UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 _________ FORM 10-K/A AMENDMENT NO. 2 TO [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1995 COMMISSION FILE NUMBER 1-11460 NTN COMMUNICATIONS, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 31-1103425 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 5966 LA PLACE COURT, CARLSBAD, CALIFORNIA 92008 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) (619) 438-7400 (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: COMMON STOCK, $.005 PAR VALUE 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 filing requirements for the past 90 days. YES [X] NO [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulations S-K (S 229.405 of this Chapter) 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. [ ] The aggregate market value of the voting stock held by non-affiliates of Registrant as of April 11, 1996, computed by reference to the closing sale price of such stock on the American Stock Exchange, was approximately $89,000,000. (All directors and executive officers of Registrant are considered affiliates.) At April 11, 1996 Registrant had 23,899,145 shares of Common Stock, $.005 par value, issued and outstanding. DOCUMENTS INCORPORATED BY REFERENCE Portions of Registrant's Annual Report to Shareholders for the period ended December 31, 1995 are incorporated by reference into Part I of this Report. PART II Item 7. Management's Discussion and Analysis of Financial Condition and --------------------------------------------------------------- Results of Operations. - ---------------------- General Management's discussion and analysis of financial condition and results of operations should be read in conjunction with the selected financial data and consolidated financial statements and notes thereto included elsewhere herein. The Company uses existing technology to develop, produce and distribute two-way multi-player interactive live events and also produces and distributes its own original interactive programs. The Company's principal sources of revenue from distribution activities are derived from (a) distribution fees in the United States; (b) advertising fees, (c) sales of equipment; (d) distribution fees from foreign licensees; (e) licensing fees from foreign and domestic licensees; and (f) the licensing of the Company's technology and equipment sales to other users. The Company also develops and publishes interactive entertainment software and video games for general consumer use on a variety of home personal computers and console entertainment systems. The principal sources of revenue from software and video game activities are derived from (a) domestic retail sales through mass merchants, warehouse clubs, general retailers and mail order catalogues, and (b) license fees and royalties from international licensees who translate and publish the video games in over a dozen countries around the world. Results of Operations Following is a comparative discussion by fiscal year of the results of operations for the last three years ended December 31, 1995. The Company believes that inflation has not had a material effect on its operations to date. Year Ended December 31, 1995 as compared to the Year Ended December 31, 1994 The Company reported a net loss of $3,948,000 for the year ended December 31, 1995 compared to net earnings of $707,000 for the year ended December 31, 1994. In 1994, the Company formed LearnStar to pursue interactive educational applications in the United States. Most of 1994 was devoted to beta testing the product and conducting preliminary market tests. In 1995, LearnStar began marketing and selling its product on a full-time basis. Due to start-up costs and relatively higher marketing costs during the first year of operations, LearnStar reported a net loss of $2,149,000 for the year ended December 31, 1995. In late 1995 the Company entered into a sale and purchase agreement to sell 45% of the stock of its subsidiary, LearnStar, Inc. Although the sale was legally consummated, the recognition of the gain of $3,354,000 was deferred in accordance with generally accepted accounting principles and will be recognized when principal payments are received in 1996 and 1997. Also in late 1995, the Company set up an allowance of $1,000,000 for inventory in connection with the upgrading of its broadcast distribution system and expensed $754,000 of costs incurred in connection with the development of the market in Mexico. Through much of its life, the Company's technology has been stable with little variation in the type of equipment used. In 1995 the Company decided to upgrade many of its computers that are utilized by its Hospitality subscriber locations. This decision was based on the improvements made in software programs and graphic displays of information that require more memory and quicker processing time. The Company anticipates that such upgrades will also occur in the future based on further technological changes which cannot be quantified currently. Further, in 1995 the Company experienced a substantial increase in legal expenses due to increased activities in litigation and other legal matters along with increased costs of developing and providing products and services, and increased marketing expenditures. Total revenue increased 24% from $24,646,000 to $30,442,000. This increase is the result of growth in many of the Company's principal revenue activities. 1 Distribution and Production Services increased 41% from $12,244,000 to $17,307,000. The increase in broadcast revenue is primarily due to an expansion in the number of subscriber locations and on-line customers contracting for services from the Company. Equipment Sales increased 55% from $4,387,000 to $6,784,000. Equipment sales include both sale and leaseback transactions and direct sales to the Company's customers. Equipment sales have been highly volatile in the past and are expected to remain so, as they are dependent on the Company's ability to engage in lease financing, the timing of expansion plans of the Company's foreign licensees and, its educational subscribers. The sales price and cost of sales for equipment sold to customers and others has been constant for the past two years. Accordingly, the increase in equipment sales from 1994 to 1995 is wholly attributable to changes in volume. As of December 31, 1995, the Company had sold and leased back subscriber systems in place at a majority of the United States subscriber locations. The Company's ability to make additional sales will be dependent on increases in the number of subscriber locations as well as the availability of financing, as to which there can be no assurance. Product Sales related to video and computer games decreased 26% from $5,263,000 to $3,884,000. Sales of video and computer game products are typically seasonal and will vary with the number of new products released in any period. The decrease in net revenue is primarily due to the glut of competing products in the market, the timing of new products released during the year and the use of more conservative amounts provided for potential returns. License Fees and Royalties increased 12% from $1,934,000 in 1994 to $2,167,000 in 1995. License Fees in 1994 predominantly relate to NTN's Hospitality and International Licensing operations whereas in 1995 license revenues predominantly relate to the Company's New World operations. Licensing arrangements are not dependent upon seasonal forces and will vary in type and amount from period to period. Other Revenue decreased from $818,000 to $300,000 in the current year's period. Other Revenue in 1994 primarily consisted of inventory transferred to the Company by its United Kingdom licensee in exchange for release from a license agreement. Other Revenue has historically varied widely. Cost of Services-Distribution and Production Services, which increased 68% from $5,198,000 in the prior year to $8,756,000 in the current year, reflects increased costs of equipment leases and other costs associated with the expansion in the number of subscribers contracting for distribution services. The gross margin on distribution and production services decreased from 58% to 49% as a result of increased costs related to commissions, service fees and increased costs of equipment leases. Cost of Sales - Product Sales relates to the Company's video game products increased from $1,502,000 to $1,844,000 or 23%. These costs vary depending upon the timing of products released, the volume of products sold, the complexity of the games and the development costs associated with each product. The gross margin on product sales decreased from 71% to 53% as the result of amortizing deferred development costs related to specific products sold in 1995. The increase in Cost of Sales-Equipment from $2,753,000 to $4,981,000, an increase of 81%, is due to the increase in equipment sales, which can vary from period to period. Before the one-time charge to earnings of $1,000,000 to upgrade the broadcast distribution