SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM S-1A
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
CHELL GROUP CORPORATION 11-2805051
(Incorporated in the State of New York) (I.R.S. Employee Identification Number)
4841
(Primary Standard Industrial Classification Code Number)
14 Meteor Drive
Toronto, Ontario M9W 1A4
(416) 675-6666
(Address, including zip code, and telephone number,
including area code, of registrant's principal executive offices)
Frederick M. Mintz, Esq.
Mintz & Fraade, P.C.
488 Madison Avenue
New York, NY 10022
(212) 486-2500
(Name and Address, including zip code, and telephone number,
including area code, of agent for service)
Approximate date of commencement of proposed sale of the securities to the
public:
As soon as practicable after the effective date of this Registration
Statement.
Our stock is traded in the over-the-counter market and is quoted on the
NASDAQ Small-Cap Market under the symbol CHEL. On May 4, 2001, the closing sale
price of the common stock as reported by NASDAQ was $1.74.
If any of the securities being registered on this Form are to be offered on a
delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, other than securities offered only in connection with dividend or interest
reinvestment plans, check the following box. |X|
If this Form is filed to register additional securities for an offering pursuant
to Rule 462(b) under the Securities Act, please check the following box and list
the Securities Act registration statement number of the earlier effective
registration statement for the same offering. |_|
If this Form is a post-effective amendment filed pursuant to Rule 462(c) under
the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. |_|
If this Form is a post-effective amendment filed pursuant to Rule 462(d) under
the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. |_|
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. |_|
Calculation of registration fee
Proposed Proposed
Title of maximum maximum
Securities to be Amount to be offering price aggregate Amount of
registered registered per share offering price registration fee
---------- ---------- --------- -------------- ----------------
Common
Stock, par value 7,012,053 $1.60(2) $11,219,284.80 $2,804.82
$0.0467(1)
Common
Stock, par value 100,000 $4.375 $437,500 $109.38
$0.0467(3)
Common 1,000,000 $1.60(2) $1,600,000 $400
Stock, par value
$0.0467(4)
Total
Total 8,112,053 Registration $3,314.20
Fee
(1) For the account of certain Selling Shareholders.
(2) Estimated solely for the purpose of calculating the registration fee.
Pursuant to Rule 457(c) of the Securities Act, the registration fee has been
calculated based upon the closing sale price as reported by NASDAQ Small Cap
Market for our common stock on May 9, 2001.
(3) Issuable upon the exercise of Warrants issued to two consultants for
services rendered.
(4) Offered by us.
We hereby amend this Registration Statement on such date or dates as may
be necessary to delay its effective date until we shall file a further amendment
which specifically states that this Registration Statement shall thereafter
become effective in accordance with Section 8(a) of the Securities Act of 1933
or until the Registration Statement shall become effective on such date as the
Commission, acting pursuant to said Section 8(a), may determine.
This Prospectus relates to 8,112,053 shares of common stock, of which
7,112,053 share are being offered by certain Selling Shareholders and 1,000,000
are being offered by us. We will not receive any of the proceeds from the sale
of common stock by the Selling Shareholders.
The 7,112,053 shares may be offered from time to time by the Selling
Shareholders through ordinary brokerage transactions in the over-the-counter
market, in negotiated transactions or otherwise, at market prices prevailing at
the time of sale or at negotiated prices. Up to 1,000,000 shares are being sold
by us, on a self-underwritten, best-efforts basis, with no minimum. Our offering
will commence on the date of this prospectus and will continue until the earlier
of _____________, 2001, all of the shares are sold or we otherwise terminate the
offering.
SUBJECT TO COMPLETION, DATED May 16, 2001
PROSPECTUS
8,112,053 Shares Common Stock
Chell Group Corporation
The common stock available for sale as a result of this prospectus will be
sold by currently existing shareholders. We will not receive any money from the
sale of our common stock as a result of this offering.
THE SECURITIES OFFERED HEREBY INVOLVE A HIGH DEGREE OF RISK.
SEE RISK FACTORS COMMENCING ON PAGE 6
THESE SECURITIES HAVE NEITHER BEEN APPROVED NOR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES COMMISSION. NEITHER THE
SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES COMMISSION HAS
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO
THE CONTRARY IS A CRIMINAL OFFENSE.
The date of this Prospectus is _____________, 2001
TABLE OF CONTENTS
Prospectus Summary............................................................1
Special Note Concerning Forward Looking Statements...........................16
Risk Factors.................................................................16
Use of Proceeds..............................................................16
Selling Shareholders.........................................................16
Plan of Distribution.........................................................18
Description of Securities to be Registered...................................19
Legal Matters................................................................21
Experts......................................................................21
Description of Business......................................................29
Management's Discussion and Analysis of Financial Condition
and Results of Operations....................................................45
Certain Relationships and Related Transactions...............................64
Available information
We are subject to the informational requirements of the Securities
Exchange Act of 1934, as amended, and in accordance therewith file reports and
other information with the Securities and Exchange Commission (the "SEC").
Reports, registration statements, proxy statements and other information filed
by us with the SEC can be inspected and copied at the public reference
facilities maintained by the SEC at Room 1024, 450 Fifth Street, NW, Washington,
D.C. 20549, and at the SEC's Regional Offices located at Citicorp Center, 500
West Madison Street, Suite 1400, Chicago, Illinois 60661 and 7 World Trade
Center, Suite 1300, New York, New York 10048. Copies of such material can be
obtained from the SEC's Public Reference Section, 450 Fifth Street, NW,
Washington, D.C. 20549, at prescribed rates. The SEC maintains a World Wide Web
site that contains reports, proxy and information statements and other
information regarding registrants that file electronically with the SEC The
address of the World Wide Web site is http://www.sec.gov.
We have filed with the SEC a Registration Statement on Form S-1, together
with all amendments and exhibits under the Securities Act of 1933, as amended,
with respect to our common stock which is the subject of this Registration
Statement. This Prospectus, which constitutes part of the Registration
Statement, does not contain all of the information set forth in the Registration
Statement, certain parts of which are omitted in accordance with the SEC's rules
and regulations. For further information with respect to us and the securities
offered hereby, reference is made to the Registration Statement and the exhibits
and the financial statements, notes and schedules filed as a part thereof or
incorporated by reference therein, which may be inspected at the SEC's public
reference facilities at the addresses set forth above or through the SEC's World
Wide Web site.
Statements contained in this Prospectus as to the contents of any contract
or other document are complete and accurate to the Registrant's best knowledge,
and in each instance are qualified in all respects by reference to the copy of
such contract or document filed as an exhibit to the Registration Statement.
Investors may rely upon the statements and representations contained in this
prospectus.
Prospectus summary
Our business
We are engaged in the business of providing merchant capital services,
interactive entertainment services and electronic/online products and services.
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 our management experience, in an effort to appreciate the
value of those companies. Interactive entertainment services involve, for
example electronic sports trivia games played on computer units installed in
bars, pubs and restaurants and audio-visual entertainment for the hospitality
industry. Electronic/online products and services involve providing business
software applications and support, as well as educational tools, over the
internet to registered subscribers. Our revenue is primarily generated through
two of our operating subsidiaries, being NTN Interactive Network Inc. and GalaVu
Entertainment Network Inc., as well as two of NTN Interactive Network's
subsidiaries, being, Interlynx Multimedia Inc., and Magic Lantern Communications
Ltd., and a subsidiary of Magic Lantern, Sonoptic Technologies Inc. According to
our most recent annual and semi-annual financial reports, our revenues by
industry segment, with their percentage of our total revenue, are set forth in
the table below:
Year ended 6-month period ended
August 31, 2000 February 28, 2001
$ amount and percentage $ amount and percentage
REVENUE
Network services 6,345,552 (32.2%) 3,274,340 (34.2%)
Pay-TV 6,517,940 (33.1%) 3,296,475 (34.4%)
Event programming 500,168 (2.5%) 197,699 (2.1%)
Ad sponsorship 675,532 (3.4%) 72,291 (0.8%)
Video/software sales 4,289,557 (21.8%) 2,118,654 (22.1%)
Video dubbing 717,596 (3.7%) (%)
Digital encoding 539,815 (2.7%) 537,752 (5.6%)
Other 107,886 (0.6%) 75,122 (0.8%)
- --------------------------------------------------------------------------------
$19,694,046 $9,572,333
All abbreviated references to dollar amounts contain in this Registration
Statement, whether denoted as "$" or "Cdn$" refer to Canadian dollars, unless
specifically denoted as "US$", in which case they refer to United States
dollars.
During the two most recent fiscal years, those ending August 31, 1999 and
August 31, 2000, we sustained operating losses in the respective approximate
amounts of $1,000,000 and $2,000,000. For the six-month period ending February
28, 2001, we sustained an operating loss in the approximate amount of
$6,700,000. We anticipate that we will incur significant operating losses in the
immediate future as well. As a result, we expect to continue to incur
significant operating losses and may not have enough money to satisfy our
exisiting obligations and expand our business operations in the future.
