ended October 31,
---------------------------------------------------------
2004 2003 2002
---------------------------------------------------------------------------------------------------
Net income (loss) - U.S. GAAP:
As reported $ 1,180,157 $ 921,690 $ (1,338,087)
Pro forma 3,181,738 799,014 (1,703,077)
---------------------------------------------------------------------------------------------------
Net income (loss) per share:
As reported - basic $ .08 $ 0.07 $ (0.10)
- diluted $ .07 $ 0.07 $ (0.10)
Pro forma - basic $ .22 $ 0.06 $ (0.13)
- diluted $ .19 $ 0.06 $ (0.13)
---------------------------------------------------------------------------------------------------
(c) Escrowed shares:
In accordance with securities regulations 1,330,400 common shares with
respect to prior public offerings were placed in escrow with an escrow
agent pursuant to escrow agreements. Under the terms of the agreements
the shares were to be released upon application by the Company and at
the discretion of securities regulators.
On October 5, 2004, 955,400 common Shares were released from escrow
and compensation, of which 252,700 were released to an officer and to
a director of the Company. Compensation expense of $289,862 was
recorded for the fair value of the shares issued to the officer and
director.
CHARTWELL TECHNOLOGY INC.
Notes to Consolidated Financial Statements
Years ended October 31, 2004, 2003 and 2002
(stated in Canadian dollars)
- --------------------------------------------------------------------------------
11. Differences in generally accepted accounting principles between Canada and
the United States (continued):
(d) Additional disclosures under U.S. GAAP:
(i) The Company follows SFAS 130 regarding comprehensive income for
purposes of reconciliation to U.S. GAAP. Under U.S. GAAP, items
defined as, other comprehensive income are separately classified
in the financial statements and the accumulated balance of other
comprehensive income (loss) is reported separately in
shareholders' equity on the balance sheet. For the three years
ended October 31, 2004 there are no items classified as other
comprehensive income, with the exception of a change in the fair
value of available for sale securities of $59,166 for the year
ended October 31, 2004 (2003 - $(1,365); 2002 - $57,801).
(ii) The 375,000 common shares held in escrow for the year ended
October 31, 2004 (2003 - 1,663,733 and 2002 - 2,330,400) have not
been included in the calculation of basic or diluted earnings per
share as they are contingently releasable and as doing so would
be anti-dilutive. This is the same treatment as under Canadian
GAAP.
(iii)In 2001, 1,330,800 stock options were repriced. In accordance
with the intrinsic value method of accounting for stock options,
an expense of $702,660 was recognized in the year of repricing.
In fiscal 2004 and 2003 these stock options have been accounted
for using variable price accounting, resulting in an expense of
$2,474,811 in 2004 and an expense of $228,900 in 2003. An expense
recapture of $95,820 was realized in 2002. At October 31, 2004,
680,600 (2003 - 1,089,000) of those options, with exercise prices
ranging between $1.06 and $1.17 per share, remained unexercised,
and expire between January, 2005 and November, 2005.
(iv) Under U.S. GAAP, deferred software development costs are
accounted for under SFAS 86, Accounting for Costs of Computer
Software to be Sold, Leased or Otherwise Marketed, which requires
the expensing of all amounts incurred to the date of technical
feasibility. Under Canadian GAAP, these amounts have been
capitalized as they meet all of the required criteria.
12. Subsequent event:
On December 7, 2004 the Company closed a private placement consisting of
2,365,592 common shares which were sold at a price of $4.65 per share for
net proceeds of $10,340,002 before underwriter expenses and related Company
legal expenses. The underwriters were granted 141,936 compensation options
exercisable at an exercise price of $5.10 per common share for a period of
18 months from the date of the closing of the private placement. All of the
securities sold pursuant to the private placement are subject to a four
month hold period. Net proceeds of financing will be used for general
corporate purposes.