system, the gross margin from equipment sales increased from 37% to 41% due to lower costs associated with certain equipment, but after consideration of this charge, the gross margin decreased to 27%. Operating Expenses rose from $14,898,000 in the prior year to $20,160,000 in the current year, an increase of 35%. Legal and Professional Fees increased 214% from $590,000 to $1,851,000 due to substantial legal expenses incurred relating to litigation and other legal matters. Selling, General and Administrative expenses increased 36% from $12,336,000 to $16,838,000 due to an increase in the number of employees hired to develop and produce new products and services and large increases in marketing activities related to the development of the LearnStar products and services. Research and Development expense decreased from $1,972,000 to $1,471,000, or 25% as the Company increased its efforts in projects in current production. Other Income (Expense) increased from $412,000 to $1,351,000 or 228%. Included in Other Income is a gain from the sale of a 10% interest in the IWN subsidiary of $329,000 and reimbursement of previously incurred legal expenses from the Company's insurance carrier of approximately $1,000,000. Income Tax expense was zero in both years. The lack of tax expense is due to the losses, the nature of revenues and expenses in each year and net operating loss carryforwards available to the Company. The Company currently has available approximately $27,000,000 of net operating loss carryovers for federal tax purposes. 2 Year Ended December 31, 1994 as compared to the Year Ended December 31, 1993 The Company reported net income of $707,000 for the year ended December 31, 1994 and a net loss $1,301,000 for the year ended December 31, 1993. For the year ended 1994, revenues grew 43% to $24,646,000 from $17,258,000 for the year ended 1993. This increase is the result of growth in the number of Locations contracting for the Company's distribution services, license fee revenue and royalties from licensees and increased equipment sales. Distribution revenues from Locations increased 81% to $12,244,000 in 1994 from $6,778,000 in 1993 and equipment sales increased 11% to $4,387,000 in 1994 from $3,970,000 in 1993. License fees and royalties in 1994 were $1,934,000 compared to $802,000 in 1993, an increase of 141%, which resulted from new licenses granted to both foreign and domestic companies. Retail sales of Products decreased 4% to $5,263,000 from $5,468,000 due to the glut of competing products on the market and the timing of new Product releases by the Company during the year. Total Cost of Sales grew to $9,453,000 in 1994 from $7,514,000 in 1993, an increase of 26%, a result of increased sales. The Company improved its gross margin on equipment sales to 37% from 32% as a result of Management's continuing efforts in controlling equipment costs and higher marginal sales. The rise in Cost of Services - Distribution and Production Services of $1,937,000 to $5,198,000 in 1994 from $3,261,000 in 1993 is due to the greater number of subscribers served. The Company improved its gross margin on Distribution and Production Services to 58% from 52% as the result of decreasing costs associated with service fees, equipment rentals and freight charges. The Company's total operating expenses increased 33% to $14,898,000 in 1994 from $11,198,000 in 1993 as a result of the Company's expanding its overall activities. Selling, General and Administrative expenses increased 32% to $12,336,000 in 1994 from $9,347,000 in 1993 as the result of an increase in the number of employees and continuing increased marketing and sales activities. Research and Development expenses increased 84% to $1,972,000 in 1994 from $1,073,000 in 1993 as the Company increased its research and development efforts. The Company also expended $3,264,000 on software development projects qualifying for capitalization in 1994 compared to $726,000 in the prior year. Interest expense of $54,000 for the year ended December 31, 1994 was reduced from $71,000 for the year ended December 31, 1993. Interest income in 1994 totaled $466,000 compared to $505,000 in 1993. The decrease in net interest income resulted from the use of funds for operations and investments in developed software in 1994. Income tax expense was zero in 1994 compared to $281,000 in 1993. The decrease in tax expense was due to the nature of the revenues and expenses in each year and net operating loss carryforwards available to the Company. Liquidity and Capital Resources Following is a discussion of the Company's recent and future sources of and demands on liquidity, as well as an analysis of liquidity levels. Expenditures have exceeded revenues from operations through most of the Company's history and may do so in the future. The Company plans to fund any such deficiency from its existing cash and, if necessary, from other sources, as discussed below. Total assets increased 37% from $31,239,000 to $42,813,000 from December 31, 1994 to December 31, 1995. Cash and Marketable Securities - Available for Sale increased from $3,429,000 to $6,475,000 at December 31, 1995. The change reflects additional cash proceeds from debt and equity sources net of cash used to fund operations and invest in the development of future products and services for the NTN Network and video game products. The 11% decrease in Accounts Receivable - Trade from $5,881,000 to $5,247,000 at December 31, 1995, reflects an enhancement in the collection efforts as well as an increase in the allowance for returns and doubtful accounts. Accounts Receivable - Other increased from $600,000 to $1,750,000, primarily the result of a large equipment sale transaction in the third quarter. The increase in Inventory from $4,628,000 to $6,503,000 is primarily the result of continued expansion of the NTN Network and development of additional video game 3 Products. Prepaid Expenses increased from $1,769,000 to $2,325,000 from December 31, 1994 to December 31, 1995 primarily due to increased prepaid expenses, deferred funding costs, and security deposits held by the Company. Interest bearing Security Deposits (both current and non-current) increased 18% from $3,200,000 to $3,775,000 as the result of increased leasing transactions related to the increase in new Locations. Software Development Costs (both current and non-current) increased 66% from $3,405,000 to $5,669,000 as the result of substantial investments made in the development of new software and Products. Net Fixed Assets increased 49% primarily due to the move to the new headquarters and expansion of the NTN Broadcast Center. Notes Receivable (both current and long term) increased from $3,262,000 to $5,206,000 or 60% primarily as the result of finalizing terms related to the sale of IWN and the sale of a license to IWN L.P. Total liabilities increased 62% from $5,782,000 to $9,362,000 from December 31, 1994 to December 31, 1995. The increase in Accounts Payable and Accrued Liabilities from $2,744,000 to $3,713,000 reflects the overall growth of the Company and the timing of payments. Customer Deposits increased from $1,006,000 to $1,284,000 from December 31, 1994 to December 31, 1995 due to deposits received from new customers throughout the year. The increase in aggregate Deferred Revenue (long-term and current) from $1,556,000 to $2,270,000 reflects additional deferred gains on the sale of the equipment involved in lease transactions, which are amortized to revenue over three-year periods. Debt (long-term and current) increased from $476,000 to $2,095,000 as a result of additional borrowings to augment working capital needed for operational expenses, new software and product development, marketing of services and purchase of broadcast-related equipment. The increase in Common Stock and Additional Paid-in-Capital reflects the issuance of 3,000,000 shares of Common Stock and conversion of preferred stock and the exercise of warrants during 1995. In late 1995 the Company began to repurchase its own shares and at year end had 50,000 shares of treasury stock. Overall, shareholders' equity increased $7,994,000 due to equity contributions of $12,164,000, less $222,000 for treasury stock purchases and the net loss of $3,948,000. Overall, the Company's working capital increased from $13,886,000 at December 31, 1994 to $18,416,000 at December 31, 1995, primarily due to significant proceeds from financing activities. Revenues from the principal business segments, Hospitality, Education and Software Development increased (Decreased) by 30%, 100% and (7%), respectively in 1995 compared to 1994. The Hospitality and Software Development segments reported profits in 1995 as well as in 1994. The Education segment reported a loss of $2,149,000 in its first year of operation. Each business segment, as well as the Company in general may continue to require additional working capital for operational expenses, new software and product development, marketing of services and purchase