1
We currently conduct our business through ten directly or indirectly owned
subsidiaries and three investment companies.
Subsidiaries
o Chell Merchant Capital Group
o NTN Interactive Network Inc.
o GalaVu Entertainment Network Inc.
o Magic Lantern Communications Ltd.
o Sonoptic Technologies Inc.
o 1113659 Ontario Ltd., operating as Viewer Services
o Tutorbuddy.com Inc.
o Interlynx Multimedia Inc.
o 348751 Canada Inc.
o Chell.com USA Inc.
Investment Companies
o Engyro, Inc.
o cDemo Inc.
o ApplicationStation.com(1)
(1) Our Acquisition of ApplicationStation is currently pending our determination
as to whether to proceed with this acquisition and obtaining the funds necessary
to do so.
2
Resignation of previous auditors
In October 2000, Ernst & Young LLP ("E&Y") resigned as our independent
accountants. E&Y's decision to resign was based upon their belief that they
could no longer rely upon the representations made by Cameron Chell, our
President and Chief Executive Order, because of disciplinary actions taken
against Mr. Chell by the Alberta Stock Exchange in November 1998. Mr. Chell, in
an agreement with the Alberta Stock Exchange, acknowledged that he had violated
certain duties of supervision, disclosure and compliance while he worked as a
registered securities representative licensed by the Alberta Securities
Commission.
We have subsequently hired the accounting firm of Lazar, Levine & Felix, LLP as
our certifying accountants. We have authorized E&Y to fully respond to any and
all inquiries of Lazar, Levine & Felix, LLP concerning E&Y's resignation.
3
The offering
Securities Offered 8,112,053 shares of common stock. This amount
includes 5,432,192 shares offered by our directors
and officers, which constitutes 58.2% of our total
issued and outstanding shares.
Common Stock Outstanding
(As of April 25, 2001) 8,906,236 Shares.
Use of Proceeds We will not receive any proceeds from sales of
Common Stock by the Selling Shareholders. We will
use the net proceeds of our offering of 1,000,000
shares of our common stock for working capital and
general corporate purposes.
Risk Factors Prospective investors should consider
carefully certain Risk Factors, which we outline
commencing on page 6 relating to an investment
in us.
NASDAQ Symbol CHEL
4
Statement of Operations Data (expressed in Canadian Dollars):
Year Ended August 31, (in Canadian $s)
- -------------------------------------------------------------------------------------------------------------
2000 1999 1998 1997 1996
---- ---- ---- ---- ----
- -------------------------------------------------------------------------------------------------------------
Operating
Revenue $ 19,694,046 $ 13,420,642 $ 14,771,972 $ 10,351,689 $ 6,318,251
- -------------------------------------------------------------------------------------------------------------
Cost of Sales 7,657,960 5,155,883 5,515,241 3,395,898 2,223,916
- -------------------------------------------------------------------------------------------------------------
Gross Profit 12,036,086 8,264,759 9,256,731 6,955,791 4,094,335
- -------------------------------------------------------------------------------------------------------------
Net income (loss) (1,985,842) (971,497) 618,065 609,387 541,059
- -------------------------------------------------------------------------------------------------------------
Net income
(loss) per share (.69) (.36) .24 .25 .25
- -------------------------------------------------------------------------------------------------------------
Weighted average
number of shares
outstanding 2,873,042 2,635,050 2,550,805 2,441,992 2,144,175
- -------------------------------------------------------------------------------------------------------------
Six-month period ending Six-month period ending
February 28, 2001 February 29, 2000
- -------------------------------------------------------------------------------------
Operating Revenue $ 9,572,333 $ 9,961,496
- -------------------------------------------------------------------------------------
Cost of Sales 3,258,445 3,529,538
- -------------------------------------------------------------------------------------
Gross Profit 6,313,888 6,431,958
- -------------------------------------------------------------------------------------
Net income (loss) (6,712,542) (675,931)
- -------------------------------------------------------------------------------------
Net income (loss) per share (.80) (.24)
- -------------------------------------------------------------------------------------
Weighted average number of 8,356,399 2,848,558
shares outstanding
- -------------------------------------------------------------------------------------
5
Risk factors
Risks related to our business:
Because we may not have operating income or net income in the future and may not
be able to obtain requisite financing, we may be unable to develop our business.
During the fiscal years ended August 31, 1999 and August 31, 2000, we
sustained an operating loss in the respective approximate amounts of $1,000,000
and $2,000,000. For the six-month period ending February 28, 2001, we sustained
an operating loss in the approximate amount of $6,700,000. We anticipate
continuing to incur significant operating expenses in the future (including
significant cost of revenues, selling, general and administrative and
amortization expenses). As a result, we may not have enough money to expand our
business in the future. Accordingly, we expect we will have to raise, by way of
debt or equity financing, considerable funds to meet our continuing needs and to
develop our businesses. There is no guarantee that we will be able to raise the
funds needed for our business. Failure to raise the necessary funds or raise
them in a timely fashion may seriously retard our growth.
We cannot guarantee our future operating results.
Sales of our products, especially in the hospitality market, are dependent
upon discretionary spending by consumers, which may be adversely affected by
unfavorable economic conditions. Any decrease in the level of consumer spending
on network programming or unfavorable conditions of any corporation or company
relied upon in any way by us could adversely affect our proposed business and
prospects. Our future operating results will depend upon numerous factors beyond
our control, including economic conditions, changes in consumer demographics,
the popularity of the sports league licensing products to us, the availability
and relative popularity of other forms of entertainment, and public tastes and
preferences, which may change rapidly and cannot be predicted.
We rely upon the services of NTN Communications, Inc., a company that has
reported substantial losses.
NTN Communications, Inc., a company based in Carlsbad, California,
provides all of the programming for our hospitality network. This programming is
supplied through independent transmission companies. In addition, NTN
Communications, Inc. is our sole supplier of selected components of our network
subscribers systems, including the interactive game, playmaker devices. We have
no equity interest in NTN Communications and the long-term viability of our
network business is dependent upon the continued availability of program content
services originating at NTN Communications Broadcast Center.
NTN Communications, Inc. has incurred substantial losses. It reported a
net loss for the
6
year ended December 31, 2000 of US$9,589,000.
If the deterioration of NTN Communications' financial health results in
its dissolution or inability to provide programming, we would be required to
obtain programming services from other sources. If NTN Communications ceases
operations or terminates program content services, we believe, but cannot
assure, that services of the nature, quantity, and quality currently provided by
NTN Communications would become available from others. Any interruption in
program content services would result in an interruption in those services
normally delivered to subscribers. Other services would continue, including the
availability of interactive programs and games, although the content of such
games would remain static. Although we believe that we would in fact be able to
find a suitable substitute for such programming services and that we would not
lose our customers, the transition between providers and any potential delay in
finding one may have an impact upon our operating costs.
Resignation of independent auditors
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. 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
7
any representations made by Cameron Chell.
Although the possibility of E&Y's resignation may pose a risk of a
perceived damage to our image and reputation, we do not believe that E&Y's
resignation as our independent auditors will have an impact on our performance.
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.
We rely upon satellite communications systems
In view of our dependence upon satellite technologies, an operating
failure to one or more of the broadcast satellites, upon which we depend, could
conceivably render the whole network useless for an indefinite period of time.
Lack of Operating History
Our two partially owned subsidiaries, cDemo and Engyro have not yet
commenced operations and will be entering a highly competitive market. Investors
should be aware of the difficulties that cDemo and Engyro will encounter, since
cDemo and Engyro are recently formed companies and have not commenced
operations, including, but not limited to, competition, unanticipated costs and
expenses, and their requirment of substantial additional capital to survive.
There can be no assurance that cDemo and Engyro will ever realize a positive net
cash flow from their planned operations. If the business and development plans
of cDemo and Engyro prove to be unsuccessful, they may not be able to continue
in business and our investment will lose most or all of its value .
We may incur significant costs to avoid investment company status and our
business may be adversely affected if we are deemed to be an investment company.
We may incur significant costs to avoid investment company status and our
business may be otherwise adversely affected if we are deemed to be an
investment company under the Investment Company Act of 1940. Some of our equity
investments in other businesses and our venture subsidiaries may constitute
investment securities under the Investment Company Act of 1940. A company may be
deemed to be an investment company if it owns investment securities with a value
exceeding 40% of its total assets, subject to certain exclusions. If we were to
be deemed an investment company, we would become subject to the requirements of
the Investment Company Act of 1940. As a consequence, we would be prohibited
from engaging in business or issuing our securities as we have in the past and
might be subject to civil and criminal penalties for noncompliance. In addition,
certain of our contracts might be voidable, and a court-
8
appointed receiver could take control of us and liquidate our business.
