UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
Amendment No. 1
FORM 10-K/A
(Mark One)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended: AUGUST 31, 2001
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: 0-18066
CHELL GROUP CORPORATION INC.
(Exact name of registrant as specified in its charter)
NEW YORK 11-2805051
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
14 METEOR DRIVE, TORONTO, ONTARIO M9W 1A4
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (416) 675-0874
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK, PAR
VALUE US$0.0467
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |_| No |X|
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. |_|
Aggregate market value (i.e., last price) of voting stock held by
non-affiliates of the Registrant, as of November 26, 2001 US$5,687,791
Indicate the number of shares outstanding of each of the Registrant's
classes of common stock, as of November 26, 2001 9,028,239 shares of common
stock, par value US$.0467 per share
DOCUMENTS INCORPORATED BY REFERENCE: NONE
PART I
EXCHANGE RATES
The currency amounts in this Annual Report on Form 10-K, including the
financial statements, are, unless otherwise indicated, expressed in Canadian
dollars ("Cdn$"). This Form 10-K contains translations of certain amounts in
Canadian dollars into United States dollars ("US$") based upon the exchange rate
in effect at the end of the period to which the amount relates, or the exchange
rate on the date specified. For such purposes, the exchange rate means the noon
buying rate in New York City for cable transfers in Canadian dollars as
certified for customs purposes by the Federal Reserve Bank of New York (the
"Noon Buying Rate"). These translations should not be construed as
representations that the Canadian dollar amounts actually represent such U.S.
dollar amounts or that Canadian dollars could be converted into U.S. dollars at
the rate indicated or at any other rate. The Noon Buying Rate at the end of each
of the five years ended August 31, the average of the Noon Buying Rates on the
last day of each month during each of such fiscal years and the high and low
Noon Buying Rate for each of such fiscal years were as follows:
August 31
---------------------------------------------------------------------------------
2001 2000 1999 1998 1997
---------------------------------------------------------------------------------
At end of period ......... Cdn$1.5508 Cdn$1.4715 Cdn$1.4965 Cdn$1.5722 Cdn$1.3885
Average for period ....... 1.5284 1.4714 1.4949 1.4390 1.3676
High for period .......... 1.5825 1.4955 1.5135 1.5770 1.3942
Low for period ........... 1.4685 1.4489 1.4760 1.4100 1.3381
- --------------------------------------------------------------------------------------------------------------------
On November 26, 2001 the Noon Buying Rate was Cdn$1.6000.
ITEM 1. BUSINESS.
We were incorporated on May 12, 1986 pursuant to the laws of the State
of New York as "TrioSearch, Inc.". In June 1988, we changed our name to "NTN
Canada, Inc.". In March 1998 we changed our name to Networks North Inc. and in
September 2000, changed our name to Chell Group Corporation. Our head office and
principal place of business is located at 14 Meteor Drive, Toronto, Ontario, M9W
1A4. Our registered office is located at 488 Madison Avenue, New York, New York,
10022.
Effective October 1, 1996, we, indirectly through NTN Interactive
Network Inc., a Canadian corporation, acquired all of the outstanding stock of
Magic Lantern Communications Ltd., an
2
Ontario corporation, and its subsidiaries. Magic Lantern currently has two
wholly owned subsidiaries, one of which is 1113659 Ontario Ltd., operating as
Viewer Services and the other of which is Tutorbuddy Inc. Magic Lantern and its
subsidiaries market and distribute an exclusively licensed library of
educational videos. Tutorbuddy, a development stage project, will provide
interactive online educational video services offering tutorial assistance.
Magic Lantern also has a 75% ownership of the outstanding stock of Sonoptic
Technologies Inc. Sonoptic operates a digital video facility.
In August 1997, we acquired certain business assets of Image Media Ltd.
and 802117 Ontario Inc., operating as Pilot Software. In September 1997, we,
indirectly through NTN Interactive Network, acquired 51% of the outstanding
stock of Interlynx Multimedia Inc., an Ontario corporation. In June 1999, we,
indirectly through NTN Interactive Network, acquired the remaining 49% of the
outstanding stock of Interlynx. Interlynx developed and markets PROFIS, an
advanced web-based training software that runs on Windows NT servers. Effective
June 2001, we sold our interest in Interlynx.
In September 1999, pursuant to an Asset Purchase Agreement we, through
our wholly owned subsidiary 1373224 Ontario Limited, acquired substantially all
of the property and assets (excluding accounts receivable) of GalaVu
Entertainment Inc., an Ontario corporation. We acquired from GalaVu in this
transaction the bulk of their equipment, which consisted of audiovisual
entertainment equipment, including computers, videocassette recorders and
transmitters, which are installed in hotels and other hospitality facilities for
the use of guests on a pay-per basis. Our decision to acquire GalaVu's assets
was based upon the anticipated synergy between the interactive and audiovisual
entertainment services provided by GalaVu and our NTN Interactive Network
subsidiary. Our decision was also based upon our intention to expand our more
profitable interactive entertainment business segment and our belief that such a
segment would provide us with a substantial positive cash flow. We believe that
the acquisition of these assets complements our previously existing line of
business undertaken by NTN Interactive Network.
3
The following is an organizational chart of the Corporation: (1)
[GRAPHIC OMITTED]
(1) All subsidiaries are 100% owned unless otherwise stated.
* Reduced from original purchase percentage due to dilution resulting from
subsequent financings.
4
The following is a chart detailing our percentage ownership in our subsidiaries
and, where applicable and available, the other entity or entities that have an
equity shareholding in these companies:
- --------------------------------------------------------------------------------------------------------------------------
SUBSIDIARY OUR PERCENTAGE OWNERSHIP OTHER ENTITIES WITH EQUITY SUBSIDIARY'S
SHARES AND PERCENTAGES REVENUES AS A
PERCENTAGE OF OUR
TOTAL REVENUES
- --------------------------------------------------------------------------------------------------------------------------
Chell Merchant Capital Group, Inc. 100% N.A. 0%
- --------------------------------------------------------------------------------------------------------------------------
NTN Interactive Network Inc. 100% N.A. 38.1%
- --------------------------------------------------------------------------------------------------------------------------
GalaVu Entertainment Network Inc. 100% N.A. 36.5%
- --------------------------------------------------------------------------------------------------------------------------
Magic Lantern Communications Ltd. 100% (through NTN N.A. 20.3%
Interactive Network, Inc.)
- --------------------------------------------------------------------------------------------------------------------------
Sonoptic Technologies Inc. 75% (through Magic 25% Govt. of 4.7%
Lantern) New Brunswick
- --------------------------------------------------------------------------------------------------------------------------
1113659 Ontario Ltd., operating as 100% (through Magic N.A. 0%
Viewer Services Lantern)
- --------------------------------------------------------------------------------------------------------------------------
Tutorbuddy Inc. 100% (through Magic N.A. 0.4%
Lantern)
- --------------------------------------------------------------------------------------------------------------------------
3484751 Canada Inc. 100% N.A. 0%
- --------------------------------------------------------------------------------------------------------------------------
Chell.com USA Inc. 100% N.A. 0%
- --------------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------------
INVESTMENT COMPANIES: OUR PERCENTAGE OTHER ENTITIES WITH EQUITY SUBSIDIARY'S
OWNERSHIP SHAREHOLDING AND REVENUES AS A
PERCENTAGES PERCENTAGE OF OUR
TOTAL REVENUES
- -----------------------------------------------------------------------------------------------------------------------------
Engyro, Inc. 22.1%** Private Venture *
Capitalists (60.0%,);
Engyro's Management (17.9%)
- -----------------------------------------------------------------------------------------------------------------------------
cDemo Inc. 14.3%** Private Venture *
Capitalists (22.32%);
cDemo's Management and
Employees (59.82%)
- -----------------------------------------------------------------------------------------------------------------------------
*Due to our current minority investment in such entities, future revenues, when
and if realized, will not be included in our total revenues.
** Reduced from original purchase percentage due to dilution resulting from
subsequent financings.
5
FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS: (IN CANADIAN $'S)
Reference is hereby made to the Business Sector data for the years
ended August 31, 2001, 2000, and 1999 in Exhibit 99.1 below.
- --------------------------------------------------------------------------------------
2001 2000 1999
$ $ $
- --------------------------------------------------------------------------------------
EXTERNAL REVENUE
Entertainment 13,588,788 14,121,764 7,569,929
Education 4,616,991 4,971,823 5,192,378
Merchant Service -- -- --
Corporate 16,595 13,703 61,384
- --------------------------------------------------------------------------------------
18,222,374 19,107,290 12,823,691
- --------------------------------------------------------------------------------------
INTER-SEGMENT REVENUE
Education 183,329 275,941 --
Corporate -- 128,283 223,435
- --------------------------------------------------------------------------------------
183,329 404,224 223,435
- --------------------------------------------------------------------------------------
OPERATING PROFIT (LOSS)
Entertainment (208,371) 515,167 446,681
Education (1,084,531) (792,665) (623,400)
Merchant Service (5,887,912) -- --
Corporate (2,635,280) (1,218,183) (319,634)
- --------------------------------------------------------------------------------------
(9,816,094) (1,495,681) (496,353)
- --------------------------------------------------------------------------------------
IDENTIFIABLE ASSETS
Entertainment 5,459,008 7,009,552 4,725,971
Education 3,793,863 3,526,317 4,290,025
Merchant Service 1,489,711 -- --
Corporate 479,330 895,894 837,653
- --------------------------------------------------------------------------------------
11,221,912 11,431,763 9,853,649
- --------------------------------------------------------------------------------------
CORPORATE ASSETS
Entertainment 3,170,363 4,352,448 3,699,785
Education (666,589) 844,142 (22,367)
Merchant Service 99,754 -- --
Corporate 2,141,512 355,590 1,063,713
- --------------------------------------------------------------------------------------
4,745,040 5,552,180 4,741,131
- --------------------------------------------------------------------------------------
CAPITAL EXPENDITURES
Entertainment 729,486 842,955 350,836
Education 650,576 319,191 250,797
Merchant Service 50,900 -- --
- --------------------------------------------------------------------------------------
1,430,962 1,162,146 601,633
- --------------------------------------------------------------------------------------
DEPRECIATION & AMORTIZATION
Entertainment 1,960,652 1,808,715 967,188
Education 507,218 408,856 428,377
Merchant Service 431,967 -- --
Corporate 140,570 31,750 33,654
- --------------------------------------------------------------------------------------
3,040,407 2,249,321 1,429,219
- --------------------------------------------------------------------------------------
We currently conduct our business through ten directly or indirectly
owned subsidiaries and three investment companies. The following is a list of
such subsidiaries, and which of our business segments each operates in:
6
- --------------------------------------------------------------------------------
Wholly-owned subsidiaries Business Segment
- --------------------------------------------------------------------------------
Chell Merchant Capital Group Merchant Services
Chell.com USA Inc. Merchant Services
NTN Interactive Network Inc. Entertainment
GalaVu Entertainment Network Inc. Entertainment
Magic Lantern Communications Ltd. Education
Sonoptic Technologies (1) Education
1113659 Ontario Ltd., operating as Viewer Services Education
Tutorbuddy Inc. Education
3484751 Canada Inc. Corporate
Investment Companies Business Segment
- --------------------------------------------------------------------------------
Engyro, Inc. (22.1%) Merchant Services
CDemo Inc. (14.3%) Merchant Services
ApplicationStation.com (2) (12.75%) Merchant Services
- --------------------------------------------------------------------------------
(1) We own 75% of Sonoptic. The government of New Brunswick owns the remaining
25%.
(2) Our acquisition of ApplicationStation is currently pending our
determination as to whether to proceed with such acquisition and obtaining
the funds required to do so.
OUR BUSINESS
We are engaged in the business of providing interactive entertainment
services, electronic/online products and services and merchant capital services.
Our core businesses are interactive entertainment services provided by our NTN
Interactive Network subsidiary and the merchant capital services provided
through our Merchant Capital Group subsidiary. GaluVu is a technology-based
entertainment provider of interactive in-room entertainment systems to hotels
across Canada. Interactive entertainment services also involve, for example
electronic sports trivia games played on computer units installed in bars, pubs
and restaurants. Our Magic Lantern subsidiary and its subsidiaries are involved
in the marketing and distribution of educational video and media resources,
providing interactive online educational video services and the conversion of
analog video to digital video formats and Interlynx designs and develops
web-based training software. Electronic/online products and services involve
providing business software applications and support, as well as educational
tools, over the Internet to registered subscribers. In addition, the business of
merchant capital services involves our investment in and acquisition of
significant but undervalued operating companies or technologies, to which we
then apply management experience, in an effort to appreciate the value of those
companies.
Our main business strategy is to operate or invest in companies that
represent the latest in technological innovations. We apply our expertise,
industry contacts, and market foresight to these companies in order to create
shareholder value.
NTN INTERACTIVE NETWORK INC.
7
Our NTN Interactive Network subsidiary is engaged in the marketing and
distribution of the NTN Entertainment Network services throughout Canada. These
activities are being conducted through an exclusive license covering Canada
granted to NTN Sports Inc., (predecessor to our NTN Interactive Network
subsidiary) by NTN Communications, Inc. of Carlsbad, California. The license
grants our NTN Interactive Network subsidiary the right to market the products
and programs of NTN Communications, Inc. throughout Canada for a 25-year term
ending December 31, 2015. NTN Communications, Inc. does not have an equity
position in us or in our NTN Interactive Network subsidiary.
THE NTN ENTERTAINMENT NETWORK
The NTN Entertainment Network is owned and operated by NTN
Communications, Inc. and uses existing technology to broadcast two-way
interactive live events to subscriber locations. The Network provides digital
data broadcast transmissions, which enable equipment and software at subscriber
locations to display text and graphics programming and to interpret responses
from Network viewers. All programming is produced at and transmitted from the
NTN Broadcast Center in Carlsbad, California. More than 3,575 restaurants,
lounges, hotels, and other hospitality sites across North America have
subscribed to these services and installed systems capable of receiving Network
broadcasts. These subscriber systems receive satellite broadcasts containing the
Network interactive programs, such that thousands of patrons at subscriber
locations can interact with the same programs simultaneously. Our NTN
Interactive Network subsidiary markets the Network throughout Canada to the
hospitality industry, installs the systems, and provides technical and marketing
support to Network sites. Over 500 Group Subscribers are located in Canada.
Designed to be hardware independent, the Network may be transmitted through a
variety of techniques including, direct satellite, cable, gateway service, FM
sideband, Internet, TV vertical blanking interval, and telephone. We currently
use direct satellite as the method of transmission.
NETWORK PROGRAMMING
The two-way interactive programming currently featured over the Network
includes a variety of interactive sports and trivia games permitting viewer
interaction and participation for 16 hours each day. All present Network
programming is structured to provide time for national, regional and local
advertisements, as well as for local inserts, which permit each subscriber to
display announcements of promotional prices or other events at its business
location.
NTN PLAY-ALONG GAMES
NTN Play-Along Games are played in conjunction with live, televised
events. The prime NTN Play-Along Game is QB1, a game of football strategy.
NTN PREMIUM TRIVIA GAMES
8
NTN Premium Trivia Games are promotion-oriented weekly game shows that
usually require an hour of participation. Prizes are awarded to the top
finishers. Games among all participating subscriber locations include the
following: Showdown, a general knowledge game; Sports Trivia Challenge, a game
focused on sports, and Spotlight, a game that quizzes players about the world of
show business and celebrities; Playback, a music news, trivia, song title and
musical topics game; and Sports IQ, a weekly sports trivia game. Half-hour
interactive trivia games comprise the majority of the Network's programming.
Countdown and Wipeout are trivia games designed for fast competitive play among
participants at each subscriber location.
NTN INTERACTIVE NETWORK MARKET
Our NTN Interactive Network subsidiary's market remains our largest
core business, considering that network services and pay-per-view television
services marketed to the restaurant and hospitality industries total
approximately 36% of our revenues. Our NTN Interactive Network subsidiary
positions the Network to prospects and clients as a means of attracting patrons
(to play the games), retaining their patronage (as they return to play again),
and increasing the length of time patrons stay in their establishment. As the
number of repeat customers and their length of stay increases, the hospitality
establishment has an increased opportunity to sell additional food and beverage.
Our NTN Interactive Network subsidiary's sales force targets the
strongest hospitality outlets in Canada, including a number of chain accounts.
Attractive rental packages are in place to support our NTN Interactive Network
subsidiary's sales efforts. Our NTN Interactive Network subsidiary promotes the
Network as one of the best and technically advanced forms of on-premises
advertising to this market, offering long-term repetitive exposure to a captive,
attentive, and enthusiastic audience.
Each end user receives the Subscriber System, including the equipment
and the proprietary software, from our NTN Interactive Network subsidiary. In
most instances, the customer rents the equipment from our NTN Interactive
Network subsidiary. Our NTN Interactive Network subsidiary, in turn, purchases
equipment from several suppliers. Following installation, each end user pays a
monthly fee to our NTN Interactive Network subsidiary for the Network services.
GALAVU ENTERTAINMENT NETWORK INC.
Our GalaVu subsidiary is a technology-based entertainment provider of
interactive in-room entertainment systems to hotels. Our GalaVu subsidiary is
currently installed in over 200 Canadian hotels, primarily small and mid sized.
Our GalaVu subsidiary's interactive system is based on proprietary technology
and provides a wide range of affordable, in-room entertainment packages.
Marketed to guests under the Round-the-Clock Entertainment brand, our GalaVu
subsidiary's suite of products include Hollywood movies on demand, premium
television
9
programming, and other information and entertainment services designed to
enhance the stay of hotel guests while generating revenue for our GalaVu
subsidiary and its hotel partners.
10
MAGIC LANTERN GROUP
Our Magic Lantern subsidiary and its subsidiaries operate in two
principal markets including, (i) the marketing and distribution of educational
video and media resources, and (ii) the conversion of analog video to digital
video formats.
Our Magic Lantern subsidiary and its subsidiaries market and distribute
an exclusively licensed library of educational video titles to schools, school
boards, and Ministries of Education across Canada and internationally, excluding
the U.S. Our Magic Lantern subsidiary's exclusive distribution rights enable it
to avoid competing for the sale of specific titles, while competing for a share
of the available media-buying budget within each educational jurisdiction.
Several years ago, our Magic Lantern subsidiary began accumulating digital
delivery rights for the titles it distributes, and approximately 65% of all
titles in its library include such rights. Our Management believes that this
extensive library of titles with digital delivery rights will favorably position
our Magic Lantern subsidiary as distribution technologies and delivery systems
migrate to digital formats, a process that is already underway in Canada.
Tutorbuddy, a development stage project, will provide interactive
online educational video services offering tutorial assistance. Tutorbuddy's web
site will provide home and school access to thousands of video subjects with
online learning support, including interaction with real-time tutor-monitored
study groups, personalized research assistance, resource-monitoring for parents
and teachers and scheduled webcasts on specific topics. Tutorbuddy's technology
will allow students, teachers and parents to search and have immediate access to
indexed video titles relevant to homework, class projects, lesson plans and
educational programs. Tutorbuddy, through its parent Magic Lantern, has access
to a library of educational content which is substantial, representing over 250
producers of content with over 12,000 educational titles in release with digital
rights negotiated to more than half the titles currently in release. Tutorbuddy
enters the education and home learning market through Magic Lantern's strong
Canadian presence where it counts some 9,000 out of the 12,000 Canadian schools
as customers.
Sonoptic, located in Saint John, New Brunswick, operates a digital
video facility which converts analog video to digital video formats suitable for
distribution through the Internet, as well as through broadband distribution
networks being established by telephone and cable companies in Canada and
elsewhere. This is a relatively new type of business and, while there are
numerous "low-end" service providers entering the market in North America, there
are no clear leaders or dominant players that have emerged. Sonoptic is also
positioning itself as a premier source for digital video consulting and
conversion services within the key markets, which are expected to emerge in the
next two to three years.
11
MERCHANT CAPITAL GROUP
BUSINESS STRATEGY
Our Merchant Capital Group subsidiary is in the business of defining,
building and re-engineering businesses using new economy technologies to
maximize market value. The Merchant Capital Group's continual focus is to
identify upcoming technology trends and create the effective infrastructure
required to build out and support these trends.
Our Merchant Capital Group subsidiary is helping to define and grow a
new business and computing model known as the Application Service Provider,
which we refer to as the Application Service Provider industry.
APPLICATION SERVICE PROVIDER - SOFTWARE AS A SERVICE
Application Service Provider is changing the way application software
is distributed. The Application Service Provider concept is based on centrally
hosted computing. Instead of purchasing software applications for installation
on personal computers, companies and individuals subscribe to (i.e. rent) the
applications and then securely access them from any web connection. Application
Service Providers are transforming software from a product to a service that
provides specific functionality for end-users without the problems of
installation, servicing, and upgrading. Most major software corporations have
announced new initiatives in the Application Service Provider market.
MERCHANT CAPITAL GROUP SERVICES:
1. Fee Based Consulting Services: Our Merchant Capital Group subsidiary
serves clients by advising them on e-commerce strategy, with particular
focus on the Application Service Provider industry. Consulting services
include, but are not limited to, business development activities,
strategic alliances, and marketing and promotional activities.
2. Creation of Businesses: Our Merchant Capital Group subsidiary intends
to create companies to become leaders in areas that we believe will
define new technological trends. The intent is to fully develop these
companies and then sell them to established industry players or via
public offerings.
3. Corporate Reengineering: Our Merchant Capital Group subsidiary intends
to target for acquisition undervalued and under-performing corporations
and apply management expertise, new economy thinking, and new
technologies in order to boost market value and corporate performance.
12
4. Merchant Capital Services: Our Merchant Capital Group subsidiary
intends to assist clients with raising funds and with merger and
acquisition activity.
MERCHANT CAPITAL GROUP STRATEGY
Our Merchant Capital Group subsidiary follows a three-way model of
defining, creating, and exploiting new trends in technology:
1. Strategic Development: Our Merchant Capital Group subsidiary
continually monitors the competitive landscape to determine if there
currently exist companies to exploit the technological trend. If not,
the Merchant Capital Group intends to develop in-house companies to
exploit the technological trend.
2. Acquisition: Our Merchant Capital Group subsidiary targets appropriate
companies for acquisition and development.
3. Research and Development: In addition to the above, our Merchant
Capital Group subsidiary maintains research and development in an
effort to discover and help create new technological trends.
These strategies and services are designed to offer our Merchant
Capital Group subsidiary's clients the following benefits within the
marketplace:
1. Brand and Market Awareness: Our Merchant Capital Group subsidiary's
activities for clients include extensive public and media relations,
marketing campaigns, brand development and identity, and promotion.
These activities are developed in close consultation with clients.
2. Business Development: Our Merchant Capital Group subsidiary has an
extensive list of market contacts and is a member of the Application
Service Provider Industry Consortium, the Personalization Consortium,
and the Rich Media Consortium. These memberships and established
relationships allow our Merchant Capital Group subsidiary to assist
client activities in the sourcing and formulation of strategic
alliances, business arrangements, joint development programs, and
general business development.
3. Additional Financings: Our Merchant Capital Group subsidiary maintains
an up-to-date database on venture capital activity. This allows our
Merchant Capital Group subsidiary to identify appropriate venture
capitalists that would be interested in pursuing financing
relationships with client companies.