of hardware components relating to its services. There can be no assurance that the Company's currently available resources will be sufficient to allow the Company to support its operations until such time, if any, as its internally generated cash flow is able to consistently sustain the Company. The Company is exploring alternative capital financing possibilities that may include (i) additional lines of credit, (ii) lease financing of equipment the Company furnishes to subscribers, (iii) licensing of the Company's technology, (iv) sales of interests in subsidiaries, or (v) sale of additional debt or equity securities. With respect to lease financing, the Company has leased for three-year terms expiring in various amounts over the next three years, the Location Systems at substantially all of its United States Locations. The Company has issued licenses and has received revenue for certain products and services for Australia, South Africa and Canada. The Company will continue to negotiate for additional lease financing and additional foreign licensing. Marketing and Expansion Plan The Company's plan to maintain profitability includes the following elements: (i) increasing sales staff; (ii) increasing advertising sales on the NTN Network; (iii) expanding Company services to corporate and education customers; (iv) pursuit of additional foreign licensing opportunities; (v) increasing use of distributors who service retailers, (vi) sales of interests in subsidiaries and (vii) expanding products and services to a wider variety of technological platforms. 4 Throughout the Company's history, the principal component of its revenues has been derived from distribution services from Locations in the Hospitality industry (restaurants, bars and hotels). Management believes that this component will continue to grow in total revenues within the next year, but may decline as a percentage of the Company's total revenues. To increase the number of Locations, the Company has taken several steps. It increased its sales staff to accommodate the growth in 1995 and the anticipated growth in 1996. The Company offers sales and technical support to its independent distributors, who are responsible for marketing the Company's services to potential Locations. In 1996, the Company will continue to attend national and regional hospitality industry trade shows and has increased its budget for advertising in trade publications. In 1995, the Company enhanced its graphics capabilities and obtained additional advertising revenues from national advertisers. The Company has a full-time Director of Advertising Sales and is currently negotiating with several potential advertisers for commercial spots on the NTN Network. The Company has produced special event and corporate training programs in which the customer uses the Company's interactive equipment to increase participant interest in training and product knowledge and to communicate rapidly with a large number of participants. Management believes special event and corporate training may offer an opportunity for growth, and has a full-time Director of Sales for special event and corporate training. In addition, the Company has commenced the development of marketing materials and a direct mail campaign for corporate training services. To enhance the Company's capabilities for use in special events and corporate training, the Company has developed a system that allows up to 800 Playmakers(TM) to be used at a single event. Revenues from sales of equipment used in Locations has historically been a material component of the Company's revenue. Potential growth in this area, however, is largely dependent on the Company's success in increasing the number of Locations and the business of the Company's foreign licensees. Management believes that another market segment with potential for long-term growth is the market for interactive television services in the home. The Company expects to remain a provider of specialized programming to networks operated by other organizations, such as cable networks, computer on-line systems and wireless or telephone-based communication networks. The Company expects to deliver the video portion of its programming directly to cable television systems, with viewer responses using equipment developed by others. In light of this, the Company expects that any significant revenues from home use of the Company's services will be dependent upon an expansion in the overall home viewer market for home interactive information and entertainment services. The Company maintains excellent working relationships with major providers of home interactive information and entertainment services. As the market for home interactive information and entertainment services expands, the Company will seek to capitalize on this market. Revenues to date from in-home programming have not been significant. The Company has plans to expand its penetration in the education sector as well. Currently, the LearnStar System is operational at over 100 schools throughout the nation. In 1995, the Company will focus efforts to expand into additional schools in many states. Revenues from these sources have not been significant in the past and no assurance can be given that plans to expand the education market will be successful. Revenues from Product sales of interactive software and video games have been fairly consistent over the past few years. In 1996, the Company plans to expand its available Products through the publication of software developed by independent sources and by continuing to internally create new games and Products. Further, the Company intends to publish Products on additional technological platforms such as the SONY Playstation and other similar type entertainment systems. Further, the Company intends to offer its services and Products to new media platforms such as on-line services and the Internet. Although there can be no assurance that the Company will prove to be successful in implementing its marketing and expansion plan, Management believes that the Company's prospects have been materially improved by the growth of the core business units and increased customer awareness. The Company has several lawsuits pending as previously described in "Legal Proceedings." There can be no assurance that any or all of the described actions will be decided in favor of the Company. The Company believes, based in part on the advice of outside, independent counsel, that the costs of defending and prosecuting these actions will not have a material adverse effect on the Company's financial position or results of operations and that any 5 adverse outcome of the litigation involving IN also will not result in a material adverse effect on the Company's financial position or results of operation, or the Company's position in the interactive industry. Other In March 1995, the Financial Accounting Standards Board issued Statement of Financial Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of" ("SFAS 121"). SFAS 121 requires that impairment losses for long lived assets be recognized if the estimated undiscounted future cash flows, without interest, is less than the carrying amount of the asset. The standard also requires that assets designated to be disposed of are to be recorded at the lower of the asset carrying value or fair value less cost to sell. The Company has not adopted SFAS 121. The adoption of SFAS 121 is not expected to have a material impact on the Company's financial position or results of operations. In October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, "Accounting for Stock-based Compensation" ("SFAS 123"), effective for fiscal years beginning after December 31, 1995. SFAS 123 establishes the fair value method of accounting for stock- based compensation arrangements, under which compensation cost is determined using the fair value of the stock option at the grant date and the number of options vested, and is recognized over the period in which the related services are rendered. If the Company were to retain its current intrinsic value based method, as allowed by SFAS 123, it will be required to disclose the pro forma effect of adopting the fair value based method. The Company will adopt SFAS 123 using the pro forma disclosure method. 6 Item 8. Consolidated Financial Statements and Supplementary Data -------------------------------------------------------- See "Index to Consolidated Financial Statements and Schedule" elsewhere in this report for a listing of the Consolidated Financial Statements and Schedule filed with this report, which are incorporated herein by reference. 7 PART IV Item 14. Exhibits, Consolidated Financial Statement Schedule, and -------------------------------------------------------- Reports on Form 8-K - ------------------- (a) The following documents are filed as part of this report: 1,2. Consolidated Financial Statements and Schedule. The Consolidated Financial Statements and Schedule of the Company and its consolidated subsidiaries are set forth beginning on page F-2 hereof and are incorporated herein by reference. 