Although the value of our investment securities currently comprises less
than 40% of our total assets, fluctuations in the value of these securities or
of other assets presently owned or acquired in the future may cause this limit
to be exceeded. Unless an exclusion or safe harbor were available to us, we
would have to attempt to reduce our investment securities as a percentage of our
total assets. This reduction can be attempted in a number of ways, including the
disposition of investment securities and the acquisition of non-investment
security assets. If we were required to sell investment securities, we may sell
them sooner than we otherwise would. These sales may be at depressed prices and
we may never realize anticipated benefits from, or may incur losses on, these
investments. Some investments may not be sold due to contractual or legal
restrictions or the inability to locate a suitable buyer. Moreover, we may incur
tax liabilities when we sell assets. We may also be unable to purchase
additional investment securities that may be important to our operating
strategy. If we decide to acquire non-investment security assets, we may not be
able to identify and acquire suitable assets and businesses.
Our strategy of expanding our business through acquisitions of other businesses
and technologies presents special risks.
We intend to continue to expand through the acquisition of businesses,
technologies, products and services from other businesses. Acquisitions involve
a number of special problems, including:
o difficulty integrating acquired technologies, operations, and
personnel with the existing business;
o diversion of management attention in connection with both
negotiating the acquisitions and integrating the assets;
o strain on managerial and operational resources as management tries
to oversee larger operations;
o exposure to unforeseen liabilities of acquired companies;
o potential issuance of securities in connection with the acquisition
which securities dilute the rights of holders of our currently
outstanding securities;
o the need to incur additional debt; and
o the requirement to record additional future operating costs for the
amortization of goodwill and other intangible assets, which amounts
could be significant.
We may not be able to successfully address these problems. Moreover, our
future operating results will depend to a significant degree upon our ability to
successfully manage growth and integrate acquisitions.
9
Our strategy of selling assets of, or investments in, the companies which we
have acquired and developed presents risks.
One element of our business plan involves raising cash for working capital
for our Application Service Provider (ASP) business by selling, in public or
private offerings, some of the companies, or portions of the companies, which we
have acquired and developed. This element of our business plan is subject to
market and other conditions largely beyond our control, including, but not
limited to, the following:
o our ability to engage in such sales;
o the timing of such sales; and
o the amount of proceeds from such sales.
As a result, we may not be able to sell some or all of these assets. In
addition, even if we were able to sell we may not be able to do so at favorable
prices. If we are unable to sell these assets at favorable prices, our business
will be adversely affected.
We own a minority share in and do not control Engyro and cDemo, and our
acquisition of ApplicationStation is pending.
As a result of our minority position in each of Engyro, a Delaware
corporation and cDemo, a Delaware corporation, and our pending acquisition of a
minority share in ApplicationStation.com Inc., a Delaware corporation, we do not
have the right to control the management and business activities of Engyro,
cDemo or ApplicationStation. As of September 19, 2000, pursuant to an Agreement
of Purchase and Sale, we acquired 34.1% of Engyro's shares and 14.3% of cDemo's
shares. In addition, we have agreed to purchase approximately one-quarter of a
51% interest in ApplicationStation. These subsidiaries in which we own a
minority share are newly formed and have not yet commenced operations or
generated revenue.
We do not own the rights to our name.
We have licensed the names Chell Group Corporation and Chell Merchant
Capital Group from Cameron Chell for a yearly fee of $1.00. Should we be unable
to maintain the agreement, our ability to widely use the name in connection with
the products or services to be rendered by us would cease. Loss of the ability
to use our name could adversely effect us.
We are open to exchange losses due to our operations' being located in Canada.
It is expected that a significant portion of our revenues may be received
in Canadian dollars and a portion of our expenses will be incurred in U.S.
dollars. As a result, decreases in the value of the Canadian dollar relative to
the U.S. dollar could materially and adversely affect our results of operations
in the future. To the extent that we do not fully hedge our currency
10
exposure and exchange risk or are not able to or do not raise our prices to
reflect an adverse change in exchange rates, the operating results of our
business would be adversely affected.
Our ownership is concentrated
Cameron Chell, the President and Chief Executive Officer, beneficially
owns approximately 59.8 % of our outstanding Common Shares. As a result, Mr.
Chell possesses significant influence over us on matters, including the election
of directors. The concentration of our share ownership may:
o delay or prevent a change in our control;
o impede a merger, consolidation, takeover, or other transaction
involving us; or
o discourage a potential acquirer from making a tender offer or
otherwise attempting to obtain control of us.
We have borrowed US$ 1.5 million in a bridge loan at an interest rate of two
percent (2%) per month.
We borrowed US$1.5 million on a short-term basis on January 16, 2001. The
principal amount, plus interest at a rate of two percent (2%) per month, which
was due on April 15, 2001, has been extended until May 15, 2001. The loan is
evidenced by a promissory note, pursuant to which we also agreed to deliver
22,500 of our Common Shares to the lender. The repayment of the Note is secured
by a Share Pledge Agreement, executed simultaneously with the Note, pursuant to
which Chell.com Ltd., which is wholly owned by Cameron Chell, our President and
CEO, pledged 500,000 shares of the common stock of Chell.com Ltd. The shares are
being held in escrow, with Morrison Brown Sosnovitch LLP acting as escrow agent.
We are currently attempting to raise funds sufficient to repay our loan
obligations as well as for use as operating funds. If we are unable to repay
this loan, for which we are already in default, in the near future, we will
incur further debt at the relatively high interest rate of 24% per year, which
will add to our financial liabilities. Additionally, our need to borrow from a
private lender at an annual rate of 24% may be perceived by prospective lenders
as an indication of our poor financial condition and inability to obtain
financing from other sources. Such a perception may also inhibit our ability to
obtain additional financing from prospective investors.
We do not maintain "key man" life insurance on the lives of any of our
employees.
We do not currently maintain "key man" life insurance on the life of any
of our employees. To the extent that the services of key personnel become
unavailable, we shall be required to retain other qualified persons and there
can be no assurance that we shall be able to employ and retain qualified persons
upon acceptable terms.
11
Not all of our Officers and Directors nor those of Engyro, cDemo and
ApplicationStation are full time employees.
To the extent that our Officers and Directors and those of Engyro and
cDemo are not full time employees, the transactions which are described in this
Prospectus involve or may involve conflicts of interest among the persons who
are associated with this transaction including, but not limited to, engaging in
other businesses similar or dissimilar to Engyro and cDemo and allocating their
time and services between Engyro and cDemo and any such other entities.
In view of the fact that Engyro, cDemo and ApplicationStation are recently
formed entities and have limited historical financial data upon which to base
their planned operating expenses, it is likely that revenues and operating
results will fluctuate.
CDemo and Engyro are recently formed entities and have limited historical
financial data upon which to base their planned operating expenses. Accordingly,
the expense levels of cDemo and Engyro are based in part upon their respective
managements, estimates and expectations with respect to future revenue and
anticipated growth. In view of a number of factors, the revenues and operating
results of cDemo and Engyro may fluctuate from quarter to quarter. Such factors
include, but are not limited to, variations in expenditures for personnel and
marketing, interest in their products and services and sales, resulting from the
introduction of new systems or services by cDemo and Engyro and their
competitors, and general economic conditions. In view of such factors, there can
be no assurance that cDemo and Engyro will be able to attain profitability on a
quarterly or annual basis.
If the ApplicationStation transaction goes forward, the same risk applies
with respect to ApplicationStation.
There may be a significant conflict of interest among those persons who are
associated with us.
There are potential conflicts of interest to which our directors and
officers will be subject in connection with our operations. Although there no
present conflicts of interest, it is possible that our directors and officers
may become engaged in business activities on their own behalf or have interests
in other companies and/or industries and situations may arise where our
directors and officers will be in direct competition with us. The conflicts of
interest will be dealt with in
12
the manner required by the laws applicable to us.
Planned Expansion into New Markets
We and our subsidiaries intend, subject to availability of funds, to
implement an aggressive marketing program to take advantage of what we believe
are significant market opportunities. There can be no assurance that the
targeted market shall accept our products or services, or even if accepted,
shall be of sufficient volume to enable them to be profitable. Significant
expenditures, management resources and time shall be required to develop broader
distribution channels. There can be no assurance that we and our subsidiaries
shall be successful in gaining market acceptance of our products or services.
Risks Related to our Industry
Our success depends greatly on increased use of the Internet by businesses and
individuals.
Our success depends greatly upon increased use of the Internet for
advertising, marketing, providing services, and conducting business. Commercial
use of the Internet is currently at an early stage of development and the future
of the Internet is not clear. In addition, it is not clear how effective
advertising on the Internet is in generating business as compared to more
traditional types of advertising such as print, television and radio. Because a
significant portion of our business depends upon our operating subsidiaries that
sell their products and provide their services via the Internet, our business
will suffer if commercial use of the Internet fails to grow in the future.