On September 19, 2000, pursuant to a purchase and sale agreement among us, our
Merchant Capital Group subsidiary, Chell.com, and Cameron Chell, we and our
Merchant Capital Group
13
subsidiary acquired certain assets from Chell.com and the following shares for
an aggregate purchase price of US$27,002,086:
(a) 480,000 shares of cDemo were acquired by us which represents
approximately 14.3% of cDemo's issued and outstanding stock;
(b) 875,000 shares of Engyro Inc. were acquired by us which represents
approximately 34% of Engyro's issued and outstanding stock; and
(c) 60,000 Common Shares of Chell.com (USA) Inc., a Nevada corporation were
acquired by us which represents 100% of Chell.com (USA)'s outstanding
stock.
(d) 962,500 Common Shares of eSupplies, Inc., which were held in escrow as
discussed below, were subsequently released.
Pursuant to the Purchase and Sale Agreement, we acquired the
above-referenced shares for an aggregate purchase price of US$25,234,583. We
also acquired certain assets from Chell.com including office leases, office
equipment and computers, insurance contracts, employment contracts and service
agreements for a price of US$1,767,503. Accordingly the combined aggregate
purchase price for the Chell.com assets, the 480,000 shares of cDemo, the
875,000 shares of Engyro Inc., and the 60,000 Common Shares of Chell.com (USA)
Inc. was US$27,002,086. The sole director and shareholder of Chell.com is
Cameron Chell. Our Merchant Capital Group subsidiary also assumed a liability
owing by Chell.com to Canadian Advantage Limited Partnership II, in the amount
of US$1,767,499 on the condition that Canadian Advantage Limited Partnership II
accept full settlement of such indebtedness by our Merchant Capital Group
subsidiary issuing 451,868 exchangeable shares of our Merchant Capital Group
subsidiary. The aggregate purchase price payable by us under the Purchase and
Sale Agreement of US$27,002,086 was paid by the issuance by us of a total of
5,396,733 of our Common Shares at the deemed price of US$3.91155 per share and
1,506,439 shares of our Merchant Capital Group which were exchangeable for our
Common Shares on a one-for-one basis. The 1,476,398 exchangeable shares of our
Merchant Capital Group that were originally issued for the 962,500 eSupplies
shares had been held in escrow pursuant to an escrow agreement dated October 11,
2000 among Cameron Chell, us and Wolff Leia Huckell, Barristers and Solicitors.
These Merchant Capital Group exchangeable shares were to be released from escrow
after receiving written notice from us that the new course of business being
taken by eSupplies fits with our business model and provides significant value
to us. Since we have subsequently determined that eSupplies' business profile
does not fit with ours, the CMCG Exchangeable Shares have been cancelled and the
962,500 eSupplies shares have been returned to Cameron Chell. Subsequent to the
cancellation of the eSupplies transaction, the aggregate purchase price was
reduced to US$21,227,081.
Pursuant to an asset purchase agreement dated September 1, 2000, Magic
Lantern acquired the assets and business operations of Richard Wolff
Enterprises, Inc., a company based in Illinois, for a purchase price of $289,590
on a discounted basis. Richard Wolff Enterprises, Inc. is not an entity related
to or affiliated with us. As a result, Magic Lantern has expanded its
14
library of educational titles and now has access to the international
distribution infrastructure formerly held by Richard Wolff Enterprises. The
asset purchase agreement also contains a purchase price adjustment clause
whereby the price may be adjusted upwards to a maximum of an additional
US$100,000 if certain revenue levels are achieved. Specifically, if gross
revenues for the acquired business exceed US$500,000 for the 12 month period
ending August 31, 2001, Magic Lantern will pay to Richard Wolff Enterprises
US$50,000, and if gross revenues exceed US$600,000 for the second 12 month
period ending August 31, 2002, Magic Lantern will pay to Richard Wolff
Enterprises an additional US$50,000. This condition has not currently been met.
In addition, the asset purchase agreement provides that Richard Wolff, President
of Richard Wolff Enterprises, has agreed to act as a consultant to Magic Lantern
for a term of 2 years to assist in the transition and growth of the business as
it expands internationally.
On October 10, 2000, pursuant to a Securities Purchase Agreement dated
October 3, 2000, we completed the issue and sale of a US$3,000,000 convertible
debenture to the VC Advantage Limited Partnership. Cameron Chell is a director
and shareholder of VC Advantage Limited Partnership. The convertible debenture
bears interest at 10% per annum, payable upon conversion, redemption or
maturity. The unpaid principal of the debenture bears interest from the date
that it is actually advanced until paid. Interest is payable in cash or stock at
our option. The convertible debenture is convertible into our Common Shares, at
US$3.00 per share, in amounts specified by VC Advantage Limited Partnership. The
maximum number of our Common Shares that VC Advantage Limited Partnership will
receive is 1,000,000. On November 30, 2000 the convertible debenture was
assigned by VC Advantage Limited Partnership to Canadian Advantage Limited
Partnership II. VC Advantage Limited Partnership assigned this convertible
debenture due to difficulty with certain of its investments, which in turn
inhibited its ability to advance the funds to us as per the terms of the
convertible debenture. Canadian Advantage Limited Partnership II is not an
entity related to or affiliated with us. A total of US$1,700,000 has been
advanced to us as at the date hereof and Canadian Advantage Limited Partnership
II is in default of its obligation to advance the balance of the funds. We also
issued 50,000 warrants for the shares of VC Advantage Limited Partnership. Each
Warrant entitles the holder thereof to acquire one of our Common Shares at
US$3.00 per share at any time prior to October 3, 2004, for an aggregate of
50,000 shares.
PLANNED FUTURE ACTIVITIES
INVESTMENT SUBSIDIARIES
Engyro
Engyro is the surviving legal entity resulting from the merger of R
Home Funding Co. Ltd., a Nevada corporation and its wholly owned Delaware
subsidiary, Engyro, Inc. Its headquarters are located in Shelton, Connecticut.
We own 22.1% of the stock of Engyro and the remaining equity of the company is
as follows: Private Venture Capitalists (60.0%,); Engyro's Management (17.9%).
Engyro has started business operations and recently announced that it will
15
provide an advanced license management and reporting solution for Microsoft(R)
Great Plains(R) Business Solutions' business process outsourcing program.
Engyro is a financial transaction engine designed to support the high
demands created by rapid growth in the Application Service Provider industry.
Engyro is focusing on providing the critical back end administrative services
for the Application Service Provider industry. Our Management believes that this
will allow integration of the billing, payment, disbursement, and settlement
functions for Application Service Provider companies. Engyro has custom designed
its system to enable simplification of the complex economic variables of
delivery, measurement and payment, with full reconciliation and posting directly
to the accounting systems of all parties in the Application Service Provider
transaction. Engyro intends to strategically deploy its service offering to give
efficient and flexible local service to the Application Service Providers',
Independent Software Vendors and Network Service Providers. Engyro's platform is
flexible enough to allow it to grow into other market areas such as
business-to-business and e-commerce. Engyro is still developing its product and
has not yet received any revenue.
Engyro's primary market is the Application Service Provider
marketplace. Most Application Service Providers have yet to develop
sophisticated and integrated accounting systems and backroom capabilities, and
typically outsource non-core operations. Engyro proposes to approach potential
customers and work with them to design creative solutions for their billing and
payment needs. Engyro also intends to approach Independent Software Vendors to
market Engyro's ability to enable them to transition to an e-commerce platform
to take advantage of new distribution channels in the Application Service
Providers. Engyro intends to approach Independent Software Vendors and Network
Service Providers and seek to assist them in their provision of Application
Service Provider value-added services to their core offering. Engyro intends to
reach its target market in the following ways:
(1) Indirectly by offering Independent Software Vendors a secure method to
enable Application Service Providers alternative subscription software
rental-models through the remote Management of the payment process; and
(2) Through strategic partnerships/marketing relationships with software
metering/monitoring companies, billing companies, accounting software
providers, Data Centers, and other components of the community of
Application Service Provider elements.
CDEMO
cDemo is a start up company that was incorporated in the State of
Delaware in February 2000. The head office is located at 236B Broadway, Chico,
California, 95926 and there is a satellite office located at 114, 1215 - 13th
Street SE, Calgary, Alberta. We own 14.3% of the stock of cDemo and the
remainder of the company's stock is distributed as follows: Private Venture
Capitalists (22.32%); cDemo's Management and Employees (59.82%), none of whom
are affiliated with us. Allan Chell, Cameron Chell's brother, is a Director and
principal
16
shareholder of cDemo and its VP of Strategic Development. cDemo is developing
its products and has not yet received any revenue.
cDemo plans to position itself as a trusted and unbiased electronic
assessment and listing service. To perform a standardized electronic assessment
and listing, cDemo has researched and developed an assessment methodology that
is capable of "commoditizing" products, and displaying them in a format that is
easy to both read and view. cDemo's unique consortium of technology partners are
producing a technological system that our Management believes will be capable of
tailoring the cDemo electronic assessment to industry and partner requirements.
The assessment software will be loaded into a rugged, handheld tablet. cDemo
plans to use this tablet device to collect and transmit an electronic
demonstration based on an Internet connection to the cDemo backend database.
cDemo's first target industry is used vehicle sales. In order for the
automotive industry and Internet-based automotive companies to access the
multi-billion dollar used vehicle industry, cDemo intends to provide the
nationwide electronic assessment and listing infrastructure necessary for this
to occur and intends to generate revenue from service providers, trade-ins,
on-site volume assessments, lease returns, advertising, and data mining.
The cDemo electronic assessment service will include:
o An unbiased and detailed 100 plus point assessment.
o Multiple digital photographs of the vehicle.
o A computer generated assessment report, book value, and rating
of the vehicle.
o A one-stop upload listing service to automotive and classified
advertisement websites.
cDemo's third party information will enable consumers to buy, sell,
trade-in, and complete finance, insurance, and extended warranty contracts
online, not all of which is possible today.
In order to establish the nationwide assessment and listing
infrastructure, cDemo plans to foster business alliances with nationwide quick
lube chains and other service stations; newspapers, photo buy publications, and
Internet based classifieds; automobile finance, insurance and extended warranty
companies; and automotive dot-com businesses. cDemo has no current business
operations and as at the date hereof, cDemo has not entered into any agreement
with third parties and there can be no assurance that cDemo will be able to do
so in the future.
COMPETITION
The market for merchant capital services, interactive entertainment
services and electronic/online products and services is rapidly evolving and
highly competitive. Although we believe that the diverse segments of the
interactive entertainment and venture capital services
17
markets will provide opportunities for more than one supplier of products and
services similar to ours, it is possible that a single supplier may dominate one
or more market segments. Competitors include a wide variety of companies and
organizations, including venture capitalists, interactive entertainment
providers, Internet software, content, service and technology companies,
telecommunication companies, cable companies and equipment/technology suppliers.
Our Merchant Capital Group subsidiary operates in the venture capital
market and competes with several similar organizations. Despite having different
business models and strategic outlooks than our Merchant Capital Group
subsidiary, our Management believes that the following companies represent our
Merchant Capital Group subsidiary's primary competition:
1. CMGI: Based in Andover, Massachusetts, CMGI creates and manages the
most diverse network of Internet companies in the world. It is a
company constructed of various companies in the following industries:
Advertising/Marketing, Content & Community, E-commerce and Enabling
Technologies. CMGI's portfolio consists of more than 60 companies, most
of which are market or segment leaders;
2. Internet Capital Group: Based in San Francisco, Internet Capital Group,
which we refer to as ICG, is an Internet holding company actively
engaged in business-to-business e-commerce through a network of partner
companies. ICG has a network of over 60 companies. The strategy of the
company is to integrate its holdings and interests into a collaborative
network that leverages knowledge and resources; and
3. Softbank: Based in Tokyo and California, Softbank is perhaps the
largest Internet market force in the world. Softbank has a global
presence and powerful global strategic partnerships. The company has
established a worldwide presence by leveraging strategic alliances with
subsidiaries such as Softbank Capital Partners (US$1.35 billion), and
Softbank Technology Group. Softbank has ownership positions in over 120
Internet companies.
Our NTN Interactive Network subsidiary operates in the interactive
entertainment services industry. In 1996, we became aware of a new entertainment
system, Sports Active, attempting to enter the hospitality market. Sports Active
offers only two programs, a football game and a trivia game. While it is
visually entertaining, it requires audio and we believe this is a significant
drawback in the restaurant environment in which it is being marketed. We have
not found this to be a significant competitive entry.
With the entrance of motion picture, cable and TV companies,
competition in the interactive entertainment and multimedia industries will
likely intensify in the future.
Our Magic Lantern subsidiary operates in a large and fragmented market.
There are many producers and distributors of educational media resources. These
market participants make up the diverse educational media supply chain. It is
believed that Magic Lantern's extensive library
18
of titles with digital delivery rights, along with our Magic Lantern
subsidiary's established relationships with Canadian schools, make it one of the
dominant players in its market.
GalaVu's competition includes other interactive in-room entertainment
providers. With the development of new satellite technologies, and the
increasing speed of network connections, GaluVu expects the competition to
develop new services. These new services may include digital programming on
demand, enhanced hotel concierge services, billing presentment and settlement,
and others. GaluVu expects that new technologies will lead to intensifying
competition in the future.
Engyro's competition includes financial institutions that are pursuing
online settlement, disbursement, and clearing services. While there are numerous
online financial institutions, most are focused on the consumer end of the
market, offering products and services aimed at allowing consumers to complete
banking activities online. In addition, many competitors exist within the
Application Service Provider financial supply chain, each offering a different
set of services that in conjunction allow Application Service Provider services
to be offered. We believe that there is currently no direct competition to
Engyro as no other financial transaction company is focused exclusively on the
Application Service Provider market.
cDemo's competition includes assessment services, newspaper classified
advertisement and related services, photo buy and sell publications,
Internet-based automobile description and search organizations, and
Internet-based automobile sales organizations. We believe that these
organizations exist within a highly fragmented market each playing a role in the
overall assessment and vehicle transaction process. We believe that cDemo is
unique within the marketplace in that it acts as an independent and unbiased
collector of information that is presented for the benefit of all participants
in the used vehicle marketplace.
EMPLOYEES
We have 125 employees in the nine operating subsidiaries, consisting of 6
executives, 14 salespersons, 55 persons involved in technical services, 6
involved in graphic development, 6 in marketing, 18 individuals involved in
administration, 11 individuals involved in finance and accounting, 2 individuals
involved in research and development, 5 individuals involved in information
services and 2 individuals involved in investor relations. We believe that our
staff is adequate for our anticipated needs.
ITEM 2. PROPERTIES.
We own an approximately 25,000 square foot parcel of land, located at
14 Meteor Drive in Toronto, Ontario, on which stands a 12,500 square foot, one
story building. We and our NTN Interactive Subsidiary presently use this
building as our principal place of business.
19
We also own an approximately 29,000 square foot parcel of land, located
at 10 Meteor Drive in Toronto, Ontario, on which stands a 14,000 square foot,
two story building. Our Magic Lantern Group Subsidiary, its subsidiaries and
GalaVu presently utilize this building as their principal place of business.
Our Magic Lantern subsidiary owns three office units, comprising an
aggregate 8,000 square feet of office space, in a building at 775 Pacific Road,
Oakville, Ontario. These premises were leased to a third party in 1999. We,
through our subsidiaries, lease 2,342 square feet of office space in Saint John,
New Brunswick for an annual rent of Cdn$35,130, 8,451 square feet of office and
warehousing space in Vancouver, British Columbia for an annual rent of
Cdn$108,939 and 961 square feet of office space in Chicago, Illinois for and
annual rent of US$18,980.
The property located at 10 Meteor Drive in Toronto, Ontario, as well as
the property located at 775 Pacific Road, Oakville, Ontario, has been financed
through a Matched Fund Term Loan, with the Royal Bank of Canada, dated April 24,
1998. The principal outstanding regarding these two properties, as at August 31,
2001 was Cdn$1,206,478.
GalaVu lease 8,619 square feet of office space in a building located at
3790 - 3820 Victoria Park Avenue, North York, Ontario, with the lease expiring
on October 31, 2002 ($77,729 annually). GalaVu is also a guarantor of a lease
dated September 22, 1999 between 15516 Canada Inc. and XON Digital
Communications Limited for a 3,500 square foot premises located in Halifax, Nova
Scotia ($39,130 annually).
Our Merchant Capital Group subsidiary leases 12,043 square feet of
office space in Suites 301, 500 and 700 in a building located at 630 - 8th
Avenue S.W. Calgary, Alberta. The combined annual rent of the three suites in
Cdn$202,087.
We believe that our facilities and those of our subsidiaries are
adequate for their present requirements.
ITEM 3. LEGAL PROCEEDINGS.
Set forth below is a description of material pending litigation to
which we are a party.
1. On June 18, 1992, Interactive Network Inc. (Interactive)
commenced a lawsuit against the us, NTN Communications and our
NTN subsidiary in the Federal Court of Canada, Trial Division,
Montreal, Quebec, under the titled INTERACTIVE NETWORK, INC. V.
NTN COMMUNICATIONS, INC., NTN SPORTS, INC. AND NTN CANADA, Inc.
This action alleges that Interactive granted NTN Communications
the right to use the Interactive Patent, which right
Communications then improperly licensed to us and our NTN
subsidiary. Interactive alleges that the license agreement
between NTN Communications and our NTN subsidiary and us
infringes upon the
20
Interactive Patent. The action seeks a declaration of the
validity of the Interactive Patent, an injunction restraining us
from further infringement, and either damages (in an unspecified
amount) or an accounting of profits derived from certain games
used in Canada. Except for the aforementioned pleadings, no
proceedings or discovery have been undertaken in this action.
We believe that the licenses granted to us by NTN Communications are
valid and that the patent infringement claims underlying this action will
ultimately be proven to be unfounded. We intend to vigorously defend our
position and to prosecute the Interactive position in the action; however, there
can be no assurance that any or all of these actions will be decided in favour
of us. We believe, based in part upon the advice of outside, independent
counsel, that the costs of defending and prosecuting these actions will not have
a material adverse effect upon our financial position.
In its Quarterly Report on Form 10-Q, for the quarter ended September
30, 1996, NTN Communications stated that "[w]ith the courts [SIC] assistance,
[Communications] and [Interactive] have been able to reach a resolution of all
pending disputes in the United States and have agreed to private arbitration
regarding any future licensing, copyright or infringement issues which may arise
between the parties." The disputes referred to in the NTN Communications Form
10-Q involved litigation in the United States involving allegations similar to
the allegations underlying the actions between Interactive and us. In the NTN
Communication Form 10-Q, NTN Communications also noted that "no substantive
action has been taken in the furtherance of" the Company Action or Interactive
Action.
2. Canada Customs and Revenue Agency is currently in discussions
with us regarding a potential liability with respect to
withholding tax on certain amounts paid to Communications. An
assessment in the amount of approximately $600,000 has been made
to date by Canada Customs and Revenue Agency and we have filed a
notice of objection.. We believe that we have valid defenses with
respect to these matters and accordingly, no amount has been
recorded in these financial statements. In the event that such
matters are settled in favour of Canada Customs and Revenue
Agency, the amounts could be material and would be recorded in
the period in which they become determinable.
Neither our property nor ourselves are a party or subject to any other
material pending legal proceedings, other than ordinary routine litigation
incidental to our business.
To our knowledge no other proceedings of a material nature have been or
are contemplated against us.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
21
PART II
ITEM 5. MARKET PRICE FOR THE REGISTRANT'S COMMON EQUITY AND
RELATED STOCKHOLDER MATTERS.
Our common stock, par value $.0467 per share (the "Common Stock"), is
traded in the over-the-counter market and is quoted on the NASDAQ SmallCap
Market ("NASDAQ"), under the symbol "CHEL". Set forth below is the range of high
and low bid prices (US$) for shares of Common Stock for each full quarterly
period within our three most recent fiscal years and our quarter of the current
year. The information reflects inter-dealer prices, without retail mark-ups,
markdowns or commissions and may not necessarily represent actual transactions.
- -----------------------------------------------------------------------------------------
HIGH LOW TRADING VOLUME
---- --- --------------
(US$) (US$)
- -----------------------------------------------------------------------------------------
1999 FISCAL YEAR
First Quarter 4.750 1.125 1,385,390
Second Quarter 5.375 2.000 4,131,407
Third Quarter 3.500 1.375 1,000,982
Fourth Quarter 3.000 1.500 874,184
2000 FISCAL YEAR
First Quarter 2.500 1.500 585,270
Second Quarter 3.625 1.375 2,109,781
Third Quarter 7.875 2.250 3,825,607
Fourth Quarter 11.438 3.000 3,323,447
2001 FISCAL YEAR
First Quarter 7.219 3.000 581,689
Second Quarter 4.813 1.813 502,712
Third Quarter 2.313 0.938 1,811,151
Fourth Quarter 1.600 0.870 2,816,087
On November 26, 2001, the closing price of the Common Shares on NASDAQ
was US$0.6000.
As of the close of business on November 26, 2001, there were 207
holders of record of our Common Stock. We believe that there are approximately
1100 beneficial holders of Common Stock.
22
As of the close of business on November 26, 2001, the following Common
Shares have been issued by us in the last twelve months:
1. The convertible preferred shares were converted, resulting in the
issuance of 300,000 shares of our common stock.
2. 5,426,772 commons shares were issued for the asset purchase from
Cameron Chell and Chell.com Ltd.
3. 145,000 common shares were issued as payment for consulting fees
rendered.
4. We issued 131,974 common shares in lieu of salary.
5. We also issued 36,602 common shares for the settlement of debt.
Pursuant to our Stock Option Plan, the following issuances of stock
were made in the last twelve months:
--------------------------------------------------------------
NUMBER OF
MONTH OF ISSUANCE COMMON SHARES ISSUED
--------------------------------------------------------------
September 2000 1.150
October 2000 5,100
January 2001 56,500
--------------------------------------------------------------
Since its inception in 1986, we have not paid any cash dividends on our
Common Stock. However, we have, in the past, declared certain stock dividends
and stock splits. We intend to retain earnings, if any, to finance operations
and, therefore, do not expect to declare or pay any cash dividends on the Common
Stock in the foreseeable future.
ITEM 6. SELECTED FINANCIAL DATA.
The following table sets forth a summary of selected financial
information regarding the Company and its subsidiaries, consolidated, for each
of the five fiscal years ended August 31, 2001. The earnings per share amounts,
prior to 1998, have been restated as required to comply with Statement of
Financial Accounting Standards No. 128 Earnings Per Share ("SFAS 128"). For
further discussion of earnings per share and the impact of SFAS 128, see Note 11
to the consolidated financial statements.