8 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Amendment No. 2 to be signed on its behalf by the undersigned, thereunto duly authorized. Date: March 28, 1997 NTN COMMUNICATIONS, INC. By: /s/ Gerald Sokol, Jr. --------------------- Gerald Sokol, Jr., President and Chief Financial Officer 9 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE Page ---- Independent Auditors' Report......................................... F-1 Consolidated Financial Statements Consolidated Balance Sheets as December 31, 1995 and 1994...... F-2 Consolidated Statements of Operations for the years ended December 31, 1995, 1994 and 1993................... F-3 Consolidated Statements of Shareholders' Equity (Deficiency) for the years ended December 31, 1995, 1994 and 1993..... F-4 Consolidated Statements of Cash Flows for the years ended December 31, 1995, 1994 and 1993................... F-5 Notes to Consolidated Financial Statements........................... F-7 Schedule II.......................................................... F-22 F-1 Independent Auditors' Consent and Report on Schedules ----------------------------------------------------- The Board of Directors NTN Communications, Inc.: We have audited the accompanying consolidated balance sheets of NTN Communications, Inc. and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1995. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule as listed in Item 14 a(2). These consolidated financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance 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 NTN Communications, Inc. and subsidiaries as of December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1995, in conformity with generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. As discussed in Note 1 to the consolidated financial statements, the Company changed its method of accounting for investments in debt and equity securities in 1994. San Diego, California April 12, 1996 KPMG Peat Marwick LLP F-2 NTN COMMUNICATIONS, INC. AND SUBSIDIARIES Consolidated Balance Sheets December 31, 1995 and 1994 1995 1994 ----------- ----------- ASSETS Current assets: Cash and cash equivalents $ 6,475,000 2,429,000 Marketable securities - available for sale -- 1,000,000 Interest-bearing security deposits (note 14) 1,575,000 1,225,000 Accounts receivable - trade, net of allowance for returns and doubtful accounts of $1,417,000 in 1995 and $1,097,000 in 1994 (note 6) 5,247,000 5,881,000 Accounts receivable - officers and directors 100,000 100,000 Accounts receivable - other 1,750,000 600,000 Notes receivable - related parties (note 4) 1,030,000 -- Software development costs, net of accumulated amortization of $787,000 in 1995 and $177,000 in 1994 1,525,000 1,212,000 Inventory, net of reserve for obsolescence of $1,000,000 in 1995 6,503,000 4,628,000 Prepaid expenses and other current assets 2,325,000 1,769,000 ----------- ----------- Total current assets 26,530,000 18,844,000 Fixed assets, net (note 5) 2,100,000 1,405,000 Interest-bearing security deposits (note 14) 2,200,000 1,975,000 Software development costs, net of accumulated amortization of $1,014,000 in 1995 and $408,000 in 1994 4,144,000 2,193,000 Notes receivable, related parties (note 6) 4,176,000 3,262,000 Deposits and other assets 3,663,000 3,560,000 ----------- ----------- Total assets $ 42,813,000 31,239,000 =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable and accrued liabilities 3,713,000 2,744,000 Short-term borrowings and current portion of long-term debt (note 6) 2,093,000 468,000 Deferred revenue 1,024,000 740,000 Customer deposits 1,284,000 1,006,000 ----------- ----------- Total current liabilities 8,114,000 4,958,000 Deferred revenue 1,246,000 816,000 Long-term debt, excluding current portion (note 6) 2,000 8,000 ----------- ----------- Total liabilities 9,362,000 5,782,000 ----------- ----------- Shareholders' equity (notes 6, 7 and 8): 10% Cumulative convertible preferred stock, $.005 par value, 10,000,000 shares authorized; issued and outstanding 162,612 in 1995 and 197,612 in 1994 1,000 1,000 Common stock, $.005 par value, 50,000,000 shares authorized; shares issued and outstanding 22,502,707 in 1995 and 19,178,060 in 1994 112,000 96,000 Additional paid-in capital 56,747,000 44,599,000 Accumulated deficit (23,187,000) (19,239,000) ----------- ----------- 33,673,000 25,457,000 Less 50,000 shares of treasury stock, at cost (222,000) -- ----------- ----------- Total shareholders' equity 33,451,000 25,457,000 ----------- ----------- Commitments and contingencies (notes 14 and 15) Total liabilities and shareholders' equity $ 42,813,000 31,239,000 =========== =========== See accompanying notes to consolidated financial statements. F-3 NTN COMMUNICATIONS, INC. AND SUBSIDIARIES Consolidated Statements of Operations For the years ended December 31, 1995, 1994 and 1993 1995 1994 1993 (NOTE 2) Distribution and production services $ 17,307,000 12,244,000 6,778,000 Product sales 3,884,000 5,263,000 5,468,000 Equipment sales 6,784,000 4,387,000 3,970,000 License fees and royalties 2,167,000 1,934,000 802,000 Other revenue 300,000 818,000 240,000 ---------- ---------- ---------- Total revenue 30,442,000 24,646,000 17,258,000 ---------- ---------- ---------- Cost of distribution and production services 8,756,000 5,198,000 3,261,000 Cost of product sales 1,844,000 1,502,000 1,537,000 Cost of equipment sales 4,981,000 2,753,000 2,716,000 ---------- ---------- ---------- Total cost of sales 15,581,000 9,453,000 7,514,000 ---------- ---------- ---------- Gross profit 14,861,000 15,193,000 9,744,000 ---------- ---------- ---------- Operating expenses: Selling, general and administrative 16,838,000 12,336,000 9,347,000 Legal and professional fees 1,851,000 590,000 778,000 Research and development 1,471,000 1,972,000 1,073,000 ---------- ---------- ---------- Total operating expenses 20,160,000 14,898,000 11,198,000 ---------- ---------- ---------- Operating income (loss) (5,299,000) 295,000 (1,454,000) Other income (expense) Interest income 478,000 466,000 505,000 Interest expense (170,000) (54,000) (71,000) Equity in earnings (loss) of affiliate (286,000) -- -- Other 1,329,000 -- -- ---------- ---------- ---------- 1,351,000 412,000 434,000 Earnings (loss) before income taxes (3,948,000) 707,000 (1,020,000) Income taxes (note 5) -- -- 281,000 ---------- ---------- ---------- Net earnings (loss) $ (3,948,000) 707,000 (1,301,000) ========== ========== ========== Net earnings (loss) per share $ (0.19) 0.03 (0.08) ========== ========== ========== Weighted average number of shares outstanding 20,301,000 21,124,000 17,135,000 ========== ========== ========== See accompanying notes to consolidated financial statements. F-4 NTN COMMUNICATIONS, INC. AND SUBSIDIARIES Consolidated Statements of Shareholders' Equity (Deficiency) For the years ended December 31, 1995, 1994 and 1993 10% CUMULATIVE CONVERTIBLE PREFERRED STOCK COMMON STOCK ADDITIONAL -------------------- ---------------------- PAID-IN ACCUMULATED TREASURY SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT STOCK TOTAL -------- -------- ---------- --------- ---------- ----------- --------- ---------- Balance, December 31, 1992 392,498 $ 2,000 13,214,597 $ 66,000 26,009,000 (18,645,000) -- 7,432,000 Issuance of stock in conversion of debt -- -- 29,646 -- 75,000 -- -- 75,000 Issuance of stock for exercise of warrants and options, net of issuance costs -- -- 5,572,868 28,000 17,419,000 -- -- 17,447,000 Conversion of preferred stock to common stock (137,498) (1,000) 38,439 -- 1,000 -- -- -- Net loss -- -- -- -- -- (1,301,000) -- (1,301,000) -------- -------- ---------- --------- ---------- ----------- --------- ---------- Balance, December 31, 1993 255,000 1,000 18,855,550 94,000 43,504,000 (19,946,000) -- 23,653,000 Issuance of stock for exercise of warrants and options, net of issuance costs -- -- 306,440 2,000 1,095,000 -- -- 1,097,000 Conversion of preferred stock to common stock (57,388) -- 16,070 -- -- -- -- -- Net earnings -- -- -- -- -- 707,000 -- 707,000 -------- -------- ---------- --------- ---------- ----------- --------- ---------- Balance, December 31, 1994 197,612 $ 1,000 19,178,060 $ 96,000 44,599,000 (19,239,000) -- 25,457,000 See accompanying notes to consolidated financial statements. F-5 NTN COMMUNICATIONS, INC. AND SUBSIDIARIES Consolidated Statements of Shareholders' Equity (Deficiency) For the years ended December 31, 1995, 1994 and 1993 10% CUMULATIVE CONVERTIBLE PREFERRED STOCK COMMON STOCK ADDITIONAL -------------------- ---------------------- PAID-IN ACCUMULATED TREASURY SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT STOCK TOTAL -------- -------- ---------- --------- ---------- ----------- --------- ---------- Issuance of stock for exercise of warrants and options, net of issuance costs -- -- 314,843 1,000 679,000 -- -- 680,000 Conversion of preferred stock to common stock (35,000) -- 9,804 -- -- -- -- -- Issuance of stock