There are risks related to the security of electronic communications that could
potentially damage our reputation and public confidence in our services.
The secure transmission of confidential information over public
telecommunications facilities is a significant barrier to electronic commerce
and communications on the Internet. Many factors may cause compromises or
breaches of the security systems we use or other Internet sites to protect
proprietary information, including advances in computer and software
functionality or new discoveries in the field of cryptography. A compromise of
security on the Internet would have a negative effect on the use of the Internet
for commerce and communications and negatively impact our business. Security
breaches of our activities, our customers and sponsors involving the storage and
transmission of proprietary information may expose us to a risk of loss or
litigation and possible liability. There can be no assurance that our security
measures will prevent security breaches.
13
We are subject to intense competition in our existing and intended business
areas and those of Engyro, cDemo, and Application Station.
Competition in the market for Internet products and services is highly
competitive. Moreover, the market for Internet products and services lacks
significant barriers to entry, enabling new businesses to enter this market
relatively easily. Competition in the market for Internet products and services
may intensify in the future. Numerous well-established companies and smaller
entrepreneurial companies are focusing significant resources on developing and
marketing products and services that will compete with our products and
services. In addition, many of our current and potential competitors have
greater financial, technical, operational and marketing resources. We may not be
able to compete successfully against these competitors in selling our goods and
services. Competitive pressures may also force prices for Internet goods and
services down and such price reductions may reduce our revenues.
Competitors with superior resources may be able to bring new, better and
cheaper products to the market more quickly than us, Engyro, cDemo, and
ApplicationStation thereby gaining a competitive edge. We, Engyro, cDemo and
ApplicationStation each believe that the quality of our respective goods and
services combined with the expertise of our respective management should give
each of us a competitive edge. However, there can be no assurance that we will
each be able to compete successfully or that competitive pressures faced by each
of us will not materially or adversely affect each of our businesses and our
operating results and financial condition.
We may not be able to keep pace with technological advances and may face
technological obsolescence.
The computer industry and related businesses are marked by rapid and
significant technological development and change. The ASP computer software, the
interactive entertainment and the online products and services aspects of our
business are heavily reliant upon the most recent technology and equipment. We
do not have the latest developments in digital and wireless technology and
equipment. It is possible that our technology and services will be rendered
obsolete by ongoing technological developments. There also is no assurance that
we will be able to respond effectively to technological changes. Our ability to
compete is dependent in large part upon our continued ability to enhance and
improve our products and technologies, our ability to adapt our services to
evolving industry standards and our ability to continually improve the
performance, features and reliability of our service and product offerings. In
order to do so, we must effectively utilize and expand our research and
development capabilities, and, once developed, expeditiously convert new
technology into products and processes which can be commercialized. Our
competitors may succeed in tapping into markets previously monopolized by us by
developing technologies, products and processes that render our processes and
products obsolete. Our development efforts are subject to all the risks inherent
in the development of new products and technologies, including unanticipated
delays, expenses, technical problems or difficulties, as well as the possible
insufficiency of funds
14
to satisfactorily complete development, which could result in abandonment or
substantial change in product commercialization. There can be no assurance that
product development efforts will be successfully completed on a timely basis, or
at all, or that unanticipated events will not occur which would result in
increased costs or material delays in product development or commercialization.
We may not be able to foresee changes in the markets for our products and
services.
The marketplace for our products and services is constantly and
continuously undergoing change. As a result, it is difficult to predict future
demand of our products and services and whether such demand will remain
consistent.
Regulation of the Internet could have an adverse effect upon us.
There are currently few laws or regulations directly applicable to the
Internet. However, based upon the increasing popularity and use of the Internet,
a number of legislative and regulatory proposals are under consideration, and
there is a possibility that a number of laws and regulations may be adopted with
respect to the Internet, relating to such issues as, user privacy, taxation,
infringement, pricing, and quality of products and services. Although we and our
subsidiaries will make every effort to comply with applicable regulations, there
can be no assurance of their ability to do so. Additionally, the adoption of
such laws and regulations may decrease growth in the use of the Internet.
Therefore, if we and our subsidiaries are unable to comply with new laws and
regulations, or Internet use decreases as a result, their business, operations
and financial conditions would be adversely affected.
Risks related to this offering:
Computer and technology related securities are generally subject to greater
volatility in price than those of traditional manufacturing or services
companies.
The stock market has from time to time experienced significant price and
volume fluctuations that may be unrelated to the operating performance of any
particular company. The market prices of the securities of many publicly-traded
companies in the computer industry have in the past been and can be expected in
the future to be especially volatile. Factors such as our operating results,
announcements by us or by our competitors concerning technological innovations,
or new products and/or systems may have a significant impact upon the market
price of our securities.
15
The shares in this offering represent a high percentage of our total outstanding
shares.
The shares to be registered in this offering (8,112,053) represent 91% of our
total issued and outstanding shares prior to this offering. Prior to this
offering, the shares of our common stock which were acquired by Chell.com Ltd.
(5,325,049), which represents 59.7% of our total issued and outstanding shares
prior to this offering, were restricted and could not be freely traded pursuant
to Rule 144 which was promulgated by the SEC pursuant to ss.4(1) of the
Securities Act of 1933.
Special note concerning forward-looking statements
Prospective investors should carefully consider the following risk
factors, in addition to the other information contained in this Registration
Statement, in evaluating an investment in the Securities offered hereby. This
Registration Statement contains forward-looking statements, which involve risks
and uncertainties. Our actual results could differ materially from those
anticipated in these forward-looking statements as a result of certain factors,
including those set forth in the preceding risk factors and elsewhere in this
Registration Statement.
The ownership and trading of our shares of common stock are speculative
and offer a high degree of risk, including, but not necessarily limited to, the
risk factors described above. One should carefully consider the following risk
factors inherent in and affecting our business before making an investment
decision.
Use of proceeds
We will not receive any proceeds from the sale of 7,112,053 shares of
common stock by the selling shareholders. We estimate that our net proceeds from
our offering of 1,000,000 shares of our common stock will be approximately
$1,400,000 (based upon an assumed public offering price of $1.60 per share)
after deducting offering expenses of $200,000. We will use the net proceeds of
our offering of shares of our common stock for working capital and general
corporate purposes. We will retain broad discretion in the allocation of the net
proceeds of this offering. The amounts we actually spend will depend upon a
number of factors, including the amount of our future revenues and other factors
described elsewhere in this prospectus. Pending such uses, the net proceeds of
this offering will be invested in short or medium term, interest-bearing,
investment grade securities.
Selling Shareholders
An aggregate of up to 8,112,053 shares may be sold pursuant to this
Prospectus of which 7,112,053 are offered by the Selling Shareholders and up to
1,000,000 shares are being sold by us, on a self-underwritten, best efforts
basis, with no minimum. As described elsewhere in this Registration Statement,
the Selling Shareholders have either held a position or office with us or had a
material relationship with us. We will not receive any of the proceeds from the
sale of the 7,112,053 shares of common stock by the Selling Shareholders.
16
The following table sets forth certain information with respect to the
Selling Shareholders:
- ---------------------------------------------------------------------------------------------------------------
Percentage of
Selling Shares Owned Shares Shares Owned Shares after
Shareholder Prior to Offering Registered After Offering(1) Offering
- ---------------------------------------------------------------------------------------------------------------
Chell.com Ltd. (2)(6) 5,325,049 5,325,049 0 0%
- ---------------------------------------------------------------------------------------------------------------
Peter Rona (3) 386,500 107,143 279,367 2.9%
- ---------------------------------------------------------------------------------------------------------------
iCapital Corporation (7) 47,500 47,500 0 0%
- ---------------------------------------------------------------------------------------------------------------
Naveen Chanana 22,500 22,500 0 0%
- ---------------------------------------------------------------------------------------------------------------
Bruce Elliot 21,974 21,974 0 0%
- ---------------------------------------------------------------------------------------------------------------
WYWITB PTY (8)
Limited 112,750 112,750 0 0%
- ---------------------------------------------------------------------------------------------------------------
CANADIAN ADVANTAGE
LIMITED PARTNERSHIP II
Limited Partnership (9) 1,238,535 1,238,535 0 0%
- ---------------------------------------------------------------------------------------------------------------
HDL Capital Corporation (4)(10) 50,000 50,000 0 0%
- ---------------------------------------------------------------------------------------------------------------
Vanguard Market
Management (5)(11) 50,000 50,000 0 0%
- ---------------------------------------------------------------------------------------------------------------
Canadian International 136,602 136,602 0 0%
Bank of Commerce
- ---------------------------------------------------------------------------------------------------------------
(1) Assumes all of the shares offered hereby are sold by the Selling
Shareholders.