STATEMENT OF OPERATIONS DATA (CANADIAN DOLLARS):
- ---------------------------------------------------------------------------------------------------------
Year Ended August 31,
2001 2000 1999 1998 1997
$ $ $ $ $
- ---------------------------------------------------------------------------------------------------------
Operating revenues 18,222,374 19,107,290 12,823,691 13,404,542 10,351,689
Cost of sales 6,818,111 7,204,919 4,874,768 5,030,602 3,395,898
Gross profit 11,404,263 11,902,371 7,948,923 8,373,940 6,955,791
Net income (loss) (11,747,639) (2,323,621) (971,497) 618,065 609,387
Net income (loss) per share (1.38) (0.81) (0.36) 0.24 0.25
Weighted average number of
Shares outstanding 8,393,589 2,873,042 2,635,050 2,550,805 2,441,992
- ---------------------------------------------------------------------------------------------------------
23
BALANCE SHEET DATA (CANADIAN DOLLARS):
- ---------------------------------------------------------------------------------------------------------
August 31,
2001 2000 1999 1998 1997
- ---------------------------------------------------------------------------------------------------------
Total assets 16,049,510 317,220,211 14,546,003 15,802,359 14,287,602
Long-term obligations 4,582,995 4,436,213 2,216,675 2,840,218 2,185,249
Shareholders' equity 3,433,152 9,383,419 10,792,767 11,033,178 9,488,648
- ---------------------------------------------------------------------------------------------------------
24
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.
INTRODUCTION
Our consolidated financial statements included in this document have
been prepared in accordance with accounting principles generally accepted in the
U.S. ("U.S. GAAP"). The information contained in this Management's Discussion
and Analysis of Financial Condition and Results of Operations is expressed in
Canadian dollars. The following discussion should be read in conjunction with
the consolidated financial statements, and notes thereto, included in this
document.
RESULTS OF OPERATIONS
YEAR ENDED AUGUST 31, 2001 COMPARED TO YEAR ENDED AUGUST 31, 2000
REVENUES. Revenues from network services for the 2001 Fiscal Year were
$6,300,891, compared to $6,345,552 for our fiscal year ended August 31, 2000
(the "2000 Fiscal Year"), a decrease of $44,661 or 0.7%. The number of
hospitality sites decreased slightly between the 2001 and 2000 fiscal years.
Revenues from Pay-tv for the 2001 Fiscal Year were $6,651,913, compared
to $6,517,940 for our 2000 Fiscal Year, an increase of $133,973 or 2.1%. The
increase is the result an increase in the buy-rate experienced in the rooms, due
to more "blockbuster" movie titles.
Revenues from event programming for the 2001 Fiscal Year were $403,993,
compared to $500,168 for the 2000 Fiscal Year, a decrease of $96,175 or 19.2%.
The decrease was due to a decreased number of corporate events hosted, both in
Canada and abroad, in 2001 when compared to the number of events hosted in 2000.
Revenues from ad sponsorship were $231,991 for the 2001 Fiscal Year,
compared to $675,532 for the 2000 Fiscal Year, a decrease of $443,541 or 65.7%.
The decrease was the result of a decrease in the number and size of corporate
sponsors over the level experienced in the previous period.
Revenues from video and software sales were $3,113,725 for the 2001
Fiscal Year, compared to $3,702,801 for the 2000 Fiscal Year, a decrease of
$589,076 or 15.9%. Decreased levels of funding by all levels of government have
resulted in tighter budget constraints placed upon educational bodies, and as a
result, sales of educational material have fallen. In addition, the demand for
analog or VHS formats is decreasing, yet the demand for the digital formats has
not increased at the same rate.
25
Revenues from video dubbing were $682,870 for the 2001 Fiscal Year
compared to $717,596 for the 2000 Fiscal Year, a decrease of $34,726 or 4.8%.
The decrease can be attributed to stabilization in the local customer base after
our Magic Lantern subsidiary and its subsidiaries' relocation in late fiscal
1998 and the focus towards more internal production, thus resulting in a lesser
push towards external revenue sources.
Revenues from digital encoding were $820,396 for the 2001 Fiscal Year,
compared to $539,815 for the 2000 Fiscal Year, an increase of $280,581 or 52.0%.
The increase can be attributed to increased demand for digital services and the
increased capacity in the production lab.
Other revenues were $16,595, compared to $107,886 for the 2000 Fiscal
Year, a decrease of $91,291 or 84.6%.
As a result of the foregoing, our total revenues in the aggregate were
$18,222,374, compared to $19,107,290 for the 2000 Fiscal Year, a decrease of
$884,916 or 4.6%.
COST OF SALES. Cost of Sales for network services for the 2001 Fiscal
Year were $2,384,303, compared to $2,160,351 for the 2000 Fiscal Year, an
increase of $223,952 or 10.4%. The number of hospitality sites outstanding in
2001 compared to the number outstanding in 2000 decreased, however we are billed
by NTN Communications, Inc. in United States dollars and the increase in cost of
sales resulted from a weaker Canadian dollar in the 2001 Fiscal year ($1.5284
for the 2001 Fiscal Year compared to $1.4714 for the 2000 Fiscal Year). As a
percentage of our total revenues, such costs increased to 13.1% for the 2001
Fiscal Year from 11.3% for the 2000 Fiscal Year.
Pay-tv costs were $2,937,189 for the 2001 Fiscal Year, compared to
$2,919,417 for the 2000 Fiscal Year, an increase of $17,772 or 0.6%. Even though
revenue increased, we are receiving lower cable costs than experienced in the
2000 Fiscal Year, thus offsetting increased promotion and royalty costs. As a
percentage of our total revenues, such costs increased to 16.1% for the 2001
Fiscal Year from 15.3% for the 2000 Fiscal Year.
Event programming costs were $255, compared to $23,819 for the 2000
Fiscal Year, a decrease of $23,564 or 98.9%. The decrease was commensurate with
the decrease in the number of events hosted in event programming revenues and
decreased costs resulting from the events being client run and not performed by
us.
Advertising sponsorship costs were nil, compared to $93,496 for the
2000 Fiscal Year. The decrease was the result of decreased costs associated with
restructuring of the department.
Video and software costs in aggregate were $1,249,851, compared to
$1,625,885 for the 2000 Fiscal Year, a decrease of $376,034 or 23.1%. The
decrease corresponds to the decrease in revenue as discussed above. As a
percentage of our total revenues, these costs have fallen to 6.9% in the 2001
Fiscal Year from 8.5% in the 2000 Fiscal Year.
26
Video dubbing costs were $244,670, compared to $157,289 for the 2000
Fiscal Year, an increase of $87,381 or 55.6%. The increase can be attributed to
a higher cost of tape and case. As a percentage of our total revenues, these
costs have risen to 1.3% in the 2001 Fiscal Year from 0.8% in the 2000 Fiscal
Year.
Digital encoding costs were $1,843 for the 2001 Fiscal Year, compared
to $111,657 for the 2000 Fiscal Year, a decrease of $109,814 or 98.3%. The
decrease is the result of digital encoding materials being supplied by
customers.
As a result of the foregoing, our total cost of sales was $6,818,111,
compared to $7,204,919 for the 2000 Fiscal Year, a decrease of $386,808 or 5.4%.
Total gross margins increased to 62.6% in the 2001 Fiscal Year from 62.3% in the
2000 Fiscal Year.
EXPENSES. Selling, general and administrative expenses for the 2001
Fiscal Year were $16,181,604, compared to $10,726,556 for the 2000 Fiscal Year,
an increase of $5,455,048 or 50.8%. The increase was caused by the addition of
the Chell Merchant Capital Group and Chell.com (USA). Chell Merchant Capital
Group's and Chell.com (USA)'s selling, general and administration expenses for
the 2001 Fiscal Year were $5,452,378 and $121,715 respectively (There are no
comparative figures for the 2000 Fiscal Year). There were increased consulting,
legal and accounting fees of $298,556, $819,215 and $302,739 respectively. These
increased due to the acquisition and the increased reporting requirements for
the Quarterly reviews. There were also increased operating costs due to the
addition of the two new companies, such as; communications ($202,531), rent and
utilities ($117,649), travel ($992,595), office supplies ($100,023). Also there
was increased advertising and promotion ($418,557) and investor and public
relations ($492,846) associated with the two new companies. In addition there
was an increase in salaries and benefits of $1,762,128. These staffing levels
have been reduced and these costs should not be incurred in the next fiscal
year. As a whole, Chell Merchant Capital Group and Chell.com (USA) attributed
for the increase in selling, general and administrative expenses, however these
costs have been dramatically decreased and should not occur with our current
company structure in the next fiscal year. As a percentage of the Company's
total revenues, total selling, general and administrative expenses increased to
88.8% for the 2001 Fiscal Year from 56.1% for the 2000 Fiscal Year.
Write-off of leaseholds was $355,560 for the 2000 Fiscal Year. Chell
Merchant Capital Group experienced the one-time write-offs.
Bad debts expense was $171,407, compared to $140,090 for the 2000
Fiscal Year, an increase of $31,317 or 22.4%. The increase resulted from an
increase in the allowance for doubtful accounts. As a percentage of our total
revenues, such costs increased to 0.9% for the 2001 Fiscal Year from 0.7% for
the 2000 Fiscal Year.
Interest and bank charges for the 2001 Fiscal Year were $1,471,379,
compared to $282,085 for the 2000 Fiscal Year, an increase of $1,189,294 or
421.6%. The increase was the
27
result of the increased debt levels associated with the purchase of Richard
Wolff Enterprises, and the increased debt for the promissory note and
convertible debenture. As a percentage of our total revenues, such costs
increased to 8.1% for the 2001 Fiscal Year from 1.5% for the 2000 Fiscal Year.
Depreciation and amortization for the 2001 Fiscal Year were $3,040,407,
compared to $2,249,321 for the 2000 Fiscal Year, an increase of $791,086 or
35.2%. This increase is the result of depreciation on the capital asset
additions in 2001, and the addition of our Chell Merchant Capital Group
subsidiary ($431,697). As a percentage of our total revenues, such costs
increased to 16.7% for the 2001 Fiscal Year from 11.8% for the 2000 Fiscal Year.
NET INCOME/LOSS. As a result of all of the above, the Company's net
loss for the 2001 Fiscal Year was $11,747,639 compared to net loss of $2,323,621
for the 2000 Fiscal Year, a change of $9,424,018. This represents a decrease in
net income as a percentage of total revenues to (64.5%) in the 2000 Fiscal Year
from (12.2%) in the 2000 Fiscal Year.
YEAR ENDED AUGUST 31, 2000 COMPARED TO YEAR ENDED AUGUST 31, 1999
REVENUES. Revenues from network services for the 2000 Fiscal Year were
$6,345,552, compared to $6,607,915 for our fiscal year ended August 31, 1999
(the "1999 Fiscal Year"), a decrease of $262,363 or 4.0%. The revenue earned
from playmaker repairs and maintenance performed by us for NTN Communications
during the 2000 Fiscal Year was $57,387 compared to $184,356 for the 1999 Fiscal
Year, a decrease of $126,969. In addition the 1999 Fiscal Year included a one
time sale that resulted in a variance of $134,630. The remaining revenues are
relatively constant between years due to the number of hospitality sites
remaining at the same level between the 2000 and 1999 fiscal years.
Revenues from Pay-tv for the 2000 Fiscal Year were $6,517,940. There is
no comparative revenue for the 1999 Fiscal Year as the revenue comes from our
GalaVu subsidiary, which was acquired in Fiscal 2000.
Revenues from event programming for the 2000 Fiscal Year were $500,168,
compared to $527,740 for the 1999 Fiscal Year, a decrease of $27,572 or 5.2%.
The decrease was due to a decreased number of corporate events hosted, both in
Canada and abroad, in 2000 when compared to the number of events hosted in 1999.
Revenues from ad sponsorship were $675,532 for the 2000 Fiscal Year,
compared to $308,602 for the 1999 Fiscal Year, an increase of $366,930 or
119.0%. The increase was the result of an increase in the number and size of
corporate sponsors over the level experienced in the previous period.
Revenues from video and software sales were $3,702,801 for the 2000
Fiscal Year, compared to $4,033,980 for the 1999 Fiscal Year, a decrease of
$331,179 or 8.2%. Decreased
28
levels of funding by all levels of government have resulted in tighter budget
constraints placed upon educational bodies, and as a result, sales of
educational material have fallen. In addition, the demand for analog or VHS
formats is decreasing, yet the demand for the digital formats has not increased
at the same rate.
Revenues from video dubbing were $717,596 for the 2000 Fiscal Year
compared to $691,156 for the 1999 Fiscal Year, an increase of $26,440 or 3.8%.
The increase can be attributed to stabilization in the local customer base after
our Magic Lantern subsidiary and its subsidiaries' relocation in late fiscal
1998.
Revenues from digital encoding were $539,815 for the 2000 Fiscal Year,
compared to $462,742 for the 1999 Fiscal Year, an increase of $77,073 or 16.7%.
The increase can be attributed to increased demand for digital services and the
increased size in the production lab.
Other revenues, which consisted primarily of revenue from installation
services, Internet services and interest income, were $107,886, compared to
$191,556 for the 1999 Fiscal Year, a decrease of $83,670 or 43.7%. Installation
services revenue was constant due to a constant number of sites and interest
income was constant due to the short-term investments remaining at a consistent
level. The change in other revenues arose primarily from Internet services;
$2,301 for the 2000 Fiscal Year compared to $98,959 for the 1999 Fiscal Year, a
decrease of $96,658. Internet services are no longer being provided.
As a result of the foregoing, our total revenues in the aggregate were
$19,107,290, compared to $12,823,691 for the 1999 Fiscal Year, an increase of
$6,283,599 or 49.0%.
COST OF SALES. Cost of Sales for network services for the 2000 Fiscal
Year were $2,160,351, compared to $2,353,705 for the 1999 Fiscal Year, a
decrease of $193,354 or 8.2%. The number of hospitality sites outstanding in
2000 compared to the number outstanding in 1999 was constant, however we are
billed by NTN Communications, Inc. in United States dollars and a $29,850
decrease in cost of sales resulted from a stronger Canadian dollar in the 2000
Fiscal year ($1.4714 for the 2000 Fiscal Year compared to $1.4949 for the 1999
Fiscal Year). As a result of the decreased revenue from playmaker repairs, the
associated cost of sales decreased by $82,654. As a percentage of our total
revenues, such costs decreased to 11.3% for the 2000 Fiscal Year from 18.4% for
the 1999 Fiscal Year.
Pay-tv costs were $2,919,417 for the 2000 Fiscal Year. There are no
comparative figures for the 1999 Fiscal Year. The Pay-tv costs as a percentage
of our total revenues were 15.3%.
Event programming costs were $23,819, compared to $24,650 for the 1999
Fiscal Year, a decrease of $831 or 3.4%. The decrease was commensurate with the
decrease in the number of events hosted in event programming revenues. As a
percentage of our total revenues, such costs decreased to 0.1% for the 2000
Fiscal Year from 0.2% for the 1999 Fiscal Year.
29
Advertising sponsorship costs were $93,496, compared to $61,255 for the
1999 Fiscal Year, an increase of $32,241 or 52.6%. The increase was the result
of increased marketing campaigns and its associated costs. As a percentage of
our total revenue such costs remained constant at 0.5% for the 2000 Fiscal Year
compared to the 1999 Fiscal Year.
Video and software costs in aggregate were $1,625,885, compared to
$1,709,626 for the 1999 Fiscal Year, a decrease of $83,741 or 4.9%. The decrease
corresponds to the decrease in revenue as discussed above. As a percentage of
our total revenues, these costs have fallen to 8.5% in the 2000 Fiscal Year from
13.3% in the 1999 Fiscal Year.
Video dubbing costs were $157,289, compared to $353,983 for the 1999
Fiscal Year, a decrease of $196,694 or 55.6%. The decrease also can be
attributed to the decrease in customer base and more efficient operations since
the acquisition of Image Media Ltd. As a percentage of our total revenues, these
have fallen to 0.8% in the 2000 Fiscal Year from 2.7% in the 1999 Fiscal Year.
Digital encoding costs were $111,657 for the 2000 Fiscal Year, compared
to $11,738 for the 1999 Fiscal Year, an increase of $99,919 or 851.2%. The
increase is associated with the increased level of production and costs
associated with the additional production facilities.
Other costs, were $113,005, compared to $359,811 for the 1999 Fiscal
Year, a decrease of $246,806 or 68.6%. As a percentage of our total revenues,
such costs decreased to 0.6% for the 2000 Fiscal Year from 2.8% for the 1999
Fiscal Year. The decrease relates primarily to Viewer Services ($222,751), which
became a wholly-owned subsidiary on June 16, 1999.
As a result of the foregoing, our total cost of sales was $7,204,919,
compared to $4,874,768 for the 1999 Fiscal Year, an increase of $2,330,151 or
47.8%. Total gross margins increased to 62.3% in the 2000 Fiscal Year from 61.9%
in the 1999 Fiscal Year.
EXPENSES. Selling, general and administrative expenses for the 2000
Fiscal Year were $10,726,556, compared to $6,830,575 for the 1999 Fiscal Year,
an increase of $3,895,981 or 57.0%. The increase was caused by the following
factors; firstly, GalaVu's selling, general and administration expenses for the
2000 Fiscal Year were $2,761,254 or 70.9% of the total increase (There are no
comparative figures for the 1999 Fiscal Year); secondly, severance packages
associated with executive restructuring; thirdly, a provision for certain
investments; fourthly, there were increased legal and accounting fees associated
with operations and items pertaining towards the Company's future; fifthly,
there was a one-time compensation charge of $337,779 resulting from the change
in the preferred share conversion rate and finally, costs associated with the
purchase of the remaining 49% of Interlynx. As a percentage of the Company's
total revenues, total selling, general and administrative expenses increased to
56.1% for the 2000 Fiscal Year from 53.3% for the 1999 Fiscal Year.
Bad debts expense was $140,090, compared to $126,170 for the 1999
Fiscal Year, an increase of $13,920 or 11.0%. The increase resulted from an
increase in the allowance for
30
doubtful accounts. As a percentage of our total revenues, such costs decreased
to 0.7% for the 2000 Fiscal Year from 1.0% for the 1999 Fiscal Year.
Interest and bank charges for the 2000 Fiscal Year were $282,085,
compared to $59,312 for the 1999 Fiscal Year, an increase of $222,773 or 375.6%.
The increase was the result of the increased debt levels associated with the
purchase of our GalaVu subsidiary. Our GalaVu subsidiary had interest charges of
$176,325 or 79.1% of the total increase. As a percentage of our total revenues,
such costs increased to 1.5% for the 2000 Fiscal Year from 0.5% for the 1999
Fiscal Year.
Depreciation and amortization for the 2000 Fiscal Year were $2,249,321,
compared to $1,429,219 for the 1999 Fiscal Year, an increase of $820,102 or
57.4%. This increase is the result of depreciation on the capital asset
additions in 2000, primarily the addition of our GalaVu subsidiary. Our GalaVu
subsidiary had depreciation and amortization for the 2000 Fiscal Year of
$936,400. As a percentage of our total revenues, such costs increased to 11.8%
for the 2000 Fiscal Year from 11.1% for the 1999 Fiscal Year.
Income Taxes. There was no provision for income taxes for the 2000
Fiscal Year, compared to $150,000 for the 1999 Fiscal Year, a decrease of
$150,000 or 100%. The provision for taxes is lower in 2000 when compared to the
1999 provision due to no individual operating unit experiencing a taxable
income.
NET INCOME/LOSS. As a result of all of the above, the Company's net
loss for the 2000 Fiscal Year was $2,323,621 compared to net loss $971,497 for
the 1999 Fiscal Year, a change of $1,352,124. This represents a decrease in net
income as a percentage of total revenues to (12.2%) in the 1999 Fiscal Year from
(7.6%) in the 1999 Fiscal Year.
LIQUIDITY AND CAPITAL RESOURCES
At August 31, 2001, we had a working capital deficit of $4,432,000 a
decrease of $6,849,551 from working capital of $2,417,551 at August 31, 2000.
Accounts receivable were $2,308,790 at August 31, 2001, compared to
$3,098,808 at August 31, 2000, a decrease of $790,018. The decrease can be
attributed to a decrease in the advertising and sponsorship sales, event
programming and software revenue and as well as a decrease in the average number
days outstanding in the receivables of Interactive. Property and equipment was
$8,260,282 at August 31, 2001 compared to $7,689,620 at August 31, 2000, an
increase of $570,662. This increase can be attributed to the following: the new
corporate wide financial and accounting package purchased and implemented in the
2001 Fiscal Year for which the approximate cost was $200,000. There was an
increase of approximately $150,000 of digital masters, that are required for the
production of digital media as well as the additional assets associated with the
acquisition of Richard Wolff Enterprises, Inc. Long-term debt was $9,658,997 in
the 2001 Fiscal Year compared to $4,774,672, an increase of $4,884,325. The
increase can be attributed to the $US1,700,000 convertible debenture associated
with the Chell
31
acquisition and the US$1,500,000 promissory note. Accounts payable were
$2,469,663 in the 2001 Fiscal Year compared to $1,379,727 in the 2000 Fiscal
Year, an increase of $1,089,936. The increase can be attributed the increase in
accounting and legal fees as a result of additional SEC reporting and as well as
the payables associated with the new entity, CMCG.
For the 2001 Fiscal Year, we had a net cash outflow of $999,192, versus
a cash outflow of $662,509 for the 2000 Fiscal Year. The net cash inflow for the
1999 Fiscal Year was $1,017,007. The decrease in net cash flow for the 2001
Fiscal Year was primarily due to cash used in investing activities and cash used
in operating activities.
Cash used in operating activities for the 2001 Fiscal Year was
$2,858,451. The major factors contributing to the cash used in operations for
the 2001 Fiscal Year include: net loss with non-cash expenses added back of
$5,506,554; increases in accounts payable and accrued liabilities of $1,072,245,
a decrease in accounts receivable, short-term investments and other assets of
$790,018, $250,051 and $111,072 respectively. The major factors contributing to
the cash provided from operations for the 2000 Fiscal Year include: net loss
with non-cash expenses added back of $436,555, an increase in accounts payable
and accrued liabilities of $919,707 and a decrease in inventory of $119,616;
cash used in operations were: increases in accounts receivable, income taxes
receivable and an increase in the net assets from discontinued operations of
$614,830, $143,227, $202,799 and $267,046 respectively. Cash provided by
operating activities for the 1999 Fiscal Year was $1,640,659. The major factor
contributing to the cash provided by operations during the 1999 Fiscal Year was
net loss with non-cash expenses added back of $460,230 and a decrease in
short-term investments of $1,780,407 reduced by the use of cash resulting from
the increase in prepaid expenses, other receivables and decrease in accounts
payable of $103,356, $153,020 and $304,370 respectively.
Cash used in investing activities in the 2001 Fiscal Year was
$3,070,672. This amount resulted from the purchase of property and equipment of
$1,430,962, and the deposit on purchase of $1,689,710 Cash used in investing
activities in the 2000 Fiscal Year was $1,162,146. This amount resulted from the
purchase of capital assets totaling $1,162,146. Cash used in investing
activities in the 1999 Fiscal Year was $614,130. This amount was primarily made
up of purchases of capital assets totaling $601,633
Cash provided by financing in the 2001 Fiscal Year were $4,929,930. The
increase is primarily due to the sale of the convertible debenture and the
bridge financing. Cash provided by financing in the 2000 Fiscal Year was
$235,606 resulting primarily from the $281,134 proceeds of exercised employee
stock options. Cash used in financing activities in the 1999 Fiscal Year totaled
$9,521. This mainly resulted from $48,007 repayment of debt offset by a $38,486
increase in loans payable.