in private offerings, net of issuance costs -- -- 3,000,000 15,000 11,469,000 -- -- 11,484,000 Acquisition of 50,000 common shares -- -- -- -- -- -- (222,000) (222,000) Net loss -- -- -- -- -- (3,948,000) -- (3,948,000) -------- -------- ---------- --------- ---------- ----------- --------- ---------- Balance, December 31, 1995 162,612 $ 1,000 22,502,707 $ 112,000 56,747,000 (23,187,000) (222,000) 33,451,000 ======== ======== ========== ========= ========== =========== ========= ========== See accompanying notes to consolidated financial statements. F-6 NTN COMMUNICATIONS, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows For the years ended December 31, 1995, 1994 and 1993 1995 1994 1993 ---------- ---------- ---------- (NOTE 2) Cash flows from operating activities: Net earnings (loss) $ (3,948,000) 707,000 (1,301,000) Adjustments to reconcile net earnings (loss) to net cash provided by (used in) operating activities: Depreciation and amortization 2,150,000 837,000 282,000 Provision for doubtful accounts 983,000 1,037,000 206,000 Loss on sale of marketable securities - available for sale 70,000 -- -- Amortization of deferred gain on sale and leaseback transactions (1,316,000) (1,300,000) (900,000) (Increase) decrease in: Accounts receivable - trade (349,000) (3,430,000) (3,094,000) Software development costs (1,033,000) (1,983,000) -- Inventory, net (1,875,000) (872,000) (2,265,000) Prepaid expenses and other assets (1,729,000) (1,413,000) (1,096,000) Increase (decrease) in: Accounts payable and accrued liabilities, net of amounts paid in stock 969,000 1,076,000 (80,000) Customer deposits 278,000 356,000 368,000 ---------- ---------- ---------- Net cash used in operating activities (5,800,000) (4,985,000) (7,880,000) ---------- ---------- ---------- Cash flows from investing activities: Capital expenditures (1,196,000) (898,000) (699,000) Notes receivable (1,944,000) (406,000) (2,653,000) Software development costs (2,857,000) (1,281,000) (726,000) Purchases of other investments (103,000) (823,000) (807,000) Purchases of marketable securities - available for sale -- -- (4,515,000) Proceeds from maturities of marketable securities - available for sale -- 2,554,000 961,000 Proceeds from sales of marketable securities - available for sale 930,000 -- -- Proceeds from sale and leaseback transactions 4,500,000 4,250,000 3,500,000 Deposits related to sale and leaseback transactions (575,000) (2,100,000) (800,000) ---------- ---------- ---------- Net cash provided by (used in) investing activities (1,245,000) 1,296,000 (5,739,000) ---------- ---------- ---------- See accompanying notes to consolidated financial statements. F-7 NTN COMMUNICATIONS, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows, Continued For the years ended December 31, 1995, 1994 and 1993 1995 1994 1993 ---------- ---------- ---------- (NOTE 2) Cash flows from financing activities: Principal payments on debt $ (1,031,000) (557,000) (237,000) Proceeds from issuance of debt 2,650,000 633,000 375,000 Purchase of equipment related to sale and leaseback transactions (2,470,000) (2,263,000) (2,103,000) Proceeds from issuance of common stock, less issuance costs paid in cash 12,164,000 1,097,000 17,447,000 Repurchase of common stock (222,000) -- -- ---------- ---------- ---------- Net cash provided by (used in) financing activities 11,091,000 (1,090,000) 15,482,000 ---------- ---------- ---------- Net increase (decrease) in cash and cash equivalents 4,046,000 (4,779,000) 1,863,000 Cash and cash equivalents at beginning of year 2,429,000 7,208,000 5,345,000 ---------- ---------- ---------- Cash and cash equivalents at end of year $ 6,475,000 2,429,000 7,208,000 ========== ========== ========== Supplemental disclosures of cash flow information: Cash paid during the year for: Interest $ 59,000 54,000 38,000 ========== ========== ========== Income taxes $ 0 399,000 62,000 ========== ========== ========== Supplemental schedule of noncash investing and financing activities - stock issued upon conversion of debt, net of issuance costs $ -- -- 75,000 ========== ========== ========== See accompanying notes to consolidated financial statements. F-8 NTN COMMUNICATIONS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements For the years ended December 31, 1995, 1994 and 1993 (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ORGANIZATION NTN Communications, Inc. ("The Company") was organized under the laws of the state of Delaware in 1984 for the purpose of investing in various business ventures. The Company, through its business units and subsidiaries develops, produces and distributes individual and multi-player interactive entertainment and education programs to a variety of media platforms. The Company is also engaged in the development and distribution of interactive video game software. The Company operates under several distribution and license agreements in the United States, United Kingdom, Australia, Germany, France and Switzerland. These products are sold primarily to wholesale distributors. Royalties result from licensing rights sold to foreign publishers. BASIS OF ACCOUNTING PRESENTATION The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, National Telecommunicator Network, Inc. and New World Computing, Inc., and its partially-owned subsidiaries IWN Corporation, Inc. and LearnStar Inc. (LearnStar). During 1995, the Company directly owned 50% of LearnStar, however the Company funded all operations of LearnStar, and accordingly LearnStar has been consolidated as if it were wholly-owned. All significant intercompany balances and transactions have been eliminated in consolidation. CASH AND CASH EQUIVALENTS For the purpose of financial statement presentation, the Company considers all highly liquid investment instruments with original maturities of three months or less to be cash equivalents. Cash and cash equivalents at December+31, 1995 and 1994, consist of operational cash accounts and certificates of deposit with original maturities of three months or less. MARKETABLE SECURITIES - AVAILABLE FOR SALE Effective January 1, 1994, the Company adopted the provisions of Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" (SFAS 115). The Company has classified applicable investments as "available for sale". Securities available for sale are carried at fair value with unrealized gains and losses, net of tax, reported as a separate component of shareholders' equity. The cost of securities sold is based on the specific identification method. At December 31, 1994 marketable securities available for sale consisted of mutual funds invested in government-backed debt instruments. The fair value of available for sale securities approximated cost. Proceeds from the sale of investment securities available for sale was $930,000 in 1995 and gross realized losses included in income in 1995 was $70,000. F-9 NTN COMMUNICATIONS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued DEPRECIATION Depreciation of fixed assets is computed using the straight-line method over the estimated useful lives of the assets (three to five years). INVENTORY Inventory is valued at the lower of cost (first-in, first-out) or market and consist principally of finished goods and equipment. The Company maintains a valuation reserve which reflects the Company's estimate of the impact on inventory of potential obsolescence, excess quantities, and declines in market prices. DEPOSITS AND OTHER ASSETS Deposits and other assets include long-term life insurance contracts and other assets. These investments are carried at cost which approximates market value. REVENUE RECOGNITION Distribution and Production Service Revenue: Revenue is recognized as the service is provided by the Company. Product Sales: Revenue is recognizes when the product is shipped. Subject to limitations, the Company permits customers to obtain exchanges within certain specified periods, and provides price protection on certain unsold merchandise. Revenue is reflected net of an allowance for returns. Equipment Sales: Revenue is recorded when equipment is shipped or transferred to the purchaser. License Fee and Royalties: For those agreements which provide the customers the right to multiple copies in exchange for guaranteed amounts, revenue is recognized upon execution of the agreement since the Company has no remaining obligations or incremental costs. Per copy royalties on sales that exceed the guarantee are recognized as earned. For those agreements which provide for the marketing rights and the future use of the Companyis name, technology and trademarks, revenue is recognized when all material services or conditions relating to the sale have been performed or satisfied. INCOME TAXES Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. VALUATION OF STOCK TRANSACTIONS For stock issued in return for services, the transactions have been recorded at the value of the services received, if determinable; if such value was not determinable, the transactions were valued at the fair market value of the stock issued. F-10 NTN COMMUNICATIONS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued SOFTWARE DEVELOPMENT COSTS The Company capitalizes costs related to the development of certain software products. In accordance with Statement of Financial Accounting Standards No.