17
(2) Messrs. David Bolink and Gord Herman, each a director on our board of
directors, own options to acquire 467,121 and 498,354 shares respectively of
Engyro (or, in the event of a sale, conversion or exchange of such shares by
Chell.com the option applies to shares received by Chell.com in exchange
therefor) from Chell.com at a total price of $1.00 from each recipient.
(3) Includes 107,143 shares issued upon conversion of our Preferred Stock. Does
not include 176,000 options to purchase shares of our Common Stock, which have
vested.
(4) Includes shares issuable upon the exercise of Warrants held by the Selling
Stockholder.
(5) Includes shares issuable upon the exercise of Warrants held by the Selling
Stockholder.
(6) Chell.com Ltd. is 100% owned by Cameron Chell.
(7) iCapital Corporation is controlled by its managing directors, Rosemary
Nguyen, Randall Letcavage and M. Blaine Riley. Neither iCapital nor any of its
principals/directors are in any way related to us.
(8) WYWITB is controlled by Craig Hawkins, a resident of Australia. Neither
WYWITB nor its principal/director is in any way related to us.
(9) Canadian Advanced Limited Partnership II is controlled by its general
partner, VHM Management, Ltd. an Ontario Corporation. As of April, 2001, VHM's
directors are Mark Valentine and Ian MacKinnon. Ian MacKinnon has resigned and
is in the process of being replaced. Neither of the companies nor any of their
principals/directors is in any way related to us. Canadian Advantage Limited
Partnership II is the assignee of a US$3,000,000 convertible debenture issued by
us to the VC Advantage Limited Partnership.
(10) HDL Capital Corporation is controlled by its principal, Bernard Grybowski.
Neither HDL nor its principal/director is in any way related to us.
(11) Vanguard Market Management, Inc. is controlled by its principal, Jeffrey
Kirsch. Neither Vanguard nor its principal/director is in any way related to us.
Plan of distribution
A total of up to 8,112,053 shares may be sold pursuant to this prospectus.
This includes 1,000,000 shares of our common stock which as of the date of this
Prospectus, have not been issued. Such share are being offered by us, using our
officers, directors, and broker dealers on a self-underwritten, best efforts
basis. The broker-dealers' commission will be paid as may be negotiated in
accordance with applicable laws and regulations. The remaining 7,112,053 shares
may be sold pursuant to this prospectus by the stockholders listed below. We
will not receive any of the proceeds from the sale of our common stock by the
selling shareholders.
The 7,112,053 shares may be offered and sold from time to time as market
conditions permit in the over-the-counter market, or otherwise, at prices and
terms then prevailing or at prices related to the then-current market price, or
in negotiated transactions. The shares offered hereby may be sold by one or more
of the following methods, without limitation: (a) a block trade in which a
broker or dealer so engaged will attempt to sell the shares as agent but may
position and resell a portion of the block as principal to facilitate the
transaction; (b) purchases by a broker or dealer as principal and resale by such
broker or dealer for its account pursuant to this Prospectus; (c) ordinary
brokerage transactions and transactions in which the broker solicits purchasers;
and (d) face-to-face transactions between sellers and purchasers without a
broker-
18
dealer. In effecting sales, brokers or dealers engaged by the Selling
Shareholder may arrange for other brokers or dealers to participate. Such broker
or dealers may receive commissions or discounts from the Selling Shareholder in
amounts to be negotiated. Such brokers and dealers and any other participating
brokers or dealers may be deemed to be "underwriters" within in the meaning of
the Securities Act, in connection with such sales. Any commissions, discounts or
other fees payable to a broker, dealer or market maker in connection with the
sale of any common stock will be borne by the Selling Stockholder.
Exchange Rates
This Registration Statement contains conversions of certain amounts in
Canadian dollars ("CDN$") 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, 2000, 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 year's were as follows:
August 31,
- --------------------------------------------------------------------------------------------------------
2000 1999 1998 1997 1996
- --------------------------------------------------------------------------------------------------------
At end of period Cdn$1.4715 Cdn$1.4965 Cdn$1.5722 Cdn$1.3885 Cdn$1.3685
- --------------------------------------------------------------------------------------------------------
Average for period 1.4714 1.4949 1.4390 1.3676 1.3634
- --------------------------------------------------------------------------------------------------------
High for period 1.4955 1.5135 1.5770 1.3942 1.3815
- --------------------------------------------------------------------------------------------------------
Low for Period 1.4489 1.4760 1.4100 1.3381 1.3401
- --------------------------------------------------------------------------------------------------------
The Noon Buying Rate as of May 8, 2001 was 1.5445.
Description of Securities to be Registered
We are authorized to issue 50,000,000 Common Shares and one share of
Special Voting Stock of which 8,906,236 Common Shares and one share of Special
Voting Stock were issued and outstanding as at the date hereof. As at the date
hereof, we had also issued warrants which enable holders thereof to acquire up
to 250,000 Common Shares and had also issued stock options which entitle holders
thereof to acquire up to 1,326,500 Common Shares.
19
Common Shares
The holders of Common Shares are entitled to one vote per share held at
meetings of shareholders, to receive such dividends as declared by us and to
receive the remaining property and assets of the Corporation upon our
dissolution or winding up. The Common Shares are not subject to any future call
or assessment and there are no pre-emptive, conversion or redemption rights
attached to such shares.
On October 12, 2000, we issued a convertible debenture in the amount of
US$3,000,000 to 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 . On November 30, 2000, VC Advantage Limited Partnership
assigned the convertible debenture to Canadian Advantage Limited Partnership II.
Canadian Advantage Limited Partnership II is not related to or affiliated with
us in any way. As of the date hereof, a total of US$1,700,000 has been advanced
and Canadian Advantage Limited Partnership II is therefore in default of its
obligation to advance the balance of the funds, US$1,300,000. Although we have
no specific material commitments with respect to our anticipation of receipt of
the installments, we intend to expend such funds on working capital and the
financing of certain of our investments. If we do not receive the balance of the
funds owed to us by Canadian Advantage Limited Partnership II, we may not have
the necessary funding to develop and expand our business operations. Although
there may be remedies available to us if Canadian Advantage Limited Partnership
II defaults on its obligation to us, we have not yet determined whether we will
pursue such remedies. We also issued 50,000 warrants to 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.
As of the date hereof, we issued 250,000 Common Share Purchase Warrants.
200,000 Warrants may be exercised for Common Shares at a price of US$4.375 at
any time prior to April 4, 2003 for an aggregate of 200,000 Common Shares.
50,000 Warrants may be exercised for Common Shares at a price of US$3.00 at any
time prior to October 3, 2004 for an aggregate of 50,000 Common Shares.
Preferred Shares
There are presently no Preferred Shares outstanding.
Special Voting Stock
The one outstanding share of Special Voting Stock, which is held by
Montreal Trust Company of Canada as trustee, for the benefit of Cameron Chell,
Chell.com and others, is entitled at any relevant date to the number of votes,
on all matters presented to our shareholders,
20
equal to (i) the number of shares of our Merchant Capital Group subsidiary
Exchangeable Shares then issued and outstanding and held by holders (other than
us or any of our subsidiaries) multiplied by (ii) the number of votes to which a
holder of one of our Common Shares is entitled with respect to such matter.
Currently, there is one exchangeable share, held by Chell.com, issued and
outstanding. No dividend shall be paid or distribution shall be made to the
holders of Special Voting Stock. The Special Voting Stock is not convertible
into any other class or series of our capital stock or into cash, property or
other rights, and may not be redeemed. Any shares of Special Voting Stock
purchased or otherwise acquired by us shall be deemed retired and shall be
cancelled and may not thereafter be reissued or otherwise disposed of by us. At
such time as the Special Voting Stock has no votes attached to it because there
are no Exchangeable Shares of our Merchant Capital Group subsidiary outstanding,
the Special Voting Stock shall be cancelled. In respect of all matters
concerning the voting of shares, the Common Shares and the Special Voting Stock
shall vote as a single class and such voting rights shall be identical in all
respects.
Shares eligible for future sale
The 8,112,053 shares of common stock offered in this offering will be
immediately tradeable without restriction under the Securities Act, except for
any shares held by an "affiliate" of ours, as that term is defined in the
Securities Act. Affiliates will be subject to the resale limitations of Rule
144 under the Securities Act.
In general, under Rule 144, a stockholder, or stockholders, whose shares
are aggregated, who has beneficially owned "restricted securities" for at least
one year will be entitled to sell an amount of shares within any three month
period, equal to the greater of:
o 1% of the then outstanding shares of common stock; or
o the average weekly trading volume in the common stock during
the four calendar weeks immediately preceding the date on
which notice of the sale is filed with the commission,
provided certain requirements are satisfied.
In addition, our affiliates must comply with additional requirements of
Rule 144 in order to sell shares of common stock, including shares acquired by
affiliates in this offering. Under Rule 144, a stockholder who had not been our
affiliate at any time during the 90 days preceding a sale by him would be
entitled to sell those shares without regard to the Rule 144 requirements if he
owned the restricted shares of common stock for a period of at least two years.