Our business plan for 2002 contemplates obtaining additional working
capital through refinancings or restructurings of our existing loan agreements,
reducing operating overhead (which has already begun through workforce
consolidation), and the possible sale of some of our existing subsidiaries. Our
management is of the opinion that they will be able to obtain enough
32
working capital and that together with funds provided by operations, there will
be sufficient working capital for the Company's requirements.
33
INFLATION
The rate of inflation has had little impact on our operations or
financial position during the year ended August 31, 2001 and August 31, 2000 and
inflation is not expected to have a significant impact on our operations or
financial position during the 2002 Fiscal Year.
We pay a number of our suppliers, including our licensor and principal
supplier, NTN Communications, Inc., in US dollars. Therefore, fluctuations in
the value of the Canadian dollar against the US dollar will have an impact on
our gross profit as well as our net income. If the value of the Canadian dollar
falls against the US dollar, our cost of sales will increase thereby reducing
our gross profit and net income. Conversely, if the value of the Canadian dollar
rises against the US dollar, our gross profit and net income will increase.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risks from changes in foreign currency exchange rates
and interest rates. The Company and its wholly-owned subsidiaries are located in
Canada and its functional currency is the Canadian dollar.
INTEREST RATE RISKS.
We also had various loans outstanding at August 31, 2001 (approximately
$9,659,000), which bear interest at a fixed rate. A hypothetical 10% adverse
change in the interest rate on this debt would negatively affect net income and
cash flow by approximately $40,000.
The company did not use any derivative financial investments to manage this
exposure.
EXCHANGE RATE RISKS.
We are subject to foreign currency exchange rate fluctuations in the Canadian
dollar value of foreign currency-denominated transactions. Based on our average
annual net currency positions in fiscal 2001 and 2000, a 10% adverse change in
average annual foreign currency exchange rates would not have been material to
our consolidated financial statements for the years ended August 31, 2001 or
2000.
34
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Set forth below is a list of the consolidated financial statements of
the Company being furnished in this Annual Report on Form 10-K pursuant to the
instructions to Item 8 to Form 10-K and their respective locations herein.
FINANCIAL STATEMENT LOCATION
- ------------------- --------
Report of Independent Auditors
Current........................................................ F - 1
Predecessor................................................... F - 2
Consolidated Balance Sheets......................................... F - 3
Consolidated Statements of Operations............................... F - 4
Consolidated Statements of Shareholders' Equity..................... F - 5
Consolidated Statements of Cash Flows............................... F - 6
Notes to Consolidated Financial Statements.......................... F - 7
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURES.
On October 12, 2000, Ernst & Young LLP ("E&Y"), the independent
accountants who were engaged as the principal accountants to audit our financial
statements resigned as our certifying accountants. E&Y's report on our financial
statements as at August 31, 1999 and for the two years then ended contained no
adverse opinion or disclaimer of opinion, and were not qualified or modified as
to uncertainty, audit scope or accounting principles. During the fiscal year
ended August 31, 1999 and during the subsequent interim period preceding E&Y's
resignation we had no disagreement with E&Y on any matter of accounting
principles or practices, financial statement disclosure, or auditing scope or
procedure. The facts and circumstances that relate to E&Y's resignation, as far
as they are known to us, are as follows:
E&Y served as our certifying accountants since 1995. E&Y orally
informed us that pursuant to E&Y's internal rules, E&Y would resign as our
certifying accountants since it was unwilling and therefore unable to rely upon
the representations of Mr. Cameron Chell, our President and Chief Executive
Officer, due to the existence of a Settlement Agreement dated November 6, 1998,
between Cameron Chell, and the Alberta Stock Exchange. On April 3, 2000, our
board of directors appointed Mr. Chell as a director and elected him as our
Chair; on April 3, 2000, Chell.com. Ltd., an Alberta corporation wholly-owned by
Mr. Chell, purchased approximately 16% of our issued and outstanding common
stock; and on April 7, 2000, we advised E&Y of the existence of the Settlement
Agreement. Pursuant to this Settlement Agreement with the Alberta Stock
Exchange, Mr. Chell acknowledged the existence of certain facts that occurred
during 1996 and 1997 while Mr. Chell was a registered representative in Alberta,
Canada, licensed by the Alberta Securities Commission, and he agreed to certain
restrictions imposed by the Alberta Stock Exchange and to pay a Cdn$25,000 civil
fine.
35
Specifically, Mr. Chell acknowledged that he had breached certain duties of
supervision, disclosure, and compliance of the Alberta Stock Exchange in
connection with various offers and sales of securities. Those restrictions
included Mr. Chell's loss of Alberta Stock Exchange approval for a five-year
period and enhanced supervision for a three-year period.
E&Y's unwillingness to rely upon Mr. Cameron Chell's representations
were based upon the existence of the Settlement Agreement with the Alberta Stock
Exchange and not based upon any representations made by Cameron Chell.
On November 1, 2000, our Board of Directors ratified the engagement of
Lazar, Levine & Felix, LLP as our auditors for the year ending August 31, 2000.
We have authorized E&Y to fully respond to any and all inquiries of Lazar,
Levine & Felix, LLP concerning E&Y's resignation.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
- -------------------------------------------------------------------------------------------------------
NAME AGE PRINCIPAL POSITIONS WITH THE COMPANY DIRECTOR
SINCE
- -------------------------------------------------------------------------------------------------------
CAMERON CHELL 33 DIRECTOR, PRESIDENT AND CHIEF EXECUTIVE OFFICER 2000
DON PAGNUTTI 51 DIRECTOR, VICE PRESIDENT-FINANCE, CHIEF FINANCIAL OFFICER 2000
ADRIAN P. TOWNING 57 DIRECTOR 1994
DAVID BOLINK 33 DIRECTOR 2000
GORDON HERMAN 43 DIRECTOR 2000
ROBERT STONE 58 DIRECTOR 2000
SHELLY SINGHAL 34 DIRECTOR 2001
MARK TRUMAN 47 SECRETARY N/A
All of our Directors and Executive Officers were re-elected at our
Annual Shareholders' Meeting held on February 28, 2001 and will hold office
until the next succeeding Annual Meeting of Shareholders or until their
successors are duly elected and qualified.
Cameron Chell is our Chairman of the Board, President and Chief
Executive Officer and is the Chairman and Chief Executive Officer of Chell.com
Ltd. Mr. Chell is a founder of the Application Service Provider Consortium and
FutureLink Corp.. He served as FutureLink's President, CEO and Chairman from
1997 to 1999. Mr. Chell is also a Director and Shareholder of VC Advantage
Limited, the general partner of VC Advantage Fund Limited Partnership. Mr. Chell
is also the Chairman of the Board of Directors of Engyro and cDemo. Previously,
Mr. Chell worked in corporate finance in the private sector. Mr. Chell worked as
a stockbroker at McDermid St. Lawrence Securities Ltd. from 1994 to 1997. On
November 6, 1998, Mr. Chell entered into a Settlement Agreement with the Alberta
Stock Exchange to resolve a pending investigation into alleged breaches by Mr.
Chell of Alberta Stock Exchange rules and bylaws. As part of the Settlement
Agreement, (i) Mr. Chell acknowledged that he had breached certain duties of
supervision, disclosure, or compliance in connection with various offers and
sales of securities and (ii) Mr. Chell was prohibited from receiving Alberta
Stock Exchange approval for a five year
36
period, subjected to a Cdn$25,000 fine and a three year period of enhanced
supervision.
Don Pagnutti was appointed our Vice President, Finance on September 19,
2000. Mr. Pagnutti has been our Chief Financial Officer since September 1998,
and was our Executive Vice President and Chief Operating Officer from September
1997 to September 2000. From 1996 to 1997, he worked for Sullivan Entertainment
Inc., as Executive Vice President and Chief Financial Officer. >From 1980 to
1996, he worked for Telemedia Communications Ltd., a large Canadian media
company as Vice President, Radio. Mr. Pagnutti is a Chartered Accountant and has
a Masters Degree in Business Administration and a Bachelor of Commerce Degree
from the University of Toronto.
Adrian Towning is a private, independent investor in several companies
involved in the communications industry. As a result of his investments, he has
served as a director of some of these companies, including Medical
Communications Corporation, which we refer to as MCC, from 1994 to July 1996. On
May 14, 1996, MCC filed a petition under Chapter 7 of the United States
Bankruptcy Code and the Bankruptcy Court appointed a Trustee of MCC on July 11,
1996. On July 16, 1996, MCC was dissolved. From 1983 to 1989, he established and
managed Anglo-Massachusetts Investments Incorporated, with offices in Boston and
London, which was involved in providing financial advice to Europeans.
David Bolink was a Managing Director of Chell Merchant Capital Group
from September 2000 to January 19, 2001 and served as Chell.com. Ltd.'s first
President from December 1999 to July 2000. Mr. Bolink served as Director of
Business Management of FutureLink Distribution Corp., an application service
provider and a provider of server-based computing services, from May 1998 to
December 1999. Mr. Bolink also served as Business Manager of Edmonton Society
for Christian Education from May 1996 to May 1998. From February 1989 to May
1996, Mr. Bolink served as Asset Manager of Wilson Holdings, a property and
financial management company.
Gordon Herman was a Senior Managing Director of Chell Merchant Capital
Group from September 2000 to January 19, 2001. Mr. Herman is currently the
Chairman/President of Madison Companies Ltd., a company listed on the Canadian
Venture Exchange Inc., which focuses on acquiring small to medium sized
facilities management companies since 1997. From 1992 to 1998, Mr. Herman was
the President/owner of Harding Hall & Graburne Insurance Inc., a property and
casualty insurance broker. From 1996 to 1998, Mr. Herman was the Vice President,
Western Canada - Acquisitions, at Equisure Financial Network, an insurance
broker network trading on the Toronto Stock Exchange. From 1988 to 1992, Mr.
Herman was the President of General Electric Capital Canada Leasing Inc.,
Canadian Operations (Canadian Subsidiary of General Electric).
Robert Stone graduated with the degree of Bachelor of Science from the
University of Toronto in 1964. From 1973 until 1997 Mr. Stone served in various
capacities with Cominco Ltd., a company listed on the Toronto Stock Exchange,
and the American Stock Exchange, being the Vice-President, Finance and Chief
Financial Officer of that company from 1980 until 1997.
37
From 1969 until 1973 Mr. Stone was the Director of Finance of Great Northern
Capital Corporation. From 1964 until 1969 Mr. Stone worked with Clarkson Gordon,
Chartered Accountants, receiving his Chartered Accountant designation in 1967.
Mr. Stone currently serves as a director of a number of companies including:
Boliden Limited; Golden Star Resources Ltd.; Mainsborne Communications
International Inc.; Manhatten Minerals Corp.; Mr. Stone is also a former
director of Agrium Inc.; Cominco Ltd.; Global Stone Corporation; Pine Point
Mines Ltd.; TVI Pacific Inc.; and United Bolero Development Corp; Union Bank of
Switzerland and West Kootenay Power & Light Company.
Mr. Singhal is currently Managing Director of Technology Investment
Banking for SBI E2-Capital (USA) Inc. Previously he was Managing Director of
Technology Investment Banking for BlueStone Capital Securities, Inc., and
Managing Director of Corporate Finance at Roth Capital Partners where he was
head of the E-Commerce Group and Manager of the Roth Capital Partners Bridge
Fund.
Mark Truman has been our Controller since December of 1994.
ITEM 11. EXECUTIVE COMPENSATION.
SUMMARY COMPENSATION TABLE
The following table sets forth information concerning the compensation
paid or accrued by us during the three years ended August 31, 2001 to the
individual who served as our Chief Financial Officer during the 2001 Fiscal Year
who received total annual salary and bonuses in excess of US$100,000
(Cdn$152,840) during the 2001 Fiscal Year (collectively, the "Named Executive
Officers").
LONG-TERM
ANNUAL COMPENSATION COMPENSATION
--------------------------------------- ------------------
OTHER ANNUAL SECURITIES UNDER ALL OTHER
NAME AND PRINCIPAL SALARY(1) BONUS COMPENSATION(1) OPTIONS/GRANTED COMPENSATION
POSITION YEAR (CDN$) (CDN$) ($) (#) ($)
- ------------------------------------ --------------------------------------- -----------------------------------
Donald Pagnutti (2) 2001 160,000 - - - -
Vice-President, Finance and 2000 156,249 - - 22,500 -
Chief Financial Officer
- ------------------------------------ --------------------------------------- -----------------------------------
NOTES:
(1) Perquisites and other personal benefits received in 1998, 1999
and 2000 did not exceed the lesser of US$50,000 and 10% of the
total annual salary and bonuses for any of the Named Executive
Officers.
(2) Mr. Pagnutti's title was changed to Vice President Finance and
Chief Financial Officer on September 19, 2000.
During the three year period ended August 31, 2001, we did not grant
any restricted stock awards or stock appreciation rights. Additionally, all of
our group life, health, hospitalization, medical reimbursement or relocation
plans, if any, do not discriminate in scope, terms or operation, in favor of the
Named Executive Officers and are generally available to all salaried employees.
Further, no Named Executive Officer received, in any of the periods
38
specified in the Summary Compensation Table, perquisites and other personal
benefits, securities or property in an aggregate amount in excess of the lesser
of $50,000 or 10% of the total salary and bonus reported for the Named Executive
Officer in the fiscal year in which such benefits were received, and no single
type of perquisite or other personal benefits exceeded 25% of the total
perquisites and other benefits reported for the Named Executive Officer in the
applicable fiscal year.
OPTION GRANTS TABLE
The following table sets forth (a) the number of shares underlying
options granted to each Named Executive Officer during the 2001 Fiscal Year, (b)
the percentage the grant represents of the total number of options granted to
all our employees during the 2001 Fiscal Year, (c) the per share exercise price
of each option, (d) the expiration date of each option, and (e) the potential
realized value of each option based on: (i) the assumption of a five (5%)
percent annualized compounded appreciation of the market price of the Common
Stock from the date of the grant of the subject option to the end of the option
term, and (ii) the assumption of a ten (10%) percent annualized compounded
appreciation of the market price of the Common Stock from the date of the grant
of the subject option to the end of the option term.
Potential Realizable Value at
Assumed Rates of Stock Price
Appreciation for Option Term
----------------------------
Name Number of Percentage of Exercise Expiration 5% 10%
Shares Total Options Price Date
underlying Granted to
Options Employees in
Granted Fiscal Year
- -----------------------------------------------------------------------------------------------------------------
Donald Pagnutti (1) Nil Nil Nil Nil Nil Nil
Vice-President,
Finance and Chief
Financial Officer
- -----------------------------------------------------------------------------------------------------------------
NOTES:
(1) Mr. Pagnutti's title was changed to Vice President Finance and
Chief Financial Officer on September 19, 2000.
OPTIONS EXERCISED AND REMAINING OUTSTANDING
Set forth in the table below is information, with respect to each of
the Named Executive Officers, as to the (a) number of shares acquired during the
2001 Fiscal Year upon each exercise of options granted to such individuals, (b)
the aggregate value realized upon each such exercise (i.e., the difference
between the market value of the shares at exercise and their exercise price),
(iii) the total number of unexercised options held on August 31, 2001,
separately identified between those exercisable and those not exercisable, and
(iv) the aggregate value of in-the-money, unexercised options held on August 31,
2001, separately identified between those exercisable and those not exercisable.
39
SECURITIES AGGREGATE
ACQUIRED ON VALUE UNEXERCISED OPTIONS AT VALUE OF UNEXERCISED IN THE MONEY
EXERCISE REALIZED AUGUST 31, 2001 OPTIONS AT AUGUST 31, 2001
(#) ($) (#) ($)
-------------- ----------- --------------------------- ----------------------------------
EXERCISABLE UNEXERCISABLE EXERCISABLE(1) UNEXERCISABLE(1)
----------- ------------- -------------- ----------------
Donald Pagnutti Nil Nil 31,875 20,625 Nil Nil
NOTE:
(1) The value of the unexercised "in-the-money" options has been
determined by subtracting the exercise price of the options
from the closing Common Share price of US$1.33 on August 31,
2001, and multiplying by the number of Common Shares that may
be acquired upon the exercise of the options. The current
exercise price of the options is higher than the closing
Common Share price of US$1.33, therefore the Value of the
options is nil.
COMPENSATION OF DIRECTORS
Prior to September 8, 2000, each director, not otherwise our full time
employee, was eligible to receive $500 for each meeting of the Board of
Directors or committee thereof which they attended, along with the reimbursement
of their reasonable expenses incurred on our behalf. In addition, each director,
not otherwise our full time was eligible to receive 1,500 stock options
annually.
As of December 11, 2000, the Board of Directors formally adopted a
standard arrangement pursuant to which only our outside directors are
compensated for their services in their capacity as directors. This compensation
arrangement is retroactive to September 19, 2000 (the date of the closing of the
Agreement of Purchase and Sale between Networks North Inc., Networks North
Acquisition Corp., Chell.com Ltd. and Cameron Chell).
OUTSIDE DIRECTOR'S COMPENSATION SCHEDULE CASH OPTIONS
(US$)
1. Directorship Acceptance Options (one time grant with a 3 year vesting schedule) 45,000
2. Annual Retainer-Chairman 20,000 10,000
3. Annual Retainer-Director 6,000
4. Annual Retainer-Committee Member (over and above directorship retainer) 3,000
5. Annual Retainer-Committee Chair (over and above directorship retainer and 2,000
committee retainer)
6. Board Meeting Attendance Fee 750/mtg.
7. Committee Attendance Fee 500/mtg
EMPLOYMENT CONTRACTS WITH NAMED EXECUTIVE OFFICERS
In November 1999, we renewed Donald Pagnutti's employment agreement
originally dated August 15, 1997, pursuant to which Mr. Pagnutti serves as our
Executive Vice President, Chief Financial Officer and Chief Operating Officer.
Effective September 19, 2000, Mr. Pagnutti's title was changed to Vice
President, Finance and Chief Financial Officer. The agreement provides for an
initial base compensation of $160,000 with annual reviews, together
40
with automobile expenses of $9,000. In addition to the fixed remuneration, we
shall pay Mr. Pagnutti a bonus at the end of each year of the term in the event
that during the said year our actual net income before taxes as audited using
the generally accepted accounting principles applied on a basis consistent with
those previous years, equaled or exceeded our projected net income before taxes
as determined by our Board of Directors at the commencement of the said year.
The agreement further provided that we grant to Mr. Pagnutti options to purchase
a minimum of 15,000 of our Common Shares.
On September 19, 2000, we entered into an employment agreement with
Cameron Chell, pursuant to which Mr. Chell serves as our President and Chief
Executive Officer. The agreement provides for an initial base compensation of
$360,000, together with automobile expenses of $8,400. In addition to the fixed
remuneration, we shall provide Mr. Chell with the services of an Executive
Assistant on an ongoing basis and an Accountant for a reasonable period of time
to allow for the completion of outstanding accounting work related to existing
companies in which Mr. Chell is involved. It was the understanding of the
parties that this agreement was to be replaced by a definitive employment
agreement before October 10, 2000, however, such agreement has not been entered
into at this time. Since the signing of this agreement, Mr. Chell has eliminated
both his salary and automobile allowance in an effort to reduce our cash
requirements. These were eliminated with the understanding that the compensation
of Mr. Chell will be mutually agreed upon between the parties.
We do not have any other employment agreements in effect with any other
executive employee.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Our Audit and Compensation Committees currently consist of Robert Stone
and Adrian P. Towning. Messrs. Stone and Towning are not our officers or
employees, and have not served in such capacities in the past. None of our
executive officers served as a director or member of the compensation committee
(or group performing similar functions) of another entity, one of whose
executive officers served on the Audit and Compensation Committee or as a
director of the Company.
41
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
Set forth in the table below is information concerning the ownership,
as of the close of business on November 30, 2001, of the Common Stock by each
person who is known us to be the beneficial owner of more than five (5%) percent
of the Common Stock, our directors and Named Executive Officers, and all
directors and executive officers as a group.
- -----------------------------------------------------------------------------------------------------
Amount and Nature of Percent of
Name and Address(1) Beneficial Ownership Class (2)
- -----------------------------------------------------------------------------------------------------
Chell.com Ltd. (3) 5,325,048 59.0%
Cameron Chell (Director, President and Chief
Executive Officer(4) 5,326,648 59.0%
Canadian Advantage Limited Partnership II 1,238,535 13.7%
Gordon Herman (Director)(5) 332,236 3.7%
David Bolink (Director)(6) 311,411 3.4%
Don Pagnutti (Vice-President - Finance and
Chief Financial Officer)(7) 33,750 0.4%
Adrian Towning (Director)(8) 25,125 1.9%
Robert Stone (Director)(9) 15,000 0.1%
SHELLY SINGHAL 0
- -----------------------------------------------------------------------------------------------------
All directors and executive officers as a group
(7 persons) (10) 5,395,523 59.8%
- -----------------------------------------------------------------------------------------------------
(1) Unless otherwise stated, the address of our directors and executive
officers is c/o Chell Group Corporation, 14 Meteor Drive, Toronto,
Ontario, Canada M9W 1A4.
(2) Unless otherwise indicated, we believe that all persons named in the
table have sole voting and investment power with respect to all shares
of Common Stock beneficially owned by them. A person is deemed to be
the beneficial owner of securities that may be acquired by such person
within 60 days from the date on which beneficial ownership is to be
determined, upon the exercise of options, warrants or convertible
securities. Each beneficial owner's percentage ownership is determined
by assuming that options, warrants and convertible securities that are
held by such person (but not those held by any other person) and which
are exercisable within such 60-day period, have been exercised.
(3) Cameron Chell is the sole director and shareholder of Chell.com Ltd.
(4) Includes 5,325,048 Common Shares held by Chell.com Ltd.
(5) Represents the vested portion of an option in Chell.com Ltd. held by
Mr. Herman, for the purchase of our common shares, which are owned by
Chell.com Ltd.
(6) Represents the vested portion of an option in Chell.com Ltd. held by
Mr. Bolink, for the purchase of our common shares, which are owned by
Chell.com Ltd.
(7) Represents options, which have vested and are available for exercise.
42
(8) Includes 3,000 of our common shares and 19,125 options, which have
vested and are available for exercise.
(9) Represents options, which have vested and are available for exercise.
(10) This percentage of stock ownership by directors and executive officers
was calculated as a percentage of our total outstanding common stock,
which was 9,028,239 at November 26, 2001.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Set forth below is a description of certain transactions between us and
our directors, executive officers, beneficial owners of five percent or more of
the outstanding Common Stock, or members of the immediate family of any of the
foregoing persons, as well as certain business relationships between the us and
our directors, which occurred or existed during the 2001 Fiscal Year and
subsequent thereto. Our management believes that the transactions described in
this section were made on terms no less favorable than those which could have
been obtained from third parties.
a) Cameron Chell is Chairman of the Board and a director in each of
Engyro and cDemo. Chell.com., a wholly owned subsidiary of
Cameron Chell, holds 120,000 warrants to purchase common shares
of cDemo at $5.00 per share and 85,000 warrants to purchase Class
A Voting Shares of eSupplies at $7.00 per share and 500,000
options at $7.00. Chell.com holds 200,000 options to purchase
shares of Engyro for $5.00 and warrants for 97,500 shares at
$5.00.
b) Gordon Herman is interim President of cDemo, a consultant to
eSupplies and receives compensation therefore. He holds an option
in Chell.com to acquire 498,354 shares of our company, which are
held by Chell.com, at a price of $1.00 (which may be adjusted up
or downward based on certain contingencies).
c) David Bolink, Engyro's Vice-President of Business Development and
is a consultant to eSupplies and receives compensation therefore.