+86, capitalization of costs begins when technological feasibility has been established and ends when the product is available for general release to customers. Amortization of costs for specific products is recognized on the relative value basis over the estimated economic life of each specific product, generally within one year. Amortization of costs related to interactive programs is recognized on a straight line basis over three to five years. ADVERTISING COSTS The Company accounts for advertising costs in accordance with SOP No. 93-7, Reporting on Advertising Costs. Direct response advertising is capitalized only if customer sales can be directly correlated to the advertising costs and if future benefit can be demonstrated. Capitalized advertising costs are amortized using the straight-line method over the estimated benefit period. Advertising expense for 1995, 1994 and 1993 was $290,000, $136,000, and $172,000, respectively. Amounts capitalized at December 31, 1995 and 1994 was $310,000 and $243,000, respectively. USE OF ESTIMATES Management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the 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 to prepare these financial statements in conformity with generally accepted accounting principles. Actual results could differ from those estimates. EARNINGS (LOSS) PER SHARE Earnings per share amounts are computed by dividing net earnings increased by preferred dividends resulting from the assumed exercise of stock options and warrants and the assumed conversion of convertible preferred shares, by the weighted average number of common and common equivalent shares outstanding during the period. Common stock equivalents represent the dilutive effect of the assumed exercise of certain outstanding options and warrants and preferred stock. The impact of the outstanding stock options and warrants and conversion of preferred stock would have had an anti- dilutive effect in years where losses are reported, and accordingly, have not been included in the computation. RECLASSIFICATIONS Certain items in the 1994 and 1993 consolidated financial statements have been reclassified to conform to the 1995 presentation. (2) MERGER On December 31, 1993, a subsidiary of the Company completed its merger with New World Computing, Inc. (New World), a developer and distributor of interactive video game software. The Company issued 1,025,000 shares of common stock for all of the outstanding common stock of New World. The transaction was accounted for as a pooling of interests. The consolidated financial statements for 1993 were restated to reflect the merger. (3) SALE OF SUBSIDIARY INTERESTS F-11 NTN COMMUNICATIONS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued In December 1995 the Company purchased the shares of LearnStar owned by ACT III Communications to increase its ownership in LearnStar to 100%. Also in December 1995, the Company sold a 45% interest in LearnStar to an unaffiliated company for $2,500,000 in return for a note receivable in the amount of $2,500,000. As the Company's basis in LearnStar is negative, the gain on the sale of the stock was $3,354,000. The gain was deferred and will be recognized as the Company receives proceeds on the note receivable arising from the sale. In December 1995, the Company entered into a sale and purchase agreement to sell 10% of its interest in IWN Inc. to an unaffiliated company for $350,000 A gain of $329,000 was recognized upon consummation of the sale. (4) NOTES RECEIVABLE - RELATED PARTIES Short-term and long-term notes receivable is as follows: 1995 1994 ----------- --------- 6% unsecured notes from officers and directors. Revised in April 1996 to mature in three annual installments beginning in April 1997 of 10%, 30% and 60%, respectively. Payable either in cash or through redemption of Company shares at fair market value. $ 3,438,000 2,947,000 Non-interest bearing note of $2,500,000 from unaffiliated company due $400,000 in 1996 and $2,100,000 in 1997, net of deferred gain. Secured by common stock. -- -- 6% - 8% unsecured notes from officers and directors. Due in December 1996. 680,000 315,000 Non-interest bearing unsecured note. Payment received in March 1996. 350,000 -- 5% unsecured note. Due from IWN L.P, an unconsolidated limited partnership in which the Company is a general partner. Due March 2000 or earlier to the extent of available cash as provided in the limited partnership agreement. 738,000 -- ----------- --------- Total 5,206,000 3,262,000 Current portion (1,030,000) -- ----------- --------- $ 4,176,000 3,262,000 =========== ========= Notes receivable from officers and directors include amounts advanced to officers and directors to obtain a federal or state income tax deduction for the Company. In 1993, the Company obtained a deduction of $6,900,000 related to compensation to officers and directors in prior years. The amount has been recorded as an addition to the Company's existing net operating loss carryforward. In order to obtain the deduction, the Company was required to withhold and to deposit amounts with the appropriate government taxing authorities on behalf of the officers and directors. F-12 NTN COMMUNICATIONS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued In 1995, the Company entered into a sale agreement to sell 45% of its shares in LearnStar in exchange for a note of $2,500,000. The gain has been deferred and will be recognized as the Company receives proceeds on the note receivable arising from the sale. (5) FIXED ASSETS Fixed assets are recorded at cost and consist of the following: 1995 1994 ----------- --------- Furniture and fixtures $ 767,000 271,000 Equipment 2,917,000 2,217,000 Automobile 47,000 47,000 ----------- --------- 3,731,000 2,535,000 Accumulated depreciation 1,631,000 1,130,000 ----------- --------- $ 2,100,000 1,405,000 =========== ========= (6) SHORT-TERM BORROWINGS AND LONG-TERM DEBT Short-term borrowings and long-term debt is as follows: 1995 1994 ----------- --------- $750,000 variable rate line of credit (30-day commercial paper rate plus 2.9%, 8.73% at December 31, 1995). Matures in October 1996. Secured by accounts receivable. $ 722,000 445,000 Variable rate loan (8.4% at December 31, 1995), due in May 1996, secured by life insurance policies. 1,356,000 -- Other. 17,000 31,000 ----------- --------- Total 2,095,000 476,000 Current portion of long-term debt (2,093,000) (468,000) ----------- --------- $ 2,000 8,000 =========== ========= The aggregate maturities of long-term debt for years subsequent to December 31, 1995 are as follows: 1996, $2,093,000; 1997, $2,000. (7) INCOME TAXES The company accounts for income taxes in accordance with Statement of Financial Accounting F-13 NTN COMMUNICATIONS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Standards No. 109, "Accounting for Income Taxes," ("SFAS 109"). Under the assets and liability method of SFAS 109, deferred tax assets and liabilities are recognized for the estimated future consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax balances. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. Under SFAS 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. At December 31, 1995, the Company has available net operating loss carryforwards of approximately $27,000,000 for federal income tax purposes, which begin to expire in 2006. The net operating loss carryforwards for state purposes, which begin to expire in 1996 are less than 50% of the federal tax amounts. The Company may have additional net operating loss carryforwards available subject to annual limitations under Internal Revenue Code 382. The income tax provision consists of the following: 1995 1994 1993 -------- -------- -------- Current Federal $ -- -- 234,000 State -- -- 71,000 -------- -------- -------- -- -- 305,000 -------- -------- -------- Deferred Federal -- -- (15,000) State -- -- (9,000) -------- -------- -------- -- -- (24,000) -------- -------- -------- Total $ -- -- 281,000 ======== ======== ======== F-14 NTN COMMUNICATIONS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued The tax effects of significant temporary differences which comprise deferred tax assets and liabilities as of December 31, 1995 and 1994 consist of the following: 1995 1994 ------------ ---------- Deferred tax assets: Book-Tax amortization difference $ 23,000 16,000 Bad debt reserve 696,000 174,000 Inventory reserve 70,000 30,000 Compensation and vacation accrual 242,000 143,000 Sale-Leaseback transactions 803,000 622,000 Prepaid litigation expense 110,000 -- NOL carryforwards 12,210,000 10,363,000 Other 44,000 -- ------------ ---------- Total gross deferred tax assets 14,198,000 11,348,000 Less: Valuation allowance (11,727,000) (9,930,000) ------------ ---------- Net deferred tax assets $ 2,471,000 1,418,000 ------------ ---------- Deferred tax liabilities: Book-Tax depreciation difference $ (105,000) (51,000) Capitalized software (2,236,000) (1,361,000) Gain on sale of IWN Inc. interest (128,000) -- Other (2,000) (6,000) ------------ ---------- Total gross deferred liabilities (2,471,000) (1,418,000) ------------ ---------- Net deferred taxes $ -- -- ============ ========== A reconciliation of income taxes atthe Federal statutory rate with the provision for income taxes follows: 1995 1994 1993 ------ ------ ------ Federal income tax rate (40%) (40%) (40%) Taxes on subsidiary not offset by net operating loss carryforwards -- -- 27.5% Effect of net operating loss carryfoward and valuation allowances 40% 40% 40% ----- ----- ----- Effective income tax rate 0% 0% 27.5% ===== ===== ===== The net change in the total valuation allowance for the years ended December 31, 1995 and 1994 was an increase of $1,797,000 and $300,000, respectively. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax F-15 NTN COMMUNICATIONS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued liabilities, projected future taxable income, and tax planning strategies in making this assessment. Based on the level of historical operating earnings and projections for taxable income for the future, management has determined that it is more likely than not that the portion of deferred tax assets not utilized through the reversal of deferred tax liabilities will not be realized. Accordingly, the Company has recorded a valuation allowance to reduce deferred tax assets to the amount that is more likely than not to be realized. (8) COMMON STOCK OPTIONS In 1995, The Company sold and issued an aggregate of 3,000,000 shares of common stock. In September and October 1995, 2,400,000 of these shares were issued at an initial price of $4.00 per share to certain institutional investors (Investors). Pursuant to the terms of the sale, the initial purchase price paid by the Investors is subject to adjustment based on the average of the closing prices ("Average Share Price") of the Common Stock for all trading days during the 60-day period commencing on January 15, 1996 ("Valuation Period"). Under the agreement, if the Average Share Price during the Valuation Period is less than $4.70, the Company will issue to the Investors, at no additional cost to the Investors, additional shares of common stock so as to result in a purchase price per share of common stock equal to 85% of the Average Share Price. Conversely, if the Average Sales Price exceeded $4.70 during the Valuation Period, the Investors are obligated to pay to the Company the dollar amount by which the product of 85% of the Average Share Price during the Valuation Period and 2,400,000 exceeds the amount provided to the Company. As a result of these terms, the Company anticipates that it will issue approximately 1,200,000 additional shares to the Investors in 1996. The Company has a qualified incentive stock option plan under which 2,000,000 restricted common shares are authorized for grant. Options granted in or after 1993 generally vest 33% annually, commencing one year from the date of grant and expire five years from the date of grant. A summary of the status of the Company's qualified incentive stock option plan follows: OUTSTANDING OPTION PRICE EXERCISABLE OPTIONS PER SHARE OPTIONS ----------- ------------ ----------- December 31, 1993 715,097 $2.25 - 8.25 317,897 Options granted 705,450 5.75 - 8.25 90,000 Options that became exercisable -- 6.50 - 8.25 133,400 Options exercised (8,867) 2.25 - 6.50 (8,867) Options lapsed and canceled (19,900) 6.38 - 6.50 -- --------- ------------ --------- December 31, 1994 1,391,780 2.25 - 8.25 532,430 Options granted 1,691,600 4.00 - 8.00 530,000 Options that became exercisable -- 6.38 - 8.25 369,450 Options exercised (10,500) 2.25 - 6.50 (10,500) Options lapsed and canceled (62,550) 4.50 - 6.50 (62,550) --------- ------------ --------- December 31, 1995 3,010,330 $2.25 - 8.25 1,358,830 ========= ============ ========= F-16 NTN COMMUNICATIONS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued The Company previously had a non-qualified stock option plan under which 1,455,000 restricted common shares were granted. Non-qualified options vest 50% annually, commencing one year from the date of grant and expire five years from the date of grant. A summary of the status of the non-qualified stock options follows: OUTSTANDING OPTION PRICE EXERCISABLE OPTIONS PER SHARE OPTIONS ----------- ------------ ----------- December 31, 1993 1,260,000 $2.00 - 8.25 460,000 Options granted 195,000 5.75 - 8.25 -- Options that became exercisable -- -- 400,000 Options exercised -- -- -- Options lapsed and canceled -- -- -- --------- ------------ ------- December 31, 1994 1,455,000 2.00 - 8.25 860,000 Options granted -- -- -- Options that became exercisable -- 5.75 - 8.25 497,500 Options exercised -- -- -- Options lapsed and canceled -- -- -- --------- ------------ ------- December 31, 1995 1,455,000 $2.00 - 8.25 1,357,500 ========= ============ ========= (9) 10% CUMULATIVE CONVERTIBLE PREFERRED STOCK The Company has authorized 10,000,000 shares of 10% cumulative convertible preferred stock, of which 162,612 and 197,612 were issued and outstanding at December 31, 1995 and 1994, respectively. The stock has no voting rights and has a $1.00 per share liquidation preference over common stock. At December 31, 1995, each share is currently convertible into .2801 shares of common stock at the option of the holder. During 1995, 35,000 shares of cumulative convertible preferred stock converted into 9,804 shares of common stock. (10) WARRANTS The Company has issued various warrants to purchase common stock, all of which are exercisable as of December 31, 1995. The following summarizes warrants issued and outstanding: OUTSTANDING WARRANT PRICE EXERCISABLE WARRANTS PER SHARE WARRANTS ----------- ------------- ----------- December 31, 1993 3,245,121 $2.00 - 20.00 3,245,121 Warrants granted 437,500 5.13 - 7.50 437,500 Warrants that became exercisable -- -- -- Warrants exercised (297,573) 2.00 - 3.70 (297,573) Warrants lapsed and canceled (3,119) 20.00 (3,119) ---------- ------------- ---------- December 31, 1994 3,381,929 2.00 - 8.00 3,381,929 Warrants granted 733,500 4.00 - 6.13 733,500 Warrants that became exercisable -- -- -- Warrants exercised (225,600) 2.00 - 3.70 (225,600) Warrants lapsed and canceled -- -- -- ---------- ------------- ---------- December 31, 1995 3,889,829 $2.00 - 8.00 3,889,829 ========= ============ ========= F-17 NTN COMMUNICATIONS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued (11) BUSINESS SEGMENT AND EXPORT SALES DATA Operating results and other financial data are presented for the principal business segments of the Company for the years ended December 31, 1995, 1994 and 1993. The Company's principal business units are its Hospitality Network (Hospitality Interactive Services), LearnStar, Inc. (Education Interactive Services) and New World (Software Development and Distribution). Corporate and Other includes other smaller segments and the corporate operations. 1995 1994 1993 ----------- ---------- ---------- Net Sales Hospitality Interactive Services $21,720,000 16,710,000 8,970,000 Education Interactive Services 1,095,000 -- -- Software Development and Distribution 5,379,000 5,747,000 6,135,000 Corporate and Other 2,248,000 2,189,000 2,153,000 ----------- ---------- ---------- Total $30,442,000 24,646,000 17,258,000 =========== ========== ========== Operating Income (Loss) Hospitality Interactive Services $ 3,547,000 2,839,000 1,461,000 Education Interactive Services (2,149,000) -- -- Software Development and Distribution 127,000 251,000 633,000 Corporate and Other (6,824,000) (2,795,000) (3,548,000) ----------- ---------- ---------- Total $(5,299,000) 295,000 (1,454,000) =========== ========== ========== Identifiable Assets Hospitality Interactive Services $28,125,000 20,246,000 21,787,000 Education Interactive Services 1,320,000 1,104,000 -- Software Development and Distribution 6,152,000 4,856,000 1,706,000 Corporate and Other 7,216,000 5,033,000 3,747,000 ----------- ---------- ---------- Total $42,813,000 31,239,000 27,240,000 =========== ========== ========== Capital Expenditures Hospitality Interactive Services $ 945,000 763,000 629,000 Education Interactive Services 116,000 -- -- Software Development and Distribution 30,000 51,000 -- Corporate and Other 105,000 84,000 70,000 ----------- ---------- ---------- Total $ 1,196,000 898,000 699,000 =========== ========== ========== Depreciation and Amortization Hospitality Interactive Services $ 965,000 499,000 249,000 Education Interactive Services 78,000 -- -- Software Development and Distribution 1,071,000 310,000 18,000 Corporate and Other 36,000 28,000 15,000 ----------- ---------- ---------- Total $ 2,150,000 837,000 282,000 =========== ========== ========== F-18 NTN COMMUNICATIONS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Sales