The foregoing summary of Rule 144 is not a complete description.
Legal matters
Certain legal matters with respect to the validity of the shares of common
stock offered hereby are being passed upon for us by Mintz & Fraade, P.C., 488
Madison Avenue, New York, New York 10022.
Experts
The consolidated financial statements of Chell Group Corporation for the
fiscal year ending August 31, 2000 appearing in this Prospectus and Registration
Statement have been audited by Lazar, Levine & Felix, LLP, independent auditors,
and the information under the caption "Selected Financial Data" at August 2000
and for the year then ended, appearing in this Prospectus and Registration
Statement have been derived from consolidated financial statements audited by
Lazar, Levine & Felix, LLP, as set forth in their report thereon appearing
elsewhere herein. The consolidated financial statements for the six-month period
ending February 28, 2001 have been reviewed by Lazar, Levine & Felix, LLP.
Such consolidated financial statements and selected financial data are
included in reliance upon such reports given on the authority of such firm as
experts in accounting and auditing.
The consolidated financial statements of Chell Group Corporation at August
31, 1999 and for the two years then ended appearing in this Prospectus and
Registration Statement have been audited by Ernst & Young LLP, independent
auditors, and the information under the caption "Selected Financial Data" at
August 1999 and for the two years then ended, appearing in this Prospectus and
Registration Statement have been derived from consolidated financial statements
audited by Ernst & Young LLP, as set forth in their report thereon appearing
elsewhere herein.
21
Such consolidated statements and selected financial data are included in
reliance upon such reports given upon the authority of such firms as experts in
accounting and auditing.
Information with Respect to the Registrant
Description of Business and Corporate History
Formation
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.
Acquisition of Magic Lantern
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 Ontario corporation, and its subsidiaries for a
purchase price of $1,553,315. The purchase price was satisfied by the payment of
$515,000 in cash and the issuance of 185,448 Common Shares. 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.com Inc.
Magic Lantern also has a 75% ownership of the outstanding stock of Sonoptic
Technologies Inc.
Acquisition of Assets of Image Media Ltd.
In August 1997, we acquired certain business assets of Image Media Ltd.
and 802117 Ontario Inc., operating as Pilot Software, for an aggregate purchase
price of $590,000, which was paid in cash.
Acquisition of Interlynx
In September 1997, we, indirectly through NTN Interactive Network,
acquired 51% of the outstanding stock of Interlynx Multimedia Inc., an Ontario
corporation, for a purchase price of $622,000. The purchase price was satisfied
by $357,000 in cash and the issue of 55,209 Common Shares at a deemed price of
$4.80 per share. In June 1999, we, indirectly through NTN Interactive Network,
acquired the remaining 49% of the outstanding stock of Interlynx. The purchase
price was satisfied by the issuance of 27,778 Common Shares and the issuance of
options to purchase up to 80,000 Common Shares at a strike price of US$3.00 per
share.
Acquisition of Assets of GalaVu
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, for a
22
purchase price of $2,958,058. The purchase price was satisfied by the issuance
of 100,000 Common Shares and the issuance of a promissory note. The promissory
note is secured by a general security interest in all of GalaVu's present and
after-acquired assets. The promissory note is payable in cash or in Common
Shares annually, at our option, 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 promissory note, the minimum amount to
be received by the holder of the promissory note is as follows: in fiscal 2001 -
$300,000; in fiscal 2002 - $500,000; in fiscal 2003 - $750,000; in fiscal 2004 -
$875,000; and in fiscal 2005 - $875,000. The purchase price was allocated to the
fixed assets of GalaVu.
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.
Recent Developments
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 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
23
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 $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
US$200,000. Richard Wolff Enterprises, Inc. is not an entity related to or
affiliated with us. As a result, Magic Lantern has expanded its 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 US$300,000 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. 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
24
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.
We entered into an agreement dated November 22, 2000 with Chell.com, a
company wholly owned by Cameron Chell, whereby we provided a deposit to
Chell.com with respect to the purchase of an interest in ApplicationStation.com,
a company in which Chell.com was planning to purchase a 51% interest by late
January 2001. The deposit permits us to obtain 25% of Chell.com's interest in
the purchase. This acquisition is subject to our further discussion and
consideration of its benefits to our business needs.
On January 16, 2001, we entered into a promissory note with Naveen Chanana
whereby we borrowed $1.5 million on a short-term basis as a bridge loan. Mr.
Chanana is not affiliated with us. The principal amount plus interest of two
percent (2%) per month was due on April 15, 2001, and has been extended until
June 15, 2001. Pursuant to the promissory note, we also issued 22,500 of our
Common Shares to Naveen Chanana. We may prepay the loan at any time.
On January 17, 2001, we entered into a Stock Purchase Agreement with
ApplicationStation.com, whereby we, Chell.com, eSupplies, B.O.T.B. Corp. and
Cameron Chell agreed to purchase and ApplicationStation.com agreed to issue
shares which would result in the purchasers' holding a 51% interest in
ApplicationStation.com. The total purchase price for the shares is US$4,080,000.
We agreed to purchase one-quarter (1/4) of the 51% interest for a purchase price
of US$1,020,000, of which amount at such time we advanced US$700,000 by way of
the deposit agreement with Chell.com dated November 22, 2000. The closing of the
transaction was scheduled for 30 days from the date of the agreement, but is
subject to several conditions including satisfactory due diligence being
completed by the purchasers and certain amendments to a technology license
agreement between ApplicationStation.com and LearningStation.com Inc. Our
acquisition of ApplicationStation is currently pending our determination as to
whether to proceed with this acquisition and obtaining the funds necessary to do
so. Cameron Chell controls Chell.com and B.O.T.B. Corp. and is a principal
shareholder of eSupplies. In the event the closing of the transaction does not
occur, and the moneys which have been advanced to ApplicationStation.com are not
returned by them for any reason, Chell.com Ltd. has pledged to us 550,000 shares
of Chell Merchant Capital Group held by Chell.com Ltd as security for such
amount.
On January 26, 2001 we entered into a Supplemental Stock Purchase
Agreement with ApplicationStation.com, whereby we, Chell.com, eSupplies, BOTB
Corp. and Cameron Chell increased the number of shares we agreed to purchase in
the Stock Purchase Agreement dated January 17, 2001 and increased our portion of
the purchase price to $1,100,000. Pursuant to a January 26, 2001 amendment to
the deposit agreement with Chell.com, we advanced the remaining $400,000
purchase price.
25
Our Merchant Capital Group subsidiary laid-off 24 employees effective
January 19, 2001 as a cost cutting measure and in an effort to find further
efficiencies following the purchase of Chell assets in September, 2000. Total
severance and termination payments to such employees are approximately $409,000.
The following is an organizational chart of the Corporation:
[FLOW CHART OMITTED]
26
(1) All subsidiaries are 100% owned unless otherwise stated.
(2) Our Acquisition of ApplicationStation is currently pending our determination
as to whether to proceed with this acquisition and obtaining the funds necessary
to do so.
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 Other Entities Subsidiary's
Ownership with Equity Revenues as a
Shareholding and Percentage of
Percentages our Total
Revenues
- --------------------------------------------------------------------------------
Chell Merchant 100% N.A. 0%
Capital Group, Inc.
- --------------------------------------------------------------------------------
NTN Interactive 100% N.A. 37.7%
Network Inc.
- --------------------------------------------------------------------------------
GalaVu Entertainment 100%(through NTN N.A. 34.5%
Network Inc. Interactive
Network, Inc.)
- --------------------------------------------------------------------------------
Magic Lantern 100% (through NTN N.A. 19.1%
Communications Ltd. Interactive
Network, Inc.)
- --------------------------------------------------------------------------------
Sonoptic Technologies 75% (through N.A. 5.7%
Inc. Magic Lantern)
- --------------------------------------------------------------------------------
1113659 Ontario Ltd., 100% (through N.A. 0%
operating as Viewer Magic Lantern)
Services
- --------------------------------------------------------------------------------
Tutorbuddy Inc. 100% (through N.A. 0%
Magic Lantern)
- --------------------------------------------------------------------------------
Interlynx Multimedia 100% (through NTN N.A. 3%
Inc. Interactive
Network, Inc.
- --------------------------------------------------------------------------------
348751 Canada Inc. 100% N.A. 0%
- --------------------------------------------------------------------------------
Chell.com USA Inc. 100% N.A. 0%
- --------------------------------------------------------------------------------
27
- --------------------------------------------------------------------------------
Investment Companies: Our Percentage Other Entities Subsidiary's
Ownership with Equity Revenues as a
Shareholding and Percentage of
Percentages our Total
Revenues
- --------------------------------------------------------------------------------
Engyro, Inc. 34.16% Private Venture None to date.