He holds an option in Chell.com to acquire 467,121 shares of our
shares, which are held by Chell.com, at a price of $1.00 (which
may be adjusted up or downward based on certain contingencies).
d) Consulting Agreement between Chell.com and Buyersangel.com Inc.
(now known as cDemo, Inc.) dated January 21, 2000 that was
assigned to us as part of the purchase of Chell.com assets
effective August 31, 2000, whereby we provide consulting services
to cDemo for a period of 12 months for a fee of US$720,000.
Cameron Chell is the Chairman of the Board of cDemo. Mr. Herman
is a director.
e) Consulting Agreement between Chell.com and R Home Funding Company
Ltd. (now known as Engyro, Inc.) dated January 17, 2000 that was
assigned to us as part of the purchase of Chell.com assets
effective August 31, 2000 whereby we provide consulting
43
services to Engyro for a period of 14 months, ending on January
15, 2001, for a fee of US$720,000. Cameron Chell is the Chairman
of the Board of Engyro.
f) Consulting Agreement between Mainsborne Communications
International Inc. and us dated September 1, 2000 whereby we
provide consulting services for a term of 1 year for a fee of
US$25,000 per month. Mr. Stone is a director of Mainsborne
Communications International Inc.
g) License Agreement between us, Cameron Chell, and Chell Merchant
Capital Group dated August 31, 2000 whereby Mr. Chell grants us
and Chell Merchant Capital Group the right to use the trademarks
"Chell.com", "Chell Merchant Capital Group" and "Chell
Corporation" in exchange for the fee of $1.00 per year.
h) Securities Purchase Agreement with VC Advantage Fund ("VC") on
October 3, 2000, for up to US$3,000,000 loan to us. VC received a
Convertible Debenture, which is convertible into our Common,
based upon an agreed conversion price of $3.00 per share. As of
November 30, 2000, VC had assigned its rights in this Agreement
to Canadian Advantage Limited Partnership ("CALP II") and a total
of US$1,700,000 has been advanced to the Company. The
US$1,700,000 advance is convertible into 566,667 Common shares.
Cameron Chell is a Director and shareholder of VC Advantage
Limited, the general partner of VC. Pursuant to the assignment of
this agreement to CALP II, this is no longer a related
transaction as Mr. Chell has no interests in CALP II.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS
ON FORM 8-K.
(a) The following financial statements and supplementary financial
information are filed as part of this Annual Report on Form 10-K:
There are no financial statement schedules either applicable or
required to be filed by the Company in this Annual Report on Form 10-K pursuant
to the instructions to Item 14 of Form 10-K.
(b) The following 8-K's have been filed since the Company's last 10-Q:
none
(c) The following list sets forth the applicable exhibits (numbered in
accordance with Item 601 of Regulation S-K) required to be filed with
this Annual Report on Form 10-K:
44
EXHIBIT
NUMBER TITLE
- ------- -----
2.1 Stock Purchase Agreement, dated October 1, 1996, among Connolly-Daw
Holdings Inc., 1199846 Ontario Ltd., Douglas Connolly, Wendy Connolly
and NTN Interactive Network Inc., minus Schedules thereto.+
3.1 Certificate of Incorporation, as amended to date.
3.2 By-Laws, as amended to date.
4.1 Specimen Stock Certificate.
10.1 License Agreement, dated March 23, 1990, between NTN Communications,
Inc. and NTN Interactive Network Inc.+
10.2 Stock Purchase Agreement, dated as of October 4, 1994, between NTN
Canada and NetStar Enterprises Inc. (formerly, Labatt Communications
Inc.).+
10.3 Option, dated as of October 4, 1994, registered in the name of NetStar
Enterprises Inc. (formerly, Labatt Communications Inc).+
10.4 Designation Agreement dated as of October 4, 1994, among NTN Canada,
Inc., NTN Interactive Network Inc. and NetStar Enterprises Inc.
(formerly Labatt Communications Inc.).+
10.5 Registration Rights Agreement, dated as of October 4, 1994, between NTN
Canada and NetStar Enterprises Inc. (formerly, Labatt Communications
Inc.). +
10.6 Promissory Note of NTN Interactive Network Inc. registered in the name
of Connolly-Daw Holdings, Inc.+
10.7 Promissory Note of NTN Interactive Network Inc., registered in the name
of 1199846 Ontario Ltd.+
10.8 Option Agreement, dated October 1, 1996, among Connolly-Daw Holdings
Inc., NTN Interactive Network Inc. and NTN Canada, Inc.+
10.9 Option Agreement, dated October 1, 1996, among 1199846 Ontario Ltd.,
NTN Interactive Network Inc. and NTN Canada, Inc.+
10.10 Registration Rights Agreement, dated October 1, 1996, among NTN Canada,
Inc., Connolly-Daw Holdings Inc. and 1199846 Ontario Ltd.+
10.11 Employment Agreement dated as of August 31, 1994, between NTN
Interactive Network Inc. and Peter Rona.+
10.12 Management Agreement, dated October 1, 1996, between Magic Lantern
Communications Ltd. and Connolly-Daw Holdings Inc.+
10.13 Employment Agreement dated October 1, 1996, between Magic Lantern
Communications Ltd. and Douglas Connolly.+
10.14 Employment Agreement dated October 1, 1996, between Magic Lantern
Communications Ltd. and Wendy Connolly.+
10.15 Asset Purchase Agreement, dated September 10, 1999, by and between
1373224 Ontario Limited, Networks North Inc. and Arthur Andersen Inc.,
to acquire the property and assets of GalaVu Entertainment Inc., from
the person appointed by the court of competent jurisdiction as the
receiver or receiver and manager of the property, assets and
undertaking of GalaVu.+
10.16 Promissory Note, dated September 10, 1999, by and between 1373224
Ontario Limited, as Debtor, and the Holder, as Creditor.+
45
10.17 General Security Agreement, dated September 10, 1999, by and between
1373224 Ontario Limited, to acquire the property and assets of GalaVu
Entertainment Inc., from the person appointed by the court of competent
jurisdiction as the receiver or receiver and manager of the property,
assets and undertaking of GalaVu.+
10.18 Securities Pledge Agreement, dated September 10, 1999, by and between
1373224 Ontario Limited to acquire the property and assets of GalaVu
Entertainment Inc., from the person appointed by the court of competent
jurisdiction as the receiver or receiver and manager of the property,
assets and undertaking of GalaVu.+
10.19 Certificate to the Escrow Agent certifying that the conditions of
Closing have been satisfied or waived. +
10.20 Certificate to the Escrow Agent certifying that the conditions of
Closing have not been satisfied or waived.+
10.21 Occupancy and Indemnity Agreement, dated September 10, 1999, by and
between 1373224 Ontario Limited to acquire the property and assets of
GalaVu Entertainment Inc., from the person appointed by the court of
competent jurisdiction as the receiver or receiver and manager of the
property, assets and undertaking of GalaVu.+
10.22 Order of the Ontario Superior Court of Justice, dated September, 1999,
approving the transaction contemplated herein, and vesting in the
Purchaser the right, title and interest of GalaVu and the Receiver, if
any, in and to the Purchased Assets, free and clear of the right, title
and interest of any other person other than Permitted Encumbrances. +
10.23 Bill of Sale, dated September 13, 1999, by and between 1373224 Ontario
Limited to acquire the property and assets of GalaVu Entertainment
Inc., from the person appointed by the court of competent jurisdiction
as the receiver or receiver and manager of the property, assets and
undertaking of GalaVu.+
10.24 Covenant of Networks North Inc., dated September 13, 1999, to allot and
issue and pay to the Bank in writing 100,000 common shares of NETN.
10.25 Agreement of Purchase and Sale dated August 4, 2000 by and among
Networks North Inc., Networks North Acquisition Corp., Chell.com Ltd.
and Cameron Chell.+
10.26 Valuation of Chell.com Ltd. and investments as of May 31, 2000 by
Stanford Keene.
22 +
23 List of Subsidiaries
27 Business Sector Date
+ Incorporated by reference. See Exhibit Index.
46
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
- -------------------------------------------------------------------------------
CHELL GROUP CORPORATION
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
Date: March 5, 2004 By: /s/ Stephen McDermott
- -------------------------------------------------------------------------------
Stephen McDermott, Chairman & CEO
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report on has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
NAME CAPACITY DATE
---- -------- ----
- ----------------------------------------
/S/ STEPHEN MCDERMOTT Director, Chairman and Chief Executive Officer March 5, 2004
- ----------------------------------------
Stephen McDermott
/S/ DAVID BOLINK Director March 5, 2004
- ----------------------------------------
David Bolink
- ----------------------------------------
47
INDEPENDENT AUDITORS REPORT
The Board of Directors
Chell Group Corporation
Toronto, Ontario
We have audited the accompanying consolidated balance sheets of Chell Group
Corporation and subsidiaries as of August 31, 2001 and 2000 and the related
consolidated statements of operations and shareholders' equity and cash flows
for each of the two years in the period ended August 31, 2001. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Chell Group
Corporation and subsidiaries as of August 31, 2001 and 2000, and the results of
their operations and their cash flows for the years then ended in conformity
with accounting principles generally accepted in the United States of America.
/S/ LAZAR LEVINE & FELIX LLP
----------------------------
New York, New York
November 16, 2001
Except for Note 17, the date of which is February 25, 2004.
F-1
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Shareholders of
Chell Group Corporation
We have audited the accompanying consolidated statements of operations,
shareholders' equity and cash flows of CHELL GROUP CORPORATION and subsidiaries
for the year ended August 31, 1999. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the consolidated results of operations and
cash flows of Chell Group Corporation and subsidiaries for the year ended August
31, 1999 in conformity with accounting principles generally accepted in the
United States.
/S/ ERNST & YOUNG LLP
---------------------
Toronto, Canada Chartered Accountants
November 12, 1999
F-2
CHELL GROUP CORPORATION INC
CONSOLIDATED BALANCE SHEETS
AS AT AUGUST 31
(Expressed in Canadian dollars)
- ------------------------------------------------------------------------------------------------------------------
2001 2000
(RESTATED - NOTE 17) (Restated - note 17)
$ $
- ------------------------------------------------------------------------------------------------------------------
ASSETS
CURRENT
Cash and cash equivalents 356,421 1,355,613
Short-term investments (note 4) 19,676 269,727
Accounts receivable, trade - net of allowance for doubtful
accounts of $227,000; [2000 - $178,000] 2,308,790 3,098,808
Other receivables (note 16) 84,814 216,990
Income taxes receivable 155,204 143,227
Inventory 105,590 206,216
Prepaid expenses 570,868 527,549
- ------------------------------------------------------------------------------------------------------------------
TOTAL CURRENT ASSETS 3,601,363 5,818,130
- ------------------------------------------------------------------------------------------------------------------
Property and equipment, net (notes 6 & 8) 8,260,282 7,689,620
Licenses, net of accumulated amortization 247,321 250,248
Goodwill, net of accumulated amortization 1,795,737 1,938,480
Notes receivable (note 5) 160,000 160,000
Deposit on purchase (note 14) 1,689,710 --
Other assets, net of amortization 212,539 202,799
Net assets from discontinued operations (note 13 [a]) 82,558 1,160,934
- ------------------------------------------------------------------------------------------------------------------
16,049,510 17,220,211
- ------------------------------------------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT
Accounts payable - trade (note 16) 2,469,663 1,379,727
Accrued liabilities 1,789,042 1,623,220
Current portion of long-term debt (note 8) 3,774,658 397,632
- ------------------------------------------------------------------------------------------------------------------
TOTAL CURRENT LIABILITIES 8,033,363 3,400,579
- ------------------------------------------------------------------------------------------------------------------
Long-term debt, less current portion (note 8), less discount of 4,523,822 4,377,040
$1,360,517 and 0, respectively
Deferred income taxes payable (note 7) 59,173 59,173
- ------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 12,616,358 7,836,792
- ------------------------------------------------------------------------------------------------------------------
COMMITMENTS AND CONTINGENT LIABILITIES (notes 9 & 12)
SHAREHOLDERS' EQUITY
Share capital (note 10)
0 Preferred shares [2000 - 900,000] -- 10,917
9,028,239 common shares [2000 - 2,925,141] 604,109 191,122
Capital in excess of par value 15,849,971 10,454,669
Deficit (13,020,928) (1,273,289)
- ------------------------------------------------------------------------------------------------------------------
TOTAL SHAREHOLDERS' EQUITY 3,433,152 9,383,419
- ------------------------------------------------------------------------------------------------------------------
16,049,510 17,220,211
- ------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these statements
F-3
CHELL GROUP CORPORATION INC
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED AUGUST 31
[Expressed in Canadian dollars]
2001 2000 1999
(RESTATED - (Restated
NOTE 17) - Note 17 )
- ------------------------------------------------------------------------------------------------------------
$ $ $
- ------------------------------------------------------------------------------------------------------------
REVENUE
Network services 6,300,891 6,345,552 6,607,915
Pay-tv 6,651,913 6,517,940 --
Event programming 403,993 500,168 527,740
Advertising sponsorship 231,991 675,532 308,602
Video and software sales 3,113,725 3,702,801 4,033,980
Video dubbing 682,870 717,596 691,156
Digital encoding 820,396 539,815 462,742
Other 16,595 107,886 191,556
- ------------------------------------------------------------------------------------------------------------
18,222,374 19,107,290 12,823,691
- ------------------------------------------------------------------------------------------------------------
COST OF SALES
Network services [NOTE 9] 2,384,303 2,160,351 2,353,705
Pay-tv 2,937,189 2,919,417 --
Event programming 255 23,819 24,650
Advertising sponsorship -- 93,496 61,255
Video and software sales 1,249,851 1,625,885 1,709,626
Video dubbing 244,670 157,289 353,983
Digital encoding 1,843 111,657 11,738
Other -- 113,005 359,811
- ------------------------------------------------------------------------------------------------------------
6,818,111 7,204,919 4,874,768
- ------------------------------------------------------------------------------------------------------------
EXPENSES
Selling, general and administrative 16,181,604 10,726,556 6,830,575
Write-off of leaseholds 355,560 -- --
Bad debts 171,407 140,090 126,170
Interest and bank charges 1,471,379 282,085 59,312
Depreciation and amortization 3,040,407 2,249,321 1,429,219
- ------------------------------------------------------------------------------------------------------------
21,220,357 13,398,052 8,445,276
- ------------------------------------------------------------------------------------------------------------
LOSS BEFORE THE UNDERNOTED ITEMS (9,816,094) (1,495,681) (496,353)
Loss on sale of subsidiary [NOTE 10] -- -- (130,000)
Loss from equity investment in Engyro [NOTE 18 ] (301,100) -- --
Income from investment in Viewer Services [NOTE13[B]] -- -- 28,576
Minority interest (27,061) 29,476 3,537
Provision for income taxes [NOTE 7] -- -- (150,000)
- ------------------------------------------------------------------------------------------------------------
LOSS FROM CONTINUING OPERATIONS (10,144,255) (1,466,205) (744,240)
Loss from discontinued operations (net of income tax) [NOTE (1,603,384) (857,416) (227,257)
13[A]]
- ------------------------------------------------------------------------------------------------------------
NET LOSS AND COMPREHENSIVE LOSS FOR THE YEAR (11,747,639) (2,323,621) (971,497)
- ------------------------------------------------------------------------------------------------------------
EARNINGS (LOSS) PER SHARE [NOTE 11]
Basic $(1.38) $(0.81) $(0.36)
Diluted $(1.38) $(0.81) $(0.36)
- ------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these statements
F-4
CHELL GROUP CORPORATION INC
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED AUGUST 31, 2001, 2000 AND 1999
(Expressed in Canadian dollars)
Capital in Accumulated Total
excess of par retained Shareholders'
Preferred Shares Common shares value earnings Equity
-------------------------------------------- (deficit)
Shares Amount Shares Amount
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, August 31, 1998 900,000 10,917 2,625,170 162,484 8,837,948 2,021,829 11,033,178
Payment for services rendered -- -- 5,500 387 26,557 -- 26,944
Interlynx acquisition (note 13[a]) -- -- 27,778 1,920 93,171 -- 95,091
Conversion of promissory notes -- -- 98,193 6,844 602,207 -- 609,051
Net loss -- -- -- -- -- (971,497) (971,497)
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, August 31, 1999 900,000 10,917 2,756,641 171,635 9,559,883 1,050,332 10,792,767
GalaVu acquisition (note 13[e]) -- -- 100,000 6,897 288,463 -- 295,360
Change in preferred share conversion rate -- -- -- 7,887 329,892 337,779
Exercise of 68,500 stock options -- -- 68,500 4,703 276,431 -- 281,134
Net loss -- -- -- -- -- (2,323,621) (2,323,621)
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, August 31, 2000 900,000 10,917 2,925,141 191,122 10,454,669 (1,273,289) 9,383,419
Purchase of assets and shares (NOTE 13[F]) -- -- 5,426,772 372,923 2,229,291 -- 2,602,214
Issued in lieu of salary -- -- 131,974 9,484 315,577 -- 325,061
Settlement of debt -- -- 36,602 2,694 109,085 -- 111,779
Preferred shares converted (900,000) (10,917) 300,000 13,065 (9) -- 2,139
Warrants -- -- -- -- 117,359 -- 117,359
Consulting services rendered -- -- 145,000 10,405 456,218 -- 466,623
Exercise of 62,750 stock options -- -- 62,750 4,416 208,637 -- 213,053
Beneficial conversion on Debt -- -- -- -- 1,959,144 -- 1,959,144
Net loss (restated - Note 17) -- -- -- -- -- (11,747,639) (11,747,639)
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, August 31, 2001
(restated Note 17) -- -- 9,028,239 604,109 15,849,971 (13,020,928) 3,433,152
- ------------------------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these statements
F-5
CHELL GROUP CORPORATION INC
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED AUGUST 31
(Expressed in Canadian dollars)
- ----------------------------------------------------------------------------------------------------------------------------
2001 2000 1999
(RESTATED - NOTE 17) (RESTATED - NOTE 17)
$ $ $
- ----------------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net loss for the year (11,747,639) (2,323,621) (971,497)
Adjustments to reconcile net loss to net cash
Provided by (used in) operating activities:
Compensation costs related to the change in the conversion rate of
Preferred shares -- 337,779 --
Depreciation and amortization 3,040,407 2,249,321 1,429,219
Amortization of discount 589,628 -- --
Accretion of interest on non-interest bearing promissory notes 183,513 173,076 31,084
Loss from investment in Viewer Services -- -- (28,576)
Write-off of leasehold improvements 355,560 -- --
Services rendered for shares 659,359 -- --
Warrants issued 174,084 -- --
Write-off of prepaids arising from Chell asset purchase 367,235 -- --
Write-off of assets arising from discontinued operations 939,513 -- --
Changes in assets and liabilities:
Decrease (increase) in short-term investments 250,051 (7,801) 1,780,407
Decrease (increase) in accounts receivable, trade 790,018 (614,830) (8,275)
Decrease (increase) in income taxes receivable (11,977) (143,227) --
Decrease in inventory 100,626 54,652 47,220
Decrease (increase) in prepaid expenses 98,779 119,616 (103,356)
Decrease (increase) in other accounts receivable 133,580 (30,796) (153,020)
Decrease (increase) in other assets 42,859 (202,799) --
Decrease (increase) in assets from discontinued operations 103,710 (267,046) (78,177)
Increase (decrease)in accounts payable and accrued liabilities 1,418,167 919,707 (304,370)
- ----------------------------------------------------------------------------------------------------------------------------
CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES (2,858,450) 264,031 1,640,659
- ----------------------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES
Purchase of property and equipment (1,430,962) (1,162,146) (601,633)
Proceeds from disposal of property and equipment -- -- 23,557
Proceeds from sale of Interlynx [Note 13[a]] 50,000 -- --
Investment in Viewer Services -- -- (36,054)
Increase in deposit on purchase (1,689,710) -- --
- ----------------------------------------------------------------------------------------------------------------------------
CASH USED IN INVESTING ACTIVITIES (3,070,672) (1,162,146) (614,130)
- ----------------------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES
Increase in notes and loans payable 5,006,134 21,908 38,485
Repayment of notes and loans payable (102,447) (67,436) (48,007)
Proceeds from exercise of options 26,243 281,134 --
- ----------------------------------------------------------------------------------------------------------------------------
CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES 4,929,930 235,606 (9,522)
- ----------------------------------------------------------------------------------------------------------------------------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS DURING THE (999,192) (662,509) 1,017,007
PERIOD
Cash and cash equivalents, beginning of period 1,355,613 2,018,122 1,001,115
- ----------------------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS, END OF PERIOD 356,421 1,355,613 2,018,122
- ----------------------------------------------------------------------------------------------------------------------------
Income taxes paid 98,491 59,956 265,771
Interest paid 146,781 121,579 67,356
F-6
2001 FISCAL YEAR - NON CASH ITEMS AROSE FROM THE PURCHASE OF CHELL.COM
ASSETS DURING THE 2001 FISCAL YEAR. THEY ARE $1,936,272 OF PROPERTY & EQUIPMENT,
$107,589 OF GOODWILL, $45,044 OF PREPAIDS, $1,404 IN OTHER ACCOUNTS RECEIVABLE
AND IN ADDITION SHARES WERE ISSUED (NOTE 13F). OTHER ASSETS OF $174,084 AROSE
FROM THE ISSUE OF WARRANTS, SHARES WERE ISSUED FOR CONSULTING FEES AND SALARIES
IN THE AMOUNT OF $659,359 ,SHARES WERE ISSUED FOR A DEBT PAYMENT ON THE GALAVU
PURCHASE IN THE AMOUNT OF $115,165, WRITE-OFF OF LEASEHOLDS OF $355,560 AND
WRITE-OFF OF PREPAIDS FROM CHELL PURCHASE OF $367,235.
2000 FISCAL YEAR - NON CASH ITEMS AROSE FROM THE PURCHASE OF GALAVU
ENTERTAINMENT NETWORK INC. DURING THE 2000 FISCAL YEAR. THEY ARE: $3,300,000 OF
LONG-TERM DEBT, AND THE ASSOCIATED UNAMORTIZED DISCOUNT OF ($637,302), ACCRETION
OF INTEREST OF $173,076 IN ACCRUED LIABILITIES; ASSUMPTION OF LIABILITIES OF
$529,440, $337,779 ONE-TIME COMPENSATION CHARGE ARISING FROM THE CHANGE IN THE
PREFERRED SHARE CONVERSION RATE AND THE ISSUANCE OF SHARES AMOUNTING TO
$295,360.
The accompanying notes are an integral part of these statement
1. DESCRIPTION OF BUSINESS AND OPERATIONS
Chell Group Corporation [the "Company"] was incorporated under the laws of the
State of New York on May 12, 1986. The Company is the holding company for NTN
Interactive Network Inc. ["Interactive"], GalaVu Entertainment Network Inc.