to foreign customers are as follows: 1995 1994 1993 ----------- ---------- ---------- Distribution and production services $ 896,000 660,000 580,000 Equipment sales 711,000 429,000 689,000 License fees and royalties 1,521,000 851,000 802,000 ----------- ---------- ---------- Total $ 3,128,000 1,940,000 2,071,000 =========== ========== ========== (12) RETIREMENT AND SAVINGS PLANS DEFINED BENEFIT PENSION PLAN The Company has established a non-qualified, con-contributory pension plan covering certain key executives. This plan is subject to modification at any time. The plan provides retirement benefits based on years of service and compensation. Net pension expense was $7,000 and $5,000 in 1995 and 1994 respectively. Accrued pension liability totaled $12,000 and $5,000 at December 31, 1995 and 1994, respectively. DEFINED CONTRIBUTION PLAN During 1994, the Company also established a defined contribution plan which is organized under Section 401(k) of the Internal Revenue Code, which allows employees who have completed at least six months of service or reached age 21, whichever is later, to defer up to 15% of their pay on a pre-tax basis. The Company, at its discretion, may contribute to the plan. For the year ended December 31, 1995 and 1994 the Company made no such contributions. DEFERRED COMPENSATION PLAN The Company also maintains an unfunded, non-qualified deferred compensation plan, which was created in 1994 for certain members of management. This plan allows participants to defer a minimum of $5,000 up to limits set by the Internal Revenue Code. (13) FAIR VALUE OF FINANCIAL INSTRUMENTS Statement of Financial Accounting Standards No. 107, "Disclosures about Fair Value of Financial Instruments", defines the fair value of a financial instrument as the amount at which the instrument could be exchanged in a current transaction between willing parties. The Company believes that the fair value of financial instrument assets and financial instrument liabilities approximate their carrying value, except that the carrying value of notes receivable at December 31, 1995 exceeds the fair value by approximately $250,000. The following methods and assumptions were used to estimate the fair value of financial instruments: The carrying values of cash and cash equivalents, marketable securities, accounts receivable, other assets, accounts payable and accrued liabilities and short-term borrowings approximates fair value because of the short maturity of those instruments. The fair value of notes receivable and interest-bearing security deposits are determined as the present value of expected future cash flows discounted at the interest rate currently offered by the Company which approximates rates currently offered by local lending institutions for instruments of similar terms and risks. (14) COMMITMENTS AND CONTINGENCIES F-19 NTN COMMUNICATIONS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued The Company leases office and production facilities and equipment under agreements which expire at various dates. In 1995, the Company entered into a noncancelable operating lease with an entity which is partially owned by the Company. The Company incurred no lease expense under the lease in 1994 and 1993. Certain leases contain renewal provisions and generally require the Company to pay utilities, insurance, taxes and other operating expenses. Additionally, the Company has entered into agreements for the sale and leaseback of certain equipment used in broadcast operations. Deferred gains on sale and leaseback transactions is amortized to operations over the three year lease terms. Each lease provides an option to the Company to repurchase the equipment at the estimated fair market value at the end of the lease terms. Included in assets are interest- bearing security deposits totaling $3,775,000 relating to these agreements. Lease expense under operating leases totaled $4,763,000, $3,272,000 and $1,425,000 in 1995, 1994 and 1993, respectively. Future minimum lease obligations under noncancelable operating leases at December 31, 1995 are as follows: YEARS ENDING RELATED PARTY OTHER - ------------ ------------- ------------- 1996 $ 285,000 4,822,000 1997 314,000 3,179,000 1998 350,000 1,198,000 1999 373,000 162,000 2000 378,000 161,000 Thereafter 189,000 12,000 ------------- ------------- Total $ 1,889,000 9,534,000 ============= ============= The Company provides services to group viewing locations, generally bars and lounges, and to third party distributors primarily throughout the United States. In addition, the Company licenses its technology and products to licensees outside of the United States. Concentration of credit risk with respect to trade receivables are limited due to the large number of customers comprising the Companys customer base, and their dispersion across many different industries and geographies. The Company performs ongoing credit evaluations of its customers financial condition and, generally, requires deposits from its customers. At December 31, 1995, the Company had no significant concentrations of credit risk. (15) LEGAL ACTIONS Beginning in 1992 the Company has been involved in various lawsuits with Interactive Network, Inc. The remaining lawsuits have all been suspended pending substantive discussions regarding a global resolution of all disputes. The Company believes, based in part on the advice of outside independent counsel, that these actions and possible resolutions will not have a material adverse effect on the Company's financial position or results of operations. The Company is also defending litigation filed by various shareholders of the Company. The class action suit seeks to recover unspecified damages for a drop in the market price of the Company's Common Stock following an announcement that an anticipated agreement under which the Company would sell certain equipment and services to an arm of the Mexican Government may be put out for bid. Whereas the Company has vigorously defended this litigation and believes, in part, based upon the opinion of outside counsel, on the merits of its defense, the Company has entered into substantive negotiations to resolve this matter out-of-court to avoid costly and protracted litigation, in the best interests of its shareholders. A preliminary framework for such a resolution has F-20 NTN COMMUNICATIONS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued been reached, however, any proposed settlement between the parties will be subject to notification to each of the class members and final court approval. In April 1995, a second class action lawsuit was filed against the Company. The lawsuit seeks unspecified damages and alleges violations of securities laws based upon the Company's projections for the fourth quarter of 1994 and for fiscal year 1994, and further alleges that certain insiders sold stock on information not generally known to the public. In July 1995, a single shareholder filed a separate lawsuit in Texas containing allegations essentially identical to those raised in the shareholder lawsuit filed in April, 1995. The Company denies the allegations in the complaints and has filed its own counterclaim against third parties for indemnification. The Company has denied liability based upon the allegations contained in the complaints which do not contain any statement or demand for a specific amount of damages. Much discovery has been undertaken and, at this time, the Company intends to continue to vigorously contest these matters. There can be no assurance that any or all of the preceding actions will be decided in favor of the Company. The Company believes, based in part on the advice of outside, independent legal counsel, that the costs of defending and prosecuting these actions will not have a material adverse effect on the Company's financial position or results of operations. F-21 Schedule II ----------- NTN COMMUNICATIONS, INC. AND SUBSIDIARIES Valuation and Qualifying Accounts Years ended December 31, 1995, 1994 and 1993 ADDITIONS BALANCE ALLOWANCE FOR BALANCE AT CHARGED TO AT END DOUBTFUL ACCOUNTS BEGINNING EXPENSE DEDUCTIONS (a) OF PERIOD - ----------------- ---------- ---------- -------------- --------- 1993 $ 70,000 206,000 96,000 180,000 1994 $ 180,000 375,000 120,000 435,000 1995 $ 435,000 987,000 663,000 759,000 (a) Reflects trade accounts receivable written off during the year. ADDITIONS BALANCE RESERVE FOR SALES BALANCE AT OFFSET TO AT END RETURNS AND ALLOWANCES BEGINNING REVENUE DEDUCTIONS (b) OF PERIOD - ---------------------- ---------- ---------- -------------- --------- 1993 $ - - - - 1994 $ - 1,261,000 599,000 662,000 1995 $ 662,000 1,186,000 1,190,000 658,000 (b) Reflects actual returns and allowances charged against the reserve during the year. ADDITIONS BALANCE BALANCE AT CHARGED TO AT END RESERVE FOR OBSOLESCENCE BEGINNING EXPENSE DEDUCTIONS (b) OF PERIOD - ------------------------ ---------- ---------- -------------- --------- 1993 $ - - - - 1994 $ - - - - 1995 $ - 1,000,000 - 1,000,000 F-22