Capitalists
(38.12%,);
Engyro's
Management
(27.72%)
- --------------------------------------------------------------------------------
cDemo Inc. 17.86% Private Venture None to date.
Capitalists
(22.32%); cDemo's
Management and
Employees (59.82%)
- --------------------------------------------------------------------------------
28
Financial Information about Industry Segments
Reference is hereby made to the Business Sector data for the years ended
August 31, 2000, 1999, and 1998 in Exhibit 99.1 below.
2000
Inter-segment
Entertainment Education E-commerce Unallocated adjustments Total
$ $ $ $ $
- -------------------------------------------------------------------------------------------------------------------------------
Total revenue 14,320,649 5,247,764 586,756 -- (461,123) 19,694,046
Operating loss 346,301 (645,208) (914,315) (822,515) 20,419 (2,015,318)
Identifiable assets 8,592,258 3,492,952 396,652 -- -- 12,481,862
Corporate assets 4,975,030 68,644 (144,941) -- -- 4,898,733
Capital expenditures 842,955 289,236 29,955 -- -- 1,162,146
Depreciation and amortization 1,733,473 408,856 204,992 -- -- 2,347,321
Income from equity investment -- -- -- -- -- --
===============================================================================================================================
1999
Inter-segment
Entertainment Education E-commerce Unallocated adjustments Total
$ $ $ $ $
- -------------------------------------------------------------------------------------------------------------------------------
Total revenue 8,115,127 5,192,378 596,951 -- (483,814) 13,420,642
Operating profit (loss) 204,843 (594,824) (229,599) -- (246,693) (866,273)
Identifiable assets 4,389,308 4,290,025 351,555 -- -- 9,030,888
Corporate assets 4,923,498 (182,367) 1,030,002 -- -- 5,771,133
Capital expenditures 350,836 147,761 103,036 -- -- 601,633
Depreciation and amortization 900,770 428,376 100,073 -- -- 1,429,219
Income from equity investment -- 28,576 -- -- -- 28,576
===============================================================================================================================
1998
Inter-segment
Entertainment Education E-commerce Unallocated adjustments Total
$ $ $ $ $
- -------------------------------------------------------------------------------------------------------------------------------
Total revenue 8,498,545 5,054,376 1,367,430 -- (148,379) 14,771,972
Operating profit (loss) 1,266,418 (389,046) 418,385 -- (148,379) 1,147,378
Identifiable assets 4,887,935 4,170,474 280,908 -- -- 9,339,317
Corporate assets 4,794,976 720,784 1,192,830 -- -- 6,708,590
Capital expenditures 1,787,043 223,700 1,800 -- -- 2,012,543
Depreciation and amortization 784,113 434,449 92,127 -- -- 1,310,689
Income from equity investment -- (25,658) -- -- -- (25,658)
===============================================================================================================================
OUR BUSINESS
We are engaged in the business of providing merchant capital services,
interactive entertainment services and electronic/online products and services.
Our core businesses are the merchant capital services provided through our
Merchant Capital Group subsidiary and the interactive entertainment services
provided by our NTN Interactive Network subsidiary. 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.
In addition, 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
29
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.
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.
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 ASP industry.
ASP - Software as a Service
ASP is changing the way application software is distributed. The ASP
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. ASP's 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 ASP 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 ASP 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
30
companies to become leaders in areas that we believe will define new
technological trends. These companies intend to be fully developed and
then sold 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.
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 ASP 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
31
identify appropriate venture capitalists that would be interested in
pursuing financing relationships with client companies.
NTN Interactive Network Inc.
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 3,100 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.
32
NTN Premium Trivia Games
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 programming, and other information and entertainment services
designed to enhance the stay of
33
hotel guests while generating revenue for our GalaVu subsidiary and its hotel
partners.
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's library of educational content 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.
Interlynx Multimedia Inc.
Interlynx has developed PROFIS, an advanced web-based training software
that runs on Windows NT servers. Interlynx's marketing efforts are targeted
toward both local and
34
international markets. The core competencies of Interlynx include programming in
Visual C++, Java, HTML, ASP and Visual Basic running on MS-DOS, Windows 3.1,
95/98 and NT, and Unix platforms.
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 34% of
the stock of Engyro and the remaining equity of the company is as follows:
Private Venture Capitalists (38.12%,); Engyro's Management (27.72%).
Engyro is a financial transaction engine designed to support the high
demands created by rapid growth in the ASP industry. Engyro is focusing on
providing the critical back end administrative services for the ASP industry.
Our Management believes that this will allow integration of the billing,
payment, disbursement, and settlement functions for ASP 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 ASP
transaction. Engyro intends to strategically deploy its service offering to give
efficient and flexible local service to the ASPs, Independent Software Vendors,
which we refer to as ISVs and Network Service Providers, which we refer to as
NSPs. 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 ASP marketplace. Most ASPs 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 ISVs to market
Engyro's ability to enable them to transition to an e-commerce platform to take
advantage of new distribution channels in the ASPs. Engyro also intends to
approach ISPs and NSPs and seek to assist them in their provision of ASP
value-added services to their core offering. Engyro intends to reach its target
market in the following ways:
1. Indirectly by offering ISVs a secure method to enable ASPs 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
35
providers, Data Centers, and other components of the community of ASP
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 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. As at the date hereof, cDemo has
not entered into any agreement with third parties and there can be no
36
assurance that cDemo will be able to do so in the future.
ApplicationStation
ApplicationStation operates as an ASP enabler, or `eASP', focusing on the
packaging, delivery and management of hosted application solutions delivered
over the Internet or private network. On November 22, 2000 we entered into a
transaction in which we, collectively with other entities (Chell.com, eSupplies,
B.O.T.B. Corp. and Cameron Chell) agreed to purchase a 51% interest in
ApplicationStation. Our percentage of that 51% interest is to be 1/4, therefore
a 12.75% ownership. This transaction has not yet been completed and our
Acquisition of ApplicationStation is currently pending our determination as to
whether to proceed with this acquisition and obtaining the funds necessary to do
so.
The remainder of ApplicationStation's stock is owned by unaffiliated third
parties.
As an eASP, ApplicationStation's prime focus is to partner with
organizations such as established software companies, telecommunications
providers, systems integrators, professional and trade associations and
governments to enable them to become ASP's in their own right.
ApplicationStation also works with large corporations to enable them to manage
enterprise ASP deployments.
ApplicationStation has three core competencies to support its eASP
position.
1. ApplicationStation has developed a proprietary ASP distribution and
management system, called App(2), that performs three critical functions: 1) it
allows for universal authentication and login for all applications being
distributed; 2) it manages the launch of any type of application, web-based,
Windows-based, all flavors of Unix, or legacy applications; and 3) it enables
customer organizations to self-manage their application rights against a
contract, greatly reducing the need for support services and related
infrastructure.
App(2) allows ASP solutions to scale rapidly across large numbers of users
and organizations, without the need to deploy large and costly support
facilities to manage application distribution. ApplicationStation.com believes
App(2) is critical to ASP growth and profitability.
2. ApplicationStation is developing and deploying a series of branded, vertical
ASP solution sets, built on and leveraging the company's "Station.com" brand.
The company plans to launch three vertical solutions: TravellerStation.com, for
the travel management industry; AutomotiveStation.com, for the automotive
service industry; and AccountingStation.com, for public accountants. The company
also plans to release at least two more brands in the second quarter of fiscal
2001: MedicalStation.com and LawStation.com. The company brings these vertical
brands to its partners for distribution to their targeted customers.
ApplicationStation also has international distribution rights for
LearningStation.com, an educational ASP, based in Charlotte, North Carolina.
37
3. ApplicationStation integrates the applications that form its vertical brands,
to enhance performance and improve value.
ApplicationStation has four primary sources of revenue: 1) the branded,
vertical products it resells through its partners; 2) products that are sold
outside of branded vertical model, but still sold through its partners; 3)
corporate licensing fees for App(2); and 4) professional services.
ApplicationStation is headquartered in Bellingham, Washington, and has
subsidiaries in Canada, the United Kingdom and Australia. In addition, it has
signed an Agreement dated October 28, 2000 to acquire majority ownership in an
established systems integrator, BDO Synergy IT, based in Sydney, Australia. This
transaction has now closed.
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 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
38
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 and Interlynx operate 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 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. Interlynx's market also includes several competitors.
Educational web-based training programs are a growing market and new entrants
are arriving continually. Therefore, Interlynx expects competitive forces to
increase in the future.
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 ASP
financial supply chain, each offering a different set of services that in
conjunction allow ASP 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 ASP 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.
39
Employees
We have 134 employees in the nine operating subsidiaries, consisting of 14
executives, 25 salespersons, 33 persons involved in technical services, 4
involved in graphic development, 17 clerical staff, 14 in marketing, 26
individuals involved in finance and administration and 1 individual involved in
investor relations. We believe that our staff is adequate for our anticipated
needs.