["GalaVu"] and Chell Merchant Capital Group ["CMCG"], all of which are
wholly-owned operating companies. The Company also owns all of the outstanding
stock of 3484751 Canada Inc., a corporation the Company established and
incorporated under the Canada Business Corporations Act on April 20, 1998.
Interactive owns all of the outstanding stock of Magic Lantern Communications
Ltd. ["Magic"]. Magic and its subsidiaries are involved in the marketing and
distribution of educational video and media resources. 3484751 Canada Inc. was
incorporated for the sole purpose of owning a property, purchased in 1998, on
behalf of the Company, which provides Magic and GalaVu with operating
facilities.
CMCG is incorporated under the Ontario Business Corporations Act and is a
technology buyout/operating company applying private equity principles and
capital market expertise to consolidate earnings and strategically grow the
solid, but undervalued public and private companies it acquires. CMCG's
acquisitions are strategically designed to support its long-term vision of the
technology market.
Interactive is incorporated under the Canada Business Corporations Act and has
signed a license agreement [the "NTNC license"] with NTN Communications, Inc.,
an unrelated Delaware company, for exclusive representation of their interactive
communications for all industry sectors in Canada. This interactive
entertainment network allows viewers to participate actively with a variety of
television programs, trivia and sports games. Present subscribers to the
Company's networks are hotels, restaurants, bars and university clubs. Each
subscriber either purchases the system hardware directly or rents the system
from Interactive. Interactive purchases the subscriber system from NTN
Communications, Inc. and various other suppliers. Following the installation,
each subscriber pays a monthly fee to Interactive for the program content and
maintenance services, which range from $650 to $750. The monthly fees for rental
systems range from approximately $255 to $290.
GalaVu is incorporated under the Ontario Business Corporations Act and is a
technology-based entertainment provider of interactive in-room entertainment
systems for small and mid-sized hotels. GalaVu's interactive system is based
upon proprietary technology and provides a suite of products including movies on
demand, premium television programming and other information and entertainment
services.
The Company's primary market to date has been Canada.
As shown in the financial statements, the Company incurred a net loss from
continuing operations of $9,622,841 during the year ended August 31, 2001 and,
as of that date, had a working capital deficiency of $4,432,000. The Company's
business plans for 2002 contemplates obtaining additional working capital
through refinancings or restructurings of its existing loan agreements, reducing
operating overhead (which has already begun through
F-7
workforce consolidation), and the possible sale of some of its existing
subsidiaries. Management is of the opinion that they will be able to obtain
enough working capital and that, together with funds provided by operations,
there will be sufficient working capital for the Company's requirements in the
future.
2. ECONOMIC DEPENDENCE
Interactive is dependent upon NTN Communications, Inc. as its sole supplier for
the transmission of program content to the Company's subscribers. In the event
that NTN Communications, Inc., which operates under the going-concern
assumption, terminates the transmission of program content, the Company
believes, but cannot assure, that such services are likely to be continued by
others. As of September 30, 2001, NTN Communications, Inc. had shareholders'
equity of $1,142,000 and a working capital deficit of $3,098,000 according to
its unaudited balance sheet included in its quarterly report. NTN
Communications, Inc. has reported a quarterly net loss for September 2001 of
$732,000, a quarterly net loss for June 2001 of $949,000 and a quarterly net
loss for March 2001 of $1,578,000. It reported a net loss for the year ended
December 31, 2000 of $9,589,000. All such amounts are quoted in U. S. dollars
[NOTE 9].
3. SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
These consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America. They
are expressed in Canadian dollars which is the currency of the primary economic
environment in which operations are conducted.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenue and expenses during the reporting period. Actual
results could differ from those estimates.
BASIS OF CONSOLIDATION
These consolidated financial statements include the accounts of the Company, its
wholly-owned subsidiaries Interactive, Magic, GalaVu, 3484751 Canada Inc.,
Interlynx, CMCG and Chell.com USA Inc. Magic conducts its operations directly
and through its wholly-owned subsidiaries, 1113659 Ontario Ltd. ["Viewer
Services"] and Tutorbuddy Inc. ["Tutorbuddy"], and its 75% ownership of Sonoptic
Technologies Inc. ["STI"]. Effective June 16, 1999, Magic acquired an additional
50% of the shares of Viewer Services, thereby making Viewer Services a
wholly-owned subsidiary of Magic. On September 10, 1997, effective September 1,
1997, Interactive acquired 51% of the outstanding shares of Interlynx. On June
1, 1999, Interactive acquired the remaining 49% of the outstanding shares of
Interlynx. Effective June 30th 2001, the Company signed an agreement to sell
Interlynx, a wholly-owned subsidiary of NTN for $50,000 and a promissory note of
$45,000. The Company's financial statements have been restated to reflect
Interlynx as a discontinued operation for all periods presented. The Company
uses the equity method for investments in which it owns less than 51%.
The 25% minority interest liability in STI has been reflected at zero due to
operating losses.
All significant intercompany transactions have been eliminated.
FOREIGN EXCHANGE TRANSLATION
F-8
U.S. dollar accounts in these consolidated financial statements are translated
into Canadian dollars on the following bases:
[a]The assets and liabilities denominated in foreign currencies are translated
at the exchange rate in effect at the consolidated balance sheet dates.
[b] Revenue and expenses are translated at a rate approximating the rates of
exchange prevailing on the dates of the transactions.
[c] Any gains and losses on foreign currency transactions are recorded in
operations as incurred.
REVENUES
Revenue from network services is recognized on a monthly basis beginning when
the systems are installed on the purchasers' premises. The payment terms are on
a monthly basis.
Revenue from Pay-tv is recognized at the time of viewing. Revenue from event
programming is recognized upon completion of the contract.
Revenue from advertising sponsorship is recognized on a monthly basis over the
term of the contract.
Revenue from video sales and video dubbing is recognized upon shipment.
Software sales are recognized in accordance with the American Institute of
Certified Public Accountants Statement of Position (SOP) 97-2, "Software Revenue
Recognition." Pursuant to SOP 97-2, software sales are recognized on sales
contracts when all of the following conditions are met: a signed contract is
obtained, delivery has occurred, the total sales price is fixed and
determinable, collectibility is probable, and any uncertainties with regard to
customer acceptance are insignificant. For those contracts that include a
combination of software and services, sales are allocated among the different
elements based on company-specific evidence of fair value of each element. Sales
allocated to software are recognized as the above criteria are met. Sales
allocated to services are recognized as services are performed and accepted by
the customer or, for maintenance agreements, ratably over the life of the
related contract.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash and term deposits, which mature in less
than three months from the date of issue. The carrying value of term deposits
approximates their fair values.
SHORT-TERM INVESTMENTS
Investments at August 31, 2001 and 2000 consist of debt securities and
marketable equity securities. The Company has classified its portfolio as
"trading". Trading securities are bought and held principally for the purpose of
selling them in the near term and are recorded at fair value. Unrealized gains
and losses on trading securities are included in the determination of net income
(loss) for the year. The fair value of these securities represents current
quoted market offer prices.
INVENTORY
Inventory consists of finished goods held for sale or rent, which are valued at
the lower of cost, using the first-in, first-out method, and net realizable
value.
F-9
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost less accumulated depreciation.
Equipment is depreciated using a declining balance rate of 20%. Computer
equipment as well as masters and libraries are depreciated using a declining
balance rate of 30%. Automobiles are depreciated on a straight-line basis over 3
years, buildings on a straight-line basis over 25 years, software on a
straight-line basis over 3 years and rental equipment and leasehold improvements
both on a straight-line basis over 5 years.
On an ongoing basis, management reviews the valuation and depreciation of
property and equipment, taking into consideration any events and circumstances
which might have impaired the carrying value. The Company assumes there is an
impairment if the carrying amount is greater than the expected net future cash
flows. The amount of impairment, if any, is measured based on projected
discounted future cash flows, using a discount rate that reflects the Company's
average cost of funds.
SOFTWARE DEVELOPMENT COSTS
The Company capitalizes the costs of software development when technological
feasibility of the computer software product is established. Capitalization of
software ceases when the product is available for release to customers.
Capitalized costs are amortized on the basis of products sold.
LICENSES AND GOODWILL
Licenses are stated at cost less accumulated amortization. Amortization for the
NTNC license is provided over a 25-year period using the straight-line basis to
December 31, 2015. Accumulated amortization amounted to $137,512 [2000-
$125,010].
On August 28, 1998, the Company entered into an agreement [the "Players
license"] for $78,401 [U.S.$50,000] with Players Network Inc. ["Players"],
whereby the Company was appointed by Players as the exclusive Canadian
distributor of its products. The Company was also granted the irrevocable
option, by Players, to purchase from treasury up to 50,000 common shares in the
capital stock of Players, at a purchase price of $1.75 per share (U.S.). This
option expired on August 28, 2000 and was not exercised. The agreement provided
the Company the right to terminate the agreement for the 30-day period
immediately following the end of the first year of the term of the agreement. In
the event the agreement is so terminated, the Company would receive, from
treasury, 50,000 common shares in the capital stock of Players. The agreement
was not terminated. Amortization of this license is provided over a 10-year
period using the straight-line basis to 2009. Accumulated amortization amounted
to $23,539 [2000 - $15,693].
Goodwill is stated at cost less accumulated amortization. Amortization is
provided using the straight-line basis over a period varying from 10 to 20
years, depending on the transaction that generated the goodwill. Accumulated
amortization amounted to $831,944 [2000 - $691,120], net of amounts included in
discontinued operations.
On an ongoing basis, management reviews the valuation and amortization of the
licenses and goodwill, taking into consideration any events and circumstances
which might have impaired the fair value. The Company assumes there is an
impairment if the carrying amount is greater than the expected net future cash
flows. The amount of impairment, if any, is measured based on projected
discounted future cash flows, using a discount rate that reflects the Company's
average cost of funds. (See "Recent Pronouncements" below)
OTHER ASSETS
Other assets are stated at cost net of amortization. Amortization is provided
using a straight-line basis over the estimated life of the assets.
F-10
INCOME TAXES
The Company accounts for deferred income tax assets and liabilities based on the
difference between the financial statement and tax basis of assets and
liabilities using enacted tax rates in accordance with SFAS No. 109. [see note
7].
EARNINGS PER SHARE
Basic earnings per share are computed by dividing income available to common
shareholders by the weighted average number of common shares outstanding for the
period excluding contingent shares issued in accordance with SFAS No. 128.
Diluted earnings per share are calculated in accordance with the treasury stock
method and are based on the weighted average number of common shares and
dilutive common share equivalents outstanding.
EMPLOYEE STOCK OPTIONS
The Company accounts for its stock option plans and its employee stock purchase
plan in accordance with the provisions of the Accounting Principles Board's
Opinion No. 25, "Accounting for Stock Issued to Employees" ["APB 25"]. [see
"Recent Pronouncements" below and note 10[c]].
RECENT PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board (FASB) issued Statements
of Financial Accounting Standards, No. 141, BUSINESS COMBINATIONS, and No. 142,
GOODWILL AND OTHER INTANGIBLE ASSETS, effective for fiscal years beginning after
December 15, 2001. Under the new rules, the pooling of interests method of
accounting for business combinations is no longer allowed and goodwill and
intangible assets deemed to have indefinite lives will no longer be amortized
but will be subject to annual impairment tests in accordance with the
Statements. Other intangible assets will continue to be amortized over their
useful lives.
In March 2000, FASB issued Interpretation No. 44 (FIN 44), "Accounting for
Certain Transactions involving Stock Compensation, an Interpretation of APB
Opinion No. 25." FIN 44 clarifies the application of APB No. 25 for certain
issues, including the definition of an employee, the treatment of the
acceleration of stock options and the accounting treatment for options assumed
in business combinations. FIN 44 became effective on July 1, 2000, but is
applicable for certain transactions dating back to December 1998. The adoption
of FIN 44 did not have a material impact on the Company's financial position or
results of operations.
In December 1999, the Securities and Exchange Commission (SEC) issued Staff
Accounting Bulletin (SAB) No. 101, "Revenue Recognition in Financial
Statements." (SAB No. 101). SAB No. 101 expresses the views of the SEC staff in
applying generally accepted accounting principles to certain revenue recognition
issues. The Company has adopted the provisions of SAB No. 101 in the first
quarter of fiscal 2001 and its adoption had no material impact on its financial
position or its results of operations.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities."(SFAS No. 133). SFAS No. 133, as amended by
SFAS No. 138, establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts (collectively referred to as derivatives) and for hedging activities.
SFAS No. 133 requires the recognition of all derivatives as either assets or
liabilities in the statement of financial position and the measurement of those
instruments at fair value. The Company was required to adopt this standard in
the first quarter of fiscal year 2001 pursuant to SFAS No. 137 (issued in June
1999), which delayed the adoption of SFAS No. 133 until that time. The Company's
adoption of SFAS No. 133 did not have a material impact on the its financial
position or its results of operations.
F-11
4. SHORT-TERM INVESTMENTS
Short-term investments consist of the following:
2001 2000
$ $
- --------------------------------------------------------------------------------
Shares 19,676 --
Money market funds -- 166,175
Debt securities
U.S. treasury securities -- 103,552
- --------------------------------------------------------------------------------
19,676 269,727
================================================================================
5. NOTE RECEIVABLE
The details of the note receivable are as follows:
2001 2000
$ $
- --------------------------------------------------------------------------------
LONG-TERM
Connolly-Daw Holdings Inc. 160,000 160,000
- --------------------------------------------------------------------------------
160,000 160,000
================================================================================
The unsecured note receivable from Connolly-Daw Holdings Inc. ["Connolly-Daw"]
bears interest at the bank's prime rate, calculated and payable monthly, not in
advance. The note is payable on demand, however, the Company does not intend to
call the note within the next fiscal year. The President and Secretary of
Connolly-Daw are the Controller and Chief Executive Officer of Magic. The bank's
prime rate was 5.75% at August 31, 2001 [2000 - 7.5%].
6. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
2001 2000
---------------------------------------- ----------------------------------------
ACCUMULATED NET BOOK Accumulated Net book
COST DEPRECIATION VALUE Cost depreciation value
$ $ $ $ $ $
- ---------------------------------------------------------------------------------------------------------------
Land 785,500 -- 785,500 785,500 -- 785,500
Buildings 1,480,401 260,489 1,219,912 1,480,401 227,505 1,252,896
Rental Equipment 3,911,487 3,574,523 336,964 3,880,304 2,886,104 994,200
Equipment 6,233,095 2,663,991 3,569,104 5,357,321 1,585,572 3,771,749
Software 810,166 301,571 508,595 591,253 151,069 440,184
Automobiles 13,383 12,559 824 13,383 8,829 4,554
Computer Equipment 1,088,304 474,908 613,396 370,084 246,661 123,423
Masters and Libraries 937,056 467,547 469,509 545,949 281,560 264,389
Leasehold improvements 1,020,353 263,875 756,478 113,301 60,576 52,725
- ---------------------------------------------------------------------------------------------------------------
16,279,745 8,019, 463 8,260,282 13,137,496 5,447,876 7,689,620
===============================================================================================================
During the year, depreciation of property and equipment was $2,667,248 [2000 -
$2,035,985; 1999 - $1,212,038].
F-12
7. INCOME TAXES AND DEFERRED INCOME TAXES
The provision for income taxes consists of the following:
2001 2000 1999
$ $ $
- --------------------------------------------------------------------------------
Current
FEDERAL -- -- 98,000
PROVINCIAL -- -- 52,000
- --------------------------------------------------------------------------------
-- -- 150,000
================================================================================
The difference between the provision for income taxes and the amount computed by
applying the combined basic federal and provincial income tax rate of 42.1%
[2000 - 43.9%; 1999 - 44.6%] to income before income taxes is as set out below:
2001 2000 1999
Taxes on continuing operations $ $ $
- ---------------------------------------------------------------------------------------------------
STATUTORY RATE APPLIED TO PRE-TAX LOSS (4,051,216) (509,125) (285,001)
Benefit of current year's losses not recognized 3,734,669 405,563 344,782
Expenses not deductible for tax purposes 316,547 117,745 167,333
Non-taxable accounting income -- -- (42,482)
Other -- (14,183) (34,632)
- ---------------------------------------------------------------------------------------------------
-- -- 150,000
===================================================================================================
2001 2000 1999
Taxes on discontinued operations $ $ $
- ---------------------------------------------------------------------------------------------------
STATUTORY RATE APPLIED TO LOSS FROM DISCONTINUED (675,025) (376,406) (101,357)
OPERATIONS
Loss of subsidiary sold during the year (539,922) -- --
Capital loss on sale of subsidiary 1,064,133 -- --
Benefit of current year's losses not recognized 150,814 376,406 101,357
- ---------------------------------------------------------------------------------------------------
-- -- --
===================================================================================================
As at August 31, 2001, the Company's deferred tax assets primarily relating to
the benefit of realizing losses available for carry forward and the timing
difference of the write-off of property and equipment, net of a valuation
allowance of $5,600,000, were nil (2000 - nil after a valuation allowance of
$1,600,000).
At October 1, 1996, Magic and its subsidiaries had aggregate operating losses of
$676,000. The purchase price of Magic has not been allocated to the operating
losses since a valuation allowance has been charged against the entire amount.
During 1999, $152,000 of these losses were applied to reduce taxable income. In
2000 and 2001 Magic did not have taxable income.
Accordingly, when realized, the tax benefit of the unrecognized loss
carryforwards will be applied to reduce goodwill related to the acquisitions of
Magic. The goodwill related to Magic was reduced by $51,687 as a result of
utilizing pre-acquisition losses during 1999.
At August 31, 2001, the Company and certain subsidiaries have non-capital loss
carryforwards of approximately $12,000,000 that can be carried forward against
future taxable income and capital losses of approximately
F-13
$2,500,000 that can be carried forward indefinitely against capital gains
realized in future years. The non-capital losses begin to expire in 2002.
F-14
8. LOANS AND NOTES PAYABLE
Loans and notes payable consists of the following:
2001 2000
$ $
- ------------------------------------------------------------------------------------------
LOANS PAYABLE
Provincial Holdings Ltd. ["PHL"] [I] 750,000 750,000
Province of New Brunswick ["PNB"] [II] -- 19,381
Atlantic Canada Opportunities Agency ["ACOA"] [III] 27,700 36,930
ACOA [IV] 32,985 38,485
ACOA [V] 18,608 21,908
Royal Bank of Canada [VI] 1,206,478 1,243,151
- ------------------------------------------------------------------------------------------
2,035,771 2,109,855
- ------------------------------------------------------------------------------------------
NOTES PAYABLE
Richard Wolfe 69,778 --
Debenture & Note Payable [VII & VIII, LESS DISCOUNT OF 3,530,233 --
1,360,517 AND 0, RESPECTIVELY.]
Promissory notes - GalaVu [NOTE 13[E]] 2,662,698 2,662,698
- ------------------------------------------------------------------------------------------
7,623,226 2,662,698
- ------------------------------------------------------------------------------------------
Liens notes -- 2,119
- ------------------------------------------------------------------------------------------
8,298,480 4,774,672
=========================================================================================
[i] In June 1995, PHL advanced $750,000 to STI. This loan is collateralized by a
demand promissory note signed by STI and bears interest at 6% per annum,
compounded annually, commencing October 1995. Interest was forgiven by PHL for
the period from October 1, 1995 to September 30, 2000. The carrying value of the
loan approximates its fair value. Subsequent to September 2000, the loan bears
interest at 6.75% compounded annually.
The loan is subject to an agreement dated March 15, 1995 which, inter
alia, provides for repayment in full of principal plus interest at the earlier
of [a] the commencement of redemption of shares pursuant to a redemption
agreement [NOTE 9[D]] or [b] September 30, 2002 subject to any extension agreed
to, or [c] on any breach of STI's obligations under the loan agreement or any
other agreement with PHL.
[ii] In June 1995, PNB advanced $100,000 to STI. The loan was subject to a loan
agreement dated May 25, 1995 and was secured by a demand promissory note which
bears interest at 9.7% per annum, calculated half-yearly, not in advance.
Subject to a forgiveness agreement outlined below, the principal plus interest
was repayable at the earlier of [a] January 31, 1998 or earlier at the option of
STI or [b] any breach of STI's obligations under the loan agreement.
A forgiveness agreement dated May 24, 1995 provides that the principal
plus interest may be forgiven in whole or in part, the amount dependent upon
STI's number of full-time employees during the 1997 calendar year. The loan was
fully forgiven during the year ended August 31, 2001.
[iii] ACOA advanced this unsecured non-interest bearing loan to STI in April
1995. The loan is repayable in five equal quarterly installments of $7,040
commencing May 1, 2000 and one final installment of $1,730. The fair value of
the loan approximates its carrying value.
[iv] ACOA advanced this unsecured non-interest bearing loan to STI in May 1999.
The loan can be increased to a maximum of $108,356. The balance drawn on this
loan at August 31, 2001 is $32,985. Commencing on
F-15
October 1, 2000, the loan was repayable as follows: six consecutive monthly
installments of $500, followed by; six consecutive monthly installments of
$1,000, followed by; six consecutive monthly installments of $1,500, followed
by; six consecutive monthly installments of $2,000, followed by; three
consecutive monthly installments of $2,500, followed by; one final installment
of $985.
The fair value of the loan approximates its carrying value.
[v] ACOA advanced this unsecured non-interest bearing loan to STI in September
2000. The loan can be increased to a maximum of $23,038. The balance drawn on
this loan at August 31, 2001 is $18,608. If the loan is increased to the
maximum, the loan would be repayable in seventy-nine equal consecutive, monthly
installments of $275, followed by one final installment of $183. The fair value
of the loan approximates its carrying value.
[vi] In April 1998, the Royal Bank of Canada made available a Matched Fund Term
Loan in the amount of $1,319,000 in order to finance the purchase of 10 Meteor
Drive, including leaseholds, and to refinance the demand installment loan on 775
Pacific Road, a property owned by Magic. Borrowings are repayable by blended
monthly payments of principal and interest based on a 20-year amortization
period with the balance due and payable at the end of the 5-year term on April
27, 2003. The interest rate in effect for the first 5-year term of the loan is
6.98%. The fair value of the loan approximates its carrying value.
The loan is collateralized by a fixed debenture of $1,000,000,
hypothecated to Magic's land and buildings, a guarantee and postponement of
claim of $650,000 signed by Magic, a collateral first mortgage in the amount of
$490,000 covering the property at 10 Meteor Drive, and a general security
agreement covering all the assets of Interactive, other than real property.
[vii] On January 15, 2001, the Company received US$1,500,000 in return for a
promissory note. The note bears interest at 2% per month and US$1,000,000 of the
principal and accrued interest is due and payable on December 5, 2001. The
remaining balance will be paid in seven monthly payments of $100,000 commencing
January 15th, 2001 with a final payment of $8,750 due on August 5, 2002.
[viii] On October 3, 2000, the Company closed the sale of a US$3,000,000
Convertible 10% Debenture to the VC Advantage Limited Partnership ("VCALP"). As
at August 31, 2001, US$1,700,000 has been advanced. This unsecured convertible
debenture is due three years from issue. EITF-00-27 "Application of Issue No.
98-5 to Certain Convertible Instruments" requires that a discount be recorded
for any beneficial conversion features associated with convertible debt. The
Company has recorded a discount of $1,959,144 in October 2000 and has amortized
$589,981 to interest expense for the year ended Aug 31, 2001. The Convertible
Debenture bears interest at 10% per annum, payable upon conversion, redemption
or maturity. The unpaid principal of the debenture bears interest from the date
that it is actually advanced until paid. Interest is payable in cash or stock at
our option. The Convertible Debenture is convertible into common stock, at
US$3.00 per share, in amounts specified by the VCALP. The maximum number of
common shares VCALP will receive is one million. On the close date, the Company
also issued 50,000 warrants to purchase 50,000 common shares at US$3.00 per
share to VCALP. The warrants have a term of four years. On November 30, 2000 the
convertible debenture was assigned by VCALP to CALP II Limited Partnership.
Approximate future annual principal payments for long-term debt, exclusive of
the above lien notes, are as follows:
$
------------------------------------------
2002 3,774,658
2003 2,615,493
2004 3,243,653
2005 8,800
2006 8,800
2007 and thereafter 7,593
------------------------------------------
9,658,997
=========================================
F-16
9. COMMITMENTS
[a] Commissions expense to NTN Communications, Inc.
Pursuant to an agreement dated March 23, 1990, Interactive pays
commissions to NTN Communications, Inc. when the related revenues are earned at
the rate of U.S. $2,205 per year per subscriber. Interactive also pays NTN
Communications, Inc. a royalty fee equal to 25% of the net revenues as defined
in the agreement derived from all services except for certain hospitality and
special projects that existed at March 23, 1990; a royalty fee equal to the
production quotation submitted by NTN Communications, Inc. plus 10% of the gross
profit of special projects [special broadcasts for a non-continuous selective
event]; and a one-time royalty fee equal to NTN Communications, Inc.'s
production costs for any new programming developed by Interactive to be added to
the existing programming schedule. The agreement expires on December 31, 2015.
Total amounts expensed in the year under this agreement were $1,865,674 [2000 -
$1,822,684; 1999 - $2,011,202].
[b] Commissions expense - other
Commissions expense to sub-licensees is recognized when the related revenues are
earned and are calculated as follows:
[i] 30% of all fees received by Interactive under any Commercial User
Agreement as then in effect if such agreement is executed through the efforts of
the sub-licensee where the establishment subject to the Commercial User
Agreement is located within the territory during the first term of any such
agreement;
[ii] 10% of all net fees received by Interactive from National Advertisers
[sponsors] based on the number of Commercial User locations within the
territory; and
[iii] 5% of all net fees received by Interactive under any Residential User
Agreement within the territory, which may only be solicited by Interactive
directly.
All commission payments are made to sub-licensees no later than the
15th of the month immediately following the month in which user fees and sponsor
fees, from which said commissions are earned, are received and collected by
Interactive.
[c] Lease commitments
The future minimum annual lease payments under operating leases are as follows:
Vehicles $
-------------------------------------------------
2002 19,915
2003 4,794
2004 9,189
2005 --
2006 --
2007 and thereafter --
-------------------------------------------------
33,898
=================================================
F-17
Office Equipment $
-------------------------------------------------
2002 150,578
2003 76,327
2004 54,197
2005 --
2006 --
2007 and thereafter
-------------------------------------------------
281,102
=================================================
Premises $
-------------------------------------------------
2002 493,190
2003 380,564
2004 380,564
2005 71,086
2006 --
2007 and thereafter --
-------------------------------------------------
1,325,404
=================================================
Operating lease expenses were $570,616 for 2001, $382,610 for 2000, and $201,366
for 1999.
[d] Redemption of shares of subsidiary
STI, a subsidiary, has entered into a redemption agreement dated March 15, 1995
with its minority shareholder [25% of common shares held], PHL. Shares held by
PHL may be redeemed by STI in minimum numbers of five after December 31, 1997
provided STI has repaid all indebtedness to PHL and PNB, or the PNB indebtedness
has been forgiven, and must be redeemed in full on or before September 20, 2002.
The redemption price is calculated at the higher of [i] the purchase price per
share [$0.04], or [ii] the purchase price per share plus the increase per share
in retained earnings of the corporation to the date of redemption, calculated by
adding back to the retained earnings the pro rata share applicable to the number
of shares being redeemed, of all interest paid or accrued on the loan by PHL and
to the corporation in the amount of $750,000 and deducting therefrom the
interest actually paid, pro rata to the number of shares being redeemed. There
has been no repayment on the loan as at August 31, 2001.
As at August 31, 2001, the value of the shares, if redeemed, totaled a nominal
amount.
[e] Standby letters of credit
GalaVu has a $100,000 standby letter of credit in favour of one of its
suppliers. Any amounts drawn on this facility are charged to our bank account.
These facilities have not been used in 2001, 2000 or 1999.
[f] Employment agreements
The Company and certain subsidiaries have entered into employment agreements
with certain executive management employees with terms of between one and two
years. These agreements expire in fiscal 2002. The remaining commitment for 2002
is approximately $208,000.
On September 19, 2000, the Company entered into an employment agreement with
Cameron Chell, pursuant to which Mr. Chell serves as the Company's President and
Chief Executive Officer. The agreement provides for an initial base compensation
of $360,000, together with automobile expenses of $8,400. In addition to the
fixed remuneration, the Company shall provide Mr. Chell with the services of an
Executive Assistant on an ongoing basis and an Accountant for a reasonable
period of time to allow for the completion of outstanding accounting work
F-18
related to existing companies in which Mr. Chell is involved. It was the
understanding of the parties that this agreement was to be replaced by a
definitive employment agreement before October 10, 2000, however, such agreement
has not been entered into at this time. Since the signing of this agreement, Mr.
Chell has eliminated both his salary and automobile allowance in an effort to
reduce our cash requirements. These were eliminated with the understanding that
the compensation of Mr. Chell will be mutually agreed upon between the parties.
10. SHARE CAPITAL
[a] Authorized shares
The Company's authorized share capital comprises 50,000,000 common shares
(increased from 20,000,000 shares on February 28, 2001),with a par value of
$0.063 [U.S. $0.0467] per share and 1,500,000 non-cumulative preferred shares
with a par value of $0.012 [U.S. $0.010] per share. The preferred shares are
voting and convertible, such that 3 preferred shares are exchangeable for 1
common share, at the option of the holders. The conversion rate in 1999 was such
that 4.67 preferred shares were exchanged for 1 common share, at the option of
the holders.
[b] Issued and outstanding shares
As at August 31, 2001, there were no preferred shares outstanding [2000 -
900,000 aggregating - $10,917] . On March 30, 2001, these 900,000 preferred
shares were converted to 300,000 common shares.
Common shares issued and outstanding for accounting purposes are as follows:
COMMON SHARES CAPITAL IN
--------------------------- EXCESS OF PAR
NUMBER AMOUNT VALUE TOTAL
# $ $ $
=========================================================================================================
BALANCE AS AT AUGUST 31, 1998 2,625,170 162,484 8,837,948 9,000,432
Payment for services rendered 5,500 387 26,557 26,944
Interlynx acquisition [NOTE 13[A]] 27,778 1,920 93,171 95,091
Conversion of promissory notes [I] 98,193 6,844 602,207 609,051
- ---------------------------------------------------------------------------------------------------------
BALANCE AS AT AUGUST 31, 1999 2,756,641 171,635 9,559,883 9,731,518
GalaVu acquisition [NOTE 13 [E]] 100,000 6,897 288,463 295,360
Exercise of 68,500 stock options 68,500 4,703 276,431 281,134
Change in preferred shares conversion rate -- 7,887 329,892 337,779
- ---------------------------------------------------------------------------------------------------------
BALANCE AS AT AUGUST 31, 2000 2,925,141 191,122 10,454,669 10,645,791
Purchase of assets and shares from
Chel.com Ltd. and Cameron Chell 5,426,772 372,923 2,229,291 2,602,214
[NOTE 13[F]]
Issued in lieu of salary 131,974 9,484 315,577 325,061
Settlement of debt 36,602 2,694 109,085 111,779
Preferred shares converted 300,000 13,065 (9) 13,056
Warrants -- -- 117,359 117,359
Consulting fees rendered 145,000 10,405 456,218 466,623
Beneficial conversion feature on debt -- -- 1,959,144 1,959,144
Exercise of 62,750 stock options 62,750 4,416 208,637 213,053
- ---------------------------------------------------------------------------------------------------------
BALANCE AS AT AUGUST 31, 2001 (RESTATED) 9,028,239 604,109 15,849,971 16,454,080
=========================================================================================================
[i] The consideration for the acquisition of Magic [NOTE 13[C]] included
promissory notes with a maturity value of $1,250,000. Under the terms of the
purchase agreement, the Company elected to issue common shares as payment
against $560,000 of these notes during fiscal 1998. In fiscal 1999, the Company
elected to issue shares to pay the remaining $609,051 outstanding on the
promissory notes.
[c] Long-Term Incentive Plan
F-19
The Company has adopted a Long-Term Incentive Plan [the "Plan"] designed to
compensate key employees of our Company for the performance of their corporate
responsibilities. The benefits to employees under the Plan are dependent upon
improvement in market value of the Company's common shares. The Plan offers
selected key employees the opportunity to purchase common shares through the
exercise of a stock option. An option entitles the employee to purchase common
shares from the Company at a price determined on the date the option is granted.
The option exercise price is the closing trading price of the stock on the day
prior to the grant date. The options vest over a four-year period from the grant
date, at the rate of 25% per year. Options granted prior to August 31, 1998 vest
over a two-year period from the grant date, 50% after one year and 50% at the
end of the second year. The options expire five years after the grant date. The
Plan also provides that selected key employees may receive common shares as an
award of Restricted Stock. Restricted Stock consists of common shares that are
awarded subject to certain conditions, such as continued employment with the
Company or an affiliate for a specified period. Up to 20% of the outstanding
common stock, on a fully diluted basis on the date of the grant, excluding
outstanding options may be issued under the plan.
The following is a summary of outstanding stock options:
WEIGHTED AVERAGE TOTAL
EXERCISE PRICE
U.S. $ #
-----------------------------------------------------------------------
BALANCE AS AT AUGUST 31, 1998 460,000
Issued 2.30 285,000
Forfeited 2.41 (18,500)
Expired 2.33 (7,500)
-----------------------------------------------------------------------
BALANCE AS AT AUGUST 31, 1999 719,000
Issued 9.42 772,000
Exercised 2.79 (68,500)
Expired 2.92 (125,500)
-----------------------------------------------------------------------
BALANCE AS AT AUGUST 31, 2000 1,297,000
Issued 4.33 94,500
Exercised 2.68 (62,750)
Expired 2.40 (3,750)
-----------------------------------------------------------------------
BALANCE AS AT AUGUST 31, 2001 1,325,000
=======================================================================
Exercise price EXPIRY DATE TOTAL
U.S. $ #
-----------------------------------------------------------------------
3.00 November 20, 2001 47,000
3.00 November 25, 2001 [I] 56,750
3.00 April 8, 2002 [I] 1,500
3.00 November 17, 2002 [I] 115,500
3.00 November 20, 2002 15,000
2.00 November 23, 2003 141,250
3.50 February 25, 2004 1,500
3.00 June 11, 2004 [NOTE 13[A]] 80,000
2.00 October 14, 2004 75,000
1.81 November 23, 2004 30,000
4.375 April 3, 2005 25,000
9.75 August 11, 2005 642,000
9.75 November 1, 2005 23,000
3.50 December 6, 2005 71,500
-----------------------------------------------------------------------
BALANCE AS AT AUGUST 31, 2000 1,325,000
=======================================================================
[i] Repriced options - At a meeting of the Company's Board of Directors on
July 10, 1998, the Board determined that it was in the best interests of the
Company to offer the holders of options, pursuant to the Company's Long-Term
Incentive Plan, a reduction in the exercise price of outstanding options to
$3.00 per share if the option holders agreed not to exercise such options for at
least six months after the repricing. Option holders were given the
F-20
choice of keeping their existing option pricing in lieu of agreeing not to
exercise such options for six months. All option holders chose to receive
repriced options. The repriced option exercise amount is the closing trading
price of the Company's stock on July 9, 1998.
The number of stock options that are exercisable at August 31, 2001 is 761,163
[2000 - 363,666].
The weighted average fair value of options granted during 2001 was U.S.
$1.17 [2000 - U.S $5.51].
The Company accounts for its stock option plans and its employee stock purchase
plan in accordance with the provisions of APB 25. Accordingly, because the
exercise price of the employee stock options equals the market price of the
underlying stock on the date of grant, no compensation expense has been
recognized in the consolidated financial statements for these plans.
Pro forma information regarding net income and earnings per share is required by
FAS 123, and has been determined as if we had accounted for its employee stock
options under the fair value method of that statement. The fair value for these
options was estimated at the date of grant using a Black-Scholes option
valuation model with the following weighted average assumptions for 2001, 2000
and 1999: risk-free interest rate of 5.39% [2000 - 5.84%; 1999 - 5.32%];
dividend yield of 0% [2000 - 0%; 1999 - 0%]; volatility factor of 0.707 [2000 -
0.848; 1999 - 0.819]; and a weighted average expected life of the options of 3
years [2000 - 4 years; 1999 - 4 years].
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options that have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
our stock options have characteristics significantly different from those of
traded options, and because changes in the subjective input assumptions can
materially affect the fair value estimate, in management's opinion, the existing
models do not necessarily provide a reliable single measure of the fair value of
its employee stock options.
The Company's pro forma net loss and loss per share follows:
2001 2000 1999
-------------------------------------------------------------------------
$ $ $
Pro forma net loss (13,000,844) (2,518,310) (1,399,105)
=========================================================================
PRO FORMA LOSS PER SHARE
Basic (1.55) (0.88) (0.53)
Diluted (1.55) (0.88) (0.53)
=========================================================================
F-21
11. EARNINGS (LOSS) PER SHARE
Earnings (loss) per share were calculated in accordance with Statement of
Financial Accounting Standards No. 128. The following table sets forth the
computation of basic and diluted earnings (loss) per share for the years ended
August 31:
- -------------------------------------------------------------------------------------------------------------
2001 2000 1999
$ $ $
=============================================================================================================
NUMERATOR
Net income (loss) [numerator for basic earnings (loss) $(11,747,639) $(2,323,621) $(971,497)
per share]
Accretion of interest on non-interest bearing convertible $183,513 $173,076 $31,084
promissory notes (anti-dilutive)
Numerator for diluted earnings (loss) per share $(11,564,126) $(2,150,545) $(940,413)
DENOMINATOR
For basic weighted average number of shares 8,393,589 2,873,042 2,635,050
EFFECT OF DILUTIVE SECURITIES
Convertible preferred shares -- -- --
Convertible promissory notes -- -- --
Employee stock options -- -- --
Denominator for diluted earnings (loss) per share - adjusted
weighted average number of shares and assumed conversions 8,393,589 2,873,042 2,635,050
Basic loss per share $(1.38) $(0.81) $(0.36)
Diluted loss per share $(1.38) $(0.81) $(0.36)
=============================================================================================================
During the year ended August 31, 2001, 900,000 preferred shares convertible to
300,000 common shares were exercised and are no longer outstanding. In addition,
options to purchase 1,325,000 common shares were outstanding. These securities
were not included in the diluted loss per share calculation because the effect
would be anti-dilutive.
At August 31, 2000, 900,000 preferred shares convertible to 300,000 common
shares were outstanding. In addition, options to purchase 1,297,000 common
shares were outstanding. These securities were not included in the diluted loss
per share calculation because the effect would be anti-dilutive.
At August 31, 1999, 900,000 preferred shares convertible to 192,857 common
shares were outstanding. In addition, options to purchase 719,000 common shares
were outstanding. These securities were not included in the diluted loss per
share calculation because the effect would be anti-dilutive.
12. CONTINGENT LIABILITIES
On June 12, 1992, the Company filed a lawsuit against an unrelated company,
Interactive Network Inc. of Mountainview, California, U.S.A. and its president.
The suit seeks a non-infringement declaration with respect to a Canadian patent.
This action was discontinued on September 9, 1998.
F-22
On June 18, 1992, Interactive Network Inc., a third party, instituted
proceedings against Communications, NTN Interactive Network Inc. and the Company
in the Federal Court of Canada and in the California Supreme Court claiming
patent infringement. It is the opinion of our Company's management and counsel,
that this patent infringement claim will be successfully defended.
Canada Customs and Revenue Agency is currently in discussions with the Company
regarding a potential liability with respect to withholding tax on certain
amounts paid to Communications. An assessment of approximately $600,000 has been
made to date by Canada Customs and Revenue Agency and the Company has filed a
notice of objection. Management and counsel believe that it has valid defenses
with respect to these matters and, accordingly, no amount has been recorded in
these consolidated financial statements. In the event that such matters are
settled in favour of Canada Customs and Revenue Agency, the amounts could be
material and would be recorded in the period in which they became determinable.
The Company and its property are not a party or subject to any other material
pending legal proceedings, other than ordinary routine litigation incidental to
its business. To the knowledge of management no other proceedings of a material
nature have been or are contemplated against the Company.
13. BUSINESS ACQUISITIONS/DISPOSITIONS
[A] INTERLYNX MULTIMEDIA INC.
Effective September 1, 1997, the Company acquired 51% of Interlynx and its
subsidiary for a purchase price of $622,000. The purchase price was satisfied by
$357,000 in cash and the issue of 55,209 shares with a value of $4.80 per share.
The acquisition was recorded using the purchase method of accounting and,
accordingly, the purchase price has been allocated as set out below:
$
---------------------------------------------------------
Goodwill 1,136,029
Net liabilities assumed (491,028)
Acquisition costs capitalized (23,001)
---------------------------------------------------------
PURCHASE PRICE 622,000
=========================================================
The excess of cost over net tangible assets (net of liabilities) acquired of
$1,136,029 was allocated to goodwill, which is being amortized over twenty
years.
The Company's 51% share of the operating results of Interlynx are included in
our consolidated statements of operations and retained earnings from the date of
acquisition.
Effective June 1, 1999 the Company acquired the remaining 49% of Interlynx. The
consideration for the purchase included the issuance of 27,778 common shares of
the Company's stock and the issuance of options to purchase 80,000 common shares
of our stock at a strike price of U.S. $3.00. These options were issued out of
the existing employee stock option plan [NOTE 10[C]]. In addition to the
employee stock option plan conditions, entitlement to these options is subject
to the achievement of annual operating profit levels [profit before income taxes
and minority interest] for the three fiscal years ending August 31, 2000, August
31, 2001 and August 31, 2002. At the end of the fiscal year ending August 31,
2000 if annual operating profits are at least $332,000, 26,666 of the options
will be deemed earned. If annual operating profits for the year ending August
31, 2001 are at least $558,000, an additional 26,667 of the options will be
deemed earned. This level of operating profit was not achieved during fiscal
2001 or 2000.
F-23
The June 1, 1999 acquisition was recorded using the purchase method of
accounting and, accordingly, the purchase price has been allocated as set out
below:
F-24
$
------------------------------------------------------
Goodwill 95,091
------------------------------------------------------
PURCHASE PRICE 95,091
======================================================
The excess of cost over tangible assets acquired of $95,091 was allocated to
goodwill, which is being amortized over twenty years.
The Company's additional 49% share of the operating results of Interlynx are
included in its consolidated statements of operations and retained earnings from
the date of acquisition.
During fiscal 2001, the Company sold Interlynx for cash consideration of $50,000
and a $45,000 promissory note receivable.
The results of Interlynx have been classified as discontinued operations in the
accompanying financial statements for all years presented.
Summarized operating results of discontinued operations are as follows:
Year Ended
August 31,
2001 2000 1999
---------- ----------- ------------
Sales $ 313,555 $ 586,756 $ 596,951
Loss before income taxes (665,673) (857,416) (227,257)
Income tax expense - - -
Net (loss) from discontinued operations, net of tax (665,673) (857,416) (227,257)
(Loss) on disposal of discontinued operations, net of tax $(937,711) $ - $ -
[B] 1113659 ONTARIO LTD.
Effective June 16, 1999, the Company acquired through its wholly-owned
subsidiary, Magic, an additional 50% of the shares of Viewer Services, thereby
making Viewer Services a wholly-owned subsidiary of Magic. This acquisition was
recorded using the purchase method of accounting for a consideration of $1 and
the assumption of net liabilities of approximately $144,000. Since the Company
had decided not to continue with this business, the net assets originally
recorded were expensed.
[C] MAGIC LANTERN COMMUNICATIONS LTD.
Effective October 1, 1996, the Company acquired 100% of Magic and its
subsidiaries for a purchase price of $1,553,315 calculated on a discounted
basis. Magic is a Canadian corporation that distributes educational videos and
provides related services. The acquisition was recorded using the purchase
method of accounting and, accordingly, the purchase price has been allocated as
set out below:
$
-------------------------------------------------------
Goodwill 2,219,623
Net liabilities assumed (575,126)
Acquisition costs capitalized (91,182)
-------------------------------------------------------
PURCHASE PRICE 1,553,315
=======================================================
F-25
The excess of cost over tangible assets acquired of $2,219,623 was allocated to
goodwill, which is being amortized over twenty years.
The purchase price was satisfied by $450,000 in cash and the issue of two
non-interest bearing promissory notes with a maturity value of $1,250,000. The
first promissory note of $703,133 is repayable by cash payments of $78,133 on
August 31, 1998, $312,500 on August 31, 1999 and $312,500 on August 31, 2000.
Notwithstanding the foregoing, the Company has the right to elect up until June
30, 1998 to issue common shares in lieu of the aforesaid payments as follows:
12,276 shares on August 31, 1998, 49,097 shares on August 31, 1999 and 49,096
shares on August 31, 2000. Should the Company not elect to deliver common
shares, the noteholder has the right, exercisable between July 1, 1998 and July
31, 1998, to require us to issue the common shares as described. The balance due
of $78,133 on August 31, 1998 was satisfied by the issuance of 12,276 common
shares. The balances due on August 31, 1999 and 2000 were satisfied by the
issuance on August 31, 1999 of 49,097 and 49,096 shares respectively [NOTE
10[B]], thereby fully extinguishing the first promissory note. The fair value of
this promissory note at August 31, 1998 approximated its carrying value.
The second promissory note of $546,867 is payable by cash payments of $312,500
on August 31, 1997 and $234,367 on August 31, 1998. Notwithstanding the
foregoing, the Company has the right to elect up until June 30, 1997 to issue
common shares in lieu of the aforesaid payments as follows: 49,097 shares on
August 31, 1997 and 36,821 shares on August 31, 1998. The payment of $65,000 and
the issuance of 38,158 common shares satisfied the balance due of $312,500 on
August 31, 1997 on September 5, 1997. The balance due of $234,367 on August 31,
1998 was satisfied by the issuance of 36,821 common shares [NOTE 10[B]]. The
fair value of this promissory note approximates its carrying value.
The operating results of Magic are included in the Company's consolidated
statements of operations and retained earnings from the date of acquisition.
[D] IMAGE MEDIA LTD. AND PILOT SOFTWARE
Effective August 18, 1997, the Company acquired certain of the business assets
of Image Media Ltd. and 802117 Ontario Inc., operating as Pilot Software, for
cash of $590,000. This acquisition was recorded using the purchase method of
accounting and, accordingly, the purchase price has been allocated as follows:
$
-----------------------------------------------------
Equipment 481,000
Goodwill 45,000
Inventory 37,000
Sundry receivable 27,000
-----------------------------------------------------
PURCHASE PRICE 590,000
=====================================================
The goodwill arising from this acquisition is amortized over 10 years.
[E] GALAVU ENTERTAINMENT NETWORK INC.
On September 13, 1999, pursuant to an Asset Purchase Agreement dated as of the
10th day of September, 1999, the Company, through its wholly-owned subsidiary,
GalaVu, acquired, effective as of September 13th, 1999, substantially all of the
property and assets [excluding accounts receivable] of GalaVu Entertainment Inc.
The purchase price was satisfied by the issuance of 100,000 common shares of the
Company's stock and the issuance of a
F-26
promissory note [the "Note"]. The Note is secured by a general security interest
in all of GalaVu's present and after-acquired assets. The Note shall be payable
in cash or in common shares of the Company's stock annually, for the term
consisting of each of the next five fiscal years in an amount equal to 50% of
the earnings before interest, taxes, depreciation and amortization of GalaVu for
the immediately preceding annual period. Pursuant to the provisions of the Note,
the minimum amount to be received by the holder of the Note is as follows:
fiscal 2001 - $300,000, fiscal 2002 - $500,000, fiscal 2003 - $750,000, fiscal
2004 - $875,000 and fiscal 2005 - $875,000.
The present value of the Note, discounted at the Company's average borrowing
rate (6.5%) amounted to $2,662,698. The fair value of the Note at August 31,
2001 approximated its carrying value. The interest accretion on the discounted
note amounted to $173,076 during fiscal 2001. This acquisition was recorded
using the purchase method of accounting and accordingly the purchase price has
been allocated as follows:
$
--------------------------------------------------
Property and equipment 3,487,498
Assumption of liabilities (529,440)
--------------------------------------------------
PURCHASE PRICE 2,958,058
==================================================
For the year ended August 31, 2001, GalaVu's gross revenue and loss
before taxes were as follows:
Gross Revenue $6,517,940
Loss before taxes ($441,636)
Per share data:
Basic loss (0.15)
Diluted (0.15)
[F] PURCHASE OF ASSETS AND SHARES FROM CHEL.COM LTD. AND CAMERON CHELL
On September 19, 2000, pursuant to an Agreement of Purchase and Sale dated as of
August 4, 2000, the Company and its subsidiary Chell Merchant Capital Group
acquired, certain assets from Chell.com Ltd. ("Chell.com") and the following
shares for an aggregate purchase price of US$27,002,086:
(a) 480,000 shares of cDemo were acquired by the Company which
represents approximately 14.3% of cDemo's issued and
outstanding stock;
(b) 875,000 shares of Engyro Inc. were acquired by the Company
which represents approximately 34% of Engyro's issued and
outstanding stock; and
(c) 60,000 Common Shares of Chell.com (USA) Inc., a Nevada
corporation were acquired by the Company which represents 100%
of Chell.com (USA)'s outstanding stock.
(d) 962,500 Common Shares of eSupplies, Inc., which were held in
escrow as discussed below, were subsequently released.
Pursuant to the Purchase and Sale Agreement, the Company acquired the
above-referenced shares for an aggregate purchase price of US$25,234,583. The
Company also acquired certain assets from Chell.com including office leases,
office equipment and computers, insurance contracts, employment contracts and
service agreements for a price of US$1,767,503. Accordingly the combined
aggregate purchase price for the Chell.com assets, the 480,000 shares of cDemo,
the 875,000 shares of Engyro Inc., and the 60,000 Common Shares of Chell.com
(USA) Inc. was US$27,002,086. The sole director and shareholder of Chell.com is
Cameron Chell. Chell Merchant Capital Group also assumed a liability owing by
Chell.com to Canadian Advantage Limited Partnership II, in the amount of
US$1,767,499 on the condition that Canadian Advantage Limited Partnership II
accept full settlement of such
F-27
indebtedness by Chell Merchant Capital Group issuing 451,868 exchangeable
shares. The aggregate purchase price payable by the Company under the Purchase
and Sale Agreement of US$27,002,086 was paid by the Company issuing a total of
5,396,733 Common Shares at the deemed price of US$3.91155 per share and
1,506,439 shares of CMCG which were exchangeable for the Company's Common Shares
on a one-for-one basis. The 1,476,398 exchangeable shares of CMCG that were
originally issued for the 962,500 eSupplies shares had been held in escrow
pursuant to an escrow agreement dated October 11, 2000 among Cameron Chell, the
Company and Wolff Leia Huckell, Barristers and Solicitors. These CMCG
exchangeable shares were to be released from escrow after receiving written
notice from the Company that the new course of business being taken by eSupplies
fit with the Company's business model and provided significant value to the
Company. Since the Company has subsequently determined that eSupplies' business
profile does not fit with the Company's business profile, the CMCG exchangeable
shares have been cancelled and the 962,500 eSupplies shares have been returned
to Cameron Chell. Subsequent to the cancellation of the eSupplies transaction,
the aggregate purchase price was reduced to US$21,227,081.
This acquisition was not reflected in the financial statements for the year
ended August 31, 2000 since shareholder approval to ratify the above purchase
transaction was not voted on and approved until September 8, 2000. As a result
of the above, Cameron Chell and Chell.com now own approximately 59% of the
Company's outstanding common stock, that is the Company has in effect been
acquired in a reverse acquisition.
This acquisition of the Company by Cameron Chell and Chell.com and the
acquisition by the Company of the equity interests, as described in the first
paragraph, are reflected at historical cost in the Company's separate financial
statements.
The Company has reflected the minority equity investments using the equity
method of accounting (see note 18).
[G] PURCHASE OF RICHARD WOLFF ENTERPRISES, INC. ASSETS
Pursuant to an asset purchase agreement dated September 1, 2000, Magic acquired
the assets and business operations of Richard Wolff Enterprises, Inc. ("RWE"), a
company based in Illinois, for a purchase price of $289,590 calculated on a
discounted basis. As a result, Magic has expanded its library of educational
titles and now has access to the international distribution infrastructure
formerly held by RWE. The acquisition was accounted for using the purchase
method of accounting and accordingly, the purchase price has been allocated to
property and equipment. The purchase price was satisfied by $154,825 in cash and
the issuance of four promissory notes with maturity values aggregating $147,350.
These promissory notes mature over a period of two years. The fair values of
these promissory notes approximate their carrying value.
The asset purchase agreement also contains a purchase price adjustment clause
whereby the price may be adjusted upwards to a maximum of an additional
US$100,000 if certain revenue levels are achieved. Specifically, if gross
revenues for the acquired business exceed US$500,000 for the 12 month period
ending August 31, 2001, Magic will pay to RWE US$50,000, and if gross revenues
exceed US$600,000 for the second 12 month period ending August 31, 2002, Magic
will pay to RWE an additional US$50,000. This condition has not currently been
met.
The operating results related to the acquisition are included in the Company's
consolidated statements of operations and retained earnings from the date of
acquisition. Pro-forma information has not been provided for the prior year
because it is not material.
NOTE 14. DEPOSIT ON PURCHASE OF APPLICATIONSTATION.COM, INC. SHARES
On November 22, 2000, the Company entered into an agreement with
Chell.com Ltd. to participate in the purchase of a 51% interest in the shares of
ApplicationStation.com, Inc. The Company has provided a deposit of
F-28
$1,689,710 to Chell.com Ltd. for its 25% share of the 51% interest in the shares
of ApplicationStation.com, Inc. In the event that closing of the transaction
does not occur and the deposit on purchase is not returned, Chell.com Ltd. has
pledged 550,000 shares of Chell Merchant Capital Group as security for such
amount. Should the purchase be completed, the Company's investment will be
reflected using the equity method of accounting.
F-29
15. SEGMENTED INFORMATION
The Company operates in the entertainment, education and merchant services
industries. Corporate relates to costs that are not associated with a specific
industry segment, but are required for the operations of the company. Business
segment information for the years ended August 31, 2001, 2000 and 1999 are as
follows:
- --------------------------------------------------------------------------------------
2001 2000 1999
$ $ $
- --------------------------------------------------------------------------------------
EXTERNAL REVENUE
Entertainment 13,588,788 14,121,764 7,569,929
Education 4,616,991 4,971,823 5,192,378
Merchant Service -- -- --
Corporate 16,595 13,703 61,384
- --------------------------------------------------------------------------------------
18,222,374 19,107,290 12,823,691
- --------------------------------------------------------------------------------------
INTER-SEGMENT REVENUE
Education 183,329 275,941 --
Corporate -- 128,283 223,435
- --------------------------------------------------------------------------------------
183,329 404,224 223,435
- --------------------------------------------------------------------------------------
OPERATING PROFIT (LOSS)
Entertainment (208,371) 515,167 446,681
Education (1,084,531) (792,665) (623,400)
Merchant Service (5,887,912) -- --
Corporate (2,635,280) (1,218,183) (319,634)
- --------------------------------------------------------------------------------------
(9,816,094) (1,495,681) (496,353)
- --------------------------------------------------------------------------------------
IDENTIFIABLE ASSETS
Entertainment 5,459,008 7,009,552 4,725,971
Education 3,793,863 3,526,317 4,290,025
Merchant Service 1,489,711 -- --
Corporate 479,330 895,894 837,653
- --------------------------------------------------------------------------------------
11,221,912 11,431,763 9,853,649
- --------------------------------------------------------------------------------------
CORPORATE ASSETS
Entertainment 3,170,363 4,352,448 3,699,785
Education (666,589) 844,142 (22,367)
Merchant Service 99,754 -- --
Corporate 2,141,512 355,590 1,063,713
- --------------------------------------------------------------------------------------
4,745,040 5,552,180 4,741,131
- --------------------------------------------------------------------------------------
CAPITAL EXPENDITURES
Entertainment 729,486 842,955 350,836
Education 650,576 319,191 250,797
Merchant Service 50,900 -- --
- --------------------------------------------------------------------------------------
1,430,962 1,162,146 601,633
- --------------------------------------------------------------------------------------
DEPRECIATION & AMORTIZATION
Entertainment 1,960,652 1,808,715 967,188
Education 507,218 408,856 428,377
Merchant Service 431,967 -- --
Corporate 140,570 31,750 33,654
- --------------------------------------------------------------------------------------
3,040,407 2,249,321 1,429,219
- --------------------------------------------------------------------------------------
Operating profit (loss) is equal to profit (loss) before income taxes and
minority interest, and includes deductions for items such as interest and
depreciation and amortization. Identifiable assets by industry are those assets
used in our operations in each industry. Corporate assets are principally cash
and cash equivalents, short-term investments and intangible assets. Net assets
from discontinued operations are not included in the schedule.
Our business segments all operate primarily in Canada.
F-30
The 2000 and 1999 comparative segmented information has been reclassified from
statements previously presented to conform with the presentation of the 2001
segmented information.
F-31
16. RELATED PARTY TRANSACTIONS
Included in other receivables is approximately $25,086 [2000 - $155,000] of
amounts due from employees and shareholders. The amounts are non-interest
bearing and are due on demand. Included in accounts payable is $210,611 owing to
Cameron Chell. This balance is non-interest bearing.
17. RESTATED FINANCIAL STATEMENTS
[A] DISCOUNT ON CONVERTIBLE DEBT
On October 3, 2000, the Company closed the sale of a US$3,000,000
Convertible 10% Debenture of which US$1,700,000 has been advanced (NOTE
8[VIII]). EITF-00-27 "Application of Issue No. 98-5 to Certain Convertible
Instruments" requires that a discount be recorded for any beneficial conversion
features associated with convertible debt. The Company did not record the
discount on the US$1,700,000 debt and therefore had to make an adjustment and
restate its Fiscal 2001 financial statements. The Company has now recorded a
discount of $1,959,144 in October 2000 and has amortized $589,981 to interest
expense for the year ended Aug 31, 2001.
Also as part of this transaction, the Company issued 50,000 warrants to
purchase 50,000 common shares at US $3.00 per share. These warrants were valued
and the Company recognized a $252,706 cost associated with these warrants. The
company had expensed $77,215 and had $175,491 as other assets. The entire
transaction has been reversed because the value of the warrants has been
included in the calculation of the discount above.
The following table presents the impact of the 2001 restatements.
----------------------------------------------------------------------------
As Previously As Restated
Reported
----------------------------------------------------------------------------
For the year ended
August 31, 2001
Balance sheet:
Other Assets 388,802 212,539
Long-term debt 5,884,339 4,523,822
Share Capital
Capital in excess of par value 14,143,533 15,849,971
Deficit (12,499,514) (13,020,928)
Statement of operations:
Selling, general and administration 16,250,171 16,181,604
Interest and Bank Charges 881,398 1,471,379
Net loss (11,226,225) (11,747,639)
EPS
Basic loss per share $1.34 $1.38
Diluted loss per share $1.34 $1.38
----------------------------------------------------------------------------
[B] CHANGE IN PREFERRED SHARES
F-32
On April 4th, 2000, the ratio at which preferred shares could be
converted to common shares was changed from 4.67 to 1 to 3 to 1. The resulting
change from 192,857 to 300,000 common shares upon conversion resulted in a
one-time compensation charge of $337,779. In order to reflect this change, the
fiscal 2000 financial statements have been restated.
The following table presents the impact of the 2000 restatements.
------------------------------------------------------------------------
As Previously As Restated
Reported
------------------------------------------------------------------------
Year ended August 31, 2000
Balance sheet:
Share Capital
Common shares 183,235 191,122
Capital in excess of par value 10,124,777 10,454,669
Deficit (935,510) (1,273,289)
Statement of operations:
Selling, general and admin 10,726,556 11,064,335
Net loss (1,985,842) (2,323,621)
------------------------------------------------------------------------
18. INVESTMENTS IN AND ADVANCES TO UNCONSOLIDATED SUBSIDIARIES:
Investments in unconsolidated subsidiaries purchased during the year ended
August 31, 2001 and other investees in which the Company has a 20% to 50%
interest or otherwise exercise significant influence are carried at cost,
adjusted for the Company's proportionate share of their undistributed earnings
or losses.
Investments carried at equity consist of the following at August 31, 2001:
Percent
Owned
cDemo Inc. 14.3%
Engyro Inc. 22.1%
At August 31, 2001, the Company's proportionate share of undistributed losses
exceeded its investment and advances by $301,100. Accordingly, the Company's
investment has been reduced to zero and $301,100 has been recorded as an expense
in the statement of operations.
F-33
19. COMPARATIVE CONSOLIDATED FINANCIAL STATEMENTS
The 2000 and 1999 comparative consolidated financial statements have been
reclassified from statements previously presented to conform to the presentation
of the 2001 consolidated financial statements.
F-34
CHELL GROUP CORPORATION INC
FORM 10-K/A No.1
November 30, 2001
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT LOCATION
- ------ ---------------------- --------
2.1 Stock Purchase Agreement, dated October 1, 1996, among
Connolly-Daw Holdings Inc., 1199846 Ontario Ltd.,
Douglas Connolly, Wendy Connolly and NTN Interactive
Network Inc., minus Schedules thereto ................. +1, Exh. 10.1
3.1 Articles of Incorporation, as amended to date ......... p. 59
3.2 By-Laws, as amended to date ............................ p. 62
4.1 Specimen Stock Certificate ............................ p. 71
10.1 License Agreement, dated March 23, 1990, between NTN
Communications, Inc. and NTN Interactive Network Inc. . +2, Exh. 10.9
10.2 Stock Purchase Agreement, dated as of October 4, 1994,
between NTN Canada and NetStar Enterprises Inc.
(formerly, Labatt Communications Inc.) ................ +3, Exh. A
10.3 Option, dated as of October 4, 1994, registered in the
name of NetStar Enterprises Inc. (formerly, Labatt
Communications Inc) ................................... +3, Exh. B
10.4 Designation Agreement dated as of October 4, 1994,
among NTN Canada, Inc., NTN Interactive Network Inc.
and NetStar Enterprises Inc. (formerly Labatt
Communications Inc.) .................................. 3, Exh. C
10.5 Registration Rights Agreement, dated as of October 4,
1994, between NTN Canada and NetStar Enterprises Inc.
(formerly, Labatt Communications Inc.) ................ 3, Exh. D
10.6 Promissory Note of NTN Interactive Network Inc.
registered in the name of Connolly-Daw Holdings, Inc. . +1, Exh. 10.2
10.7 Promissory Note of NTN Interactive Network Inc.,
registered in the name of 1199846 Ontario Ltd. ........ +1, Exh. 10.3
10.8 Option Agreement, dated October 1, 1996, among
Connolly-Daw Holdings Inc., NTN Interactive Network
Inc. and NTN Canada, Inc. ............................. +1, Exh. 10.5
10.9 Option Agreement, dated October 1, 1996, among 1199846
Ontario Ltd., NTN Interactive Network Inc. and NTN
Canada, Inc. .......................................... +1, Exh. 10.6
10.10 Registration Rights Agreement, dated October 1, 1996,
among NTN Canada, Inc., Connolly-Daw Holdings Inc. and
1199846 Ontario Ltd. .................................. 1, Exh. 10.4
10.11 Employment Agreement dated as of August 31, 1994,
between NTN Interactive Network Inc. and Peter Rona. .. +4, Exh. 10.11
10.12 Management Agreement dated October 1, 1996, between
Magic Lantern Communications Ltd. and Connolly-Daw
Holdings Inc. ......................................... +4, Exh. 10.12
68
10.13 Employment Agreement dated October 1, 1996, between
Magic Lantern Communications Ltd. and Douglas Connolly +4, Exh. 10.13
10.14 Employment Agreement dated October 1, 1996, between
Magic Lantern Communications Ltd. and Wendy Connolly .. +4, Exh. 10.14
10.15 Asset Purchase Agreement, dated September 10, 1999, by
and between 1373224 Ontario Limited, Networks North
Inc. and Arthur Andersen Inc., to acquire the property
and assets of GalaVu Entertainment Inc., from the
person appointed by the court of competent jurisdiction
as the receiver or receiver and manager of the
property, assets and undertaking of GalaVu. ........... +5, Exh. 10.15
10.16 Promissory Note, dated September 10, 1999, by and
between 1373224 Ontario Limited, as Debtor, and the
Holder, as Creditor ................................... +5, Exh. 10.16
10.17 General Security Agreement, dated September 10, 1999,
by and between 1373224 Ontario Limited, to acquire the
property and assets of GalaVu Entertainment Inc., from
the person appointed by the court of competent
jurisdiction as the receiver or receiver and manager of
the property, assets and undertaking of GalaVu ........ +5, Exh. 10.17
10.18 Securities Pledge Agreement, dated September 10, 1999,
by and between 1373224 Ontario Limited to acquire the
property and assets of GalaVu Entertainment Inc., from
the person appointed by the court of competent
jurisdiction as the receiver or receiver and manager of
the property, assets and undertaking of GalaVu ........ +5, Exh. 10.18
10.19 Certificate to the Escrow Agent certifying that the
conditions of Closing have been satisfied or waived ... +5, Exh. 10.19
10.20 Certificate to the Escrow Agent certifying that the
conditions of Closing have not been satisfied or waived +5, Exh. 10.20
10.21 Occupancy and Indemnity Agreement, dated September 10,
1999, by and between 1373224 Ontario Limited to acquire
the property and assets of GalaVu Entertainment Inc.,
from the person appointed by the court of competent
jurisdiction as the receiver or receiver and manager of
the property, assets and undertaking of GalaVu ........ +5, Exh. 10.21
10.22 Order of the Ontario Superior Court of Justice, dated
September, 1999, approving the transaction contemplated
herein, and vesting in the Purchaser the right, title
and interest of GalaVu and the Receiver, if any, in and
to the Purchased Assets, free and clear of the right,
title and interest of any other person other than
Permitted Encumbrances ................................ 5, Exh. 10.22
10.23 Bill of Sale, dated September 13, 1999, by and between
1373224 Ontario Limited to acquire the property and
assets of GalaVu Entertainment Inc., from the person
appointed by the court of competent jurisdiction as the
receiver or receiver and manager of the property,
assets and undertaking of GalaVu ...................... +5, Exh. 10.23
69
10.24 Covenant of Networks North Inc. for valuable
consideration to allot and issue and pay to the
Receiver 100,000 common shares in accordance with the
Purchase Agreement date September 10, 1999, between
1373224 Ontario Limited and the Receiver .............. 5, Exh. 10.24
10.25 Agreement of Purchase and Sale dated August 4, 2000 by
and among Networks North Inc., Networks North
Acquisition Corp., Chell.com Ltd. and Cameron Chell ... 6, Exh. A.
10.26 Valuation of Chell.com Ltd. as of May 31, 2000 by
Stanford Keene ........................................ +6, Exh. B.
22 List of Subsidiaries .................................. p. 110
- ----------
+1 All Exhibits so indicated are incorporated herein by reference to the
exhibit listed above in the Company's Current Report on Form 8-K (Date of
Report: October 2, 1996) (File No. 0-18066), filed on October 17, 1996.
+2 All Exhibits so indicated are incorporated herein by reference to the
exhibit listed above in the Annual Report on Form 10-K of NTN
Communications, Inc., for its fiscal year ended December 31, 1990) (File
No. 2-91761-C), filed on April 1, 1991.
+3 All Exhibits so indicated are incorporated herein by reference to the
exhibit listed above in the Company's Current Report on Form 8-K (Date of
Report: October 4, 1994) (File No. 0-18066), filed on October 18, 1994.
+4 All Exhibits so indicated are incorporated herein by reference to the
exhibit listed above in the Company's Annual Report on Form 10-K (Date of
Report: November 27, 1996) (File No. 0-18066), filed on December 16, 1996.
+5 All Exhibits so indicated are incorporated herein by reference to the
exhibit listed above in the Company's 8-K (Date of Report: September 13,
1997) (File No. 0-18066), filed on December 16, 1996.
+6 All Exhibits so indicated are incorporated herein by reference to the
exhibit number listed above in the Definitive Proxy Statement on Form 14A
of the Registrant (File No. 000-18066), filed with the Securities and
Exchange Commission on August 8, 2000.
+ Filed electronically pursuant to Item 401 of Regulation S-T.
70
EXHIBIT 22. LIST OF SUBSIDIARIES OF CHELL GROUP CORPORATION AS AT
NOVEMBER 26, 2001
Name of Subsidiary(1) Jurisdiction of Incorporation
- --------------------- -----------------------------
Chell Merchant Capital Group, Inc.......................................ONTARIO
Magic Lantern Communications Ltd.(2) ................................... Canada
NTN Interactive Network Inc............................................. Canada
3484751 Canada Inc...................................................... Canada
Sonoptic Technologies Inc.(4)........................................... Canada
GalaVu Entertainment Network Inc. ..................................... Ontario
TutorBuddy Inc.(3)..................................................... Ontario
Chell.com (USA) Ltd..................................................... Nevada
- ----------
NOTES:
(1) Unless otherwise indicated, all named entities are wholly-owned
subsidiaries of Chell Group Corporation.
(2) Wholly-owned subsidiary of NTN Interactive Network Inc.
(3) Wholly-owned subsidiary of Magic Lantern Communications Ltd.
(4) Majority owned (75%) subsidiary of Magic Lantern Communications Ltd.
71