Our Merchant Capital Group subsidiary laid-off 24 employees effective
January 19, 2001 as a cost cutting measure and in an effort to find further
efficiencies following the purchase of Chell assets in September 2000. Total
severance and termination payments to employees are approximately US$409,000.
Description of Property
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, our NTN Interactive Network subsidiary and Interlynx
presently utilize this building as our principal place of business.
We also own an approximately 29,000 square foot parcel of land, located at
10 Meteor Drive, 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 located 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 annual rent of $38,643, 8,451 square feet of
office and warehousing space in Vancouver, British Columbia for annual rent of
$84,510 and 961 square feet of office space in Chicago, Illinois for 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 balance outstanding regarding these two properties, as at
March 3, 2000 was $1,221,452.
GalaVu leases 8,619 square feet of office space in a building located at
3790 - 3820 Victoria Park Avenue, North York, Ontario, which lease expires on
October 31, 2002. GalaVu is also a guarantor of a lease dated September 22, 1999
between 151516 Canada Inc. and XON Digital Communications Limited for a 3,500
square foot premises located in Halifax, Nova Scotia.
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, T2P
40
1G6. The combined annual rent of the three suites is $202,087.
We believe that our and facilities and those of our subsidiaries are
adequate for their present requirements.
Legal Proceedings
Set forth below is a description of material pending litigation to which
we are a party.
1. (a) On June 12, 1992, we, together with NTN Communications, Inc. and
NTN Interactive Network, commenced a lawsuit against Interactive Network, Inc.
and its president, David Lockton, in the Federal Court of Canada, Trial
Division, in Montreal, Quebec, under the title NTN Communications, Inc., NTN
Sports, Inc. and NTN Canada, Inc. v. David Lockton and Interactive Network, Inc.
We are seeking a declaration of non-infringement with respect to Canadian
Patent No. 1,274,903 held by Interactive Network, and to establish that we, NTN
Communications, Inc. and NTN Interactive Network have properly done business in
Canada since the fall of 1986.
The basis for our claim is that the systems we used to produce interactive
programming are not within the scope of the claims of Interactive Network's
Patent. We thereafter amended our complaint to include a claim of invalidity of
the Patent based upon untrue and materially misleading claims made by
Interactive in its petition for the Patent. Except for the aforementioned
pleadings, no proceedings or discovery have been undertaken in our action.
(b) Subsequent to the commencement of our action, and on June 18, 1992,
Interactive Networks commenced a lawsuit against us, NTN Communications, Inc and
NTN Interactive Network 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 Networks granted NTN Communications, Inc. the right to use
Interactive Network's Patent, which right NTN Communications then improperly
licensed to us and NTN Interactive Network. Interactive Networks alleges that
the license agreement between NTN Communications, Inc. and us and NTN
Interactive Network infringes upon Interactive Network's Patent. The action
seeks a declaration of the validity of Interactive Network's 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 the this action.
Management believes that the licenses granted to us by NTN Communications,
Inc. are valid and that the patent infringement claims underlying the
Interactive action will ultimately be proven to be unfounded. We intend to
vigorously defend our position in the Interactive action and to prosecute our
position in our action; however, there can be no assurance that any or all of
these actions will be decided in our favor. 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
41
material adverse effect upon our financial position.
In its Quarterly Report on Form 10-Q, for the quarter ended September 30,
1996, NTN Communications, Inc. stated that "[w]ith the courts [sic] assistance,
[NTN Communications, Inc.] 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, Inc. Form 10-Q involved litigation in the United States
involving allegations similar to the allegations underlying our action and the
Interactive action. In the NTN Communications, Inc. Form 10-Q, NTN
Communications, Inc. also noted that "no substantive action has been taken in
the furtherance of our action or the 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 NTN Communications, Inc.. No assessment has been made to date by
Canada Customs and Revenue Agency. Management believes that it has 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.
We and our property are not 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.
42
Market Price & Dividends on the Registrant's Common Equity & Related Stockholder
Matters
Our common stock, par value US$.0467 per share,is traded in the
over-the-counter market and is quoted on the NASDAQ Small Cap Market under the
symbol "CHEL". Set forth below is the range of high and low bid prices (US$) for
shares of common stock for each full quarterly period within our three most
recent fiscal years and our first quarter of the current year. The information
reflects inter-dealer prices, without retail mark-ups, markdowns or commissions
and may not necessarily represent actual transactions. We have never declared
dividends on our stock in our history.
High Low Trading Volume
---- --- --------------
(US$) (US$)
1998 Fiscal Year
First Quarter 6.375 4.000 227,190
Second Quarter 4.500 2.75 141,073
Third Quarter 4.250 1.875 306,909
Fourth Quarter 4.500 1.188 1,269127
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 4.8125 1.8125 ________
On May 4, 2001, the closing price of the Common Shares on NASDAQ was
US$1.74
As of the close of business on April 20, 2001, there were 214 holders of
record of our common stock. We believe that there are approximately 1,100
beneficial holders of common stock.
43
Financial Information
Set forth below is a list of our financial information being furnished in
this Registration Statement on Form S-1 pursuant to the instructions to Item 11
(e) to Form S-1 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 and Retained Earnings............ F - 4
Consolidated Statements of Cash Flows.................................. F - 5
Notes to Consolidated Financial Statements............................. F - 6
Audited Financial Statements of Engyro................................. F - 28
Audited Financial Statements of cDemo, Inc............................. F - 40
Audited Financial Statements of eSupplies, Inc......................... F - 54
Pro Forma Financials................................................... F - 70
- ----------
* Page F-1 follows page 74 to this Registration Statement on Form S-1.
Selected Financial Data
The following table sets forth a summary of selected financial information
regarding us and our subsidiaries, consolidated, for each of the five fiscal
years ended August 31, 2000 and the six-months ended February 28, 2001 and 2000.
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 13 to the consolidated financial statements.
Statement of Operations Data (expressed in Canadian Dollars):
Year ended August 31: (In Canadian $'s)
- ----------------------------------------------------------------------------------------------------------
2000 1999 1998 1997 1996
---- ---- ---- ---- ----
- ----------------------------------------------------------------------------------------------------------
Operating
Revenue $ 19,694,046 $ 13,420,642 $ 14,771,972 $ 10,351,689 $ 6,318,251
- ----------------------------------------------------------------------------------------------------------
Cost of Sales 7,657,960 5,155,883 5,515,241 3,395,898 2,223,916
- ----------------------------------------------------------------------------------------------------------
Gross Profit 12,036,086 8,264,759 9,256,731 6,955,791 4,094,335
- ----------------------------------------------------------------------------------------------------------
Net
loss (1,985,842) (971,497) 618,065 609,387 541,059
- ----------------------------------------------------------------------------------------------------------
Net
loss per share (.69) (.36) .24 .25 .25
- ----------------------------------------------------------------------------------------------------------
Weighted average
number of shares
outstanding 2,873,042 2,635,050 2,550,805 2,441,992 2,144,175
- ----------------------------------------------------------------------------------------------------------
44
Six-month period ending February 28: (In Canadian $'s)
2001 2000
- --------------------------------------------------------------------------------
Operating Revenue $ 9,572,333 $ 9,961,496
- --------------------------------------------------------------------------------
Cost of Sales 3,258,445 3,529,538
- --------------------------------------------------------------------------------
Gross Profit 6,313,888 6,431,958
- --------------------------------------------------------------------------------
Net loss (6,712,542) (675,931)
- --------------------------------------------------------------------------------
Net loss
per share (.80) (.24)
- --------------------------------------------------------------------------------
Weighted average
number of shares
outstanding 8,356,399 2,848,558
- --------------------------------------------------------------------------------
Balance sheet data (Canadian Dollars):
As at August 31:
2000 1999 1998 1997 1996
- ----------------------------------------------------------------------------------------
Total assets 17,380,595 14,802,021 16,047,907 14,287,602 9,883,093
- ----------------------------------------------------------------------------------------
Long-term obligations 4,833,845 2,216,675 2,840,218 2,185,249 -0-
- ----------------------------------------------------------------------------------------
Shareholders' equity 9,383,419 10,792,767 11,033,178 9,488,648 8,877,434
- ----------------------------------------------------------------------------------------
As At February 28, 2001
- --------------------------------------------------------------------------------
Total assets 19,649,602
- --------------------------------------------------------------------------------
Long-term obligations 9,957,858
- --------------------------------------------------------------------------------
Shareholders' equity 6,284,084
- --------------------------------------------------------------------------------
Management's Discussion & Analysis of Financial Condition &
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
45
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, 2000 Compared to Year Ended August 31, 1999
Revenues. Revenues from network services for the 2000 Fiscal Year were
Cdn$6,345,552, compared to Cdn$6,607,915 for our fiscal year ended August 31,
1999 (the "1999 Fiscal Year"), a decrease of Cdn$262,363 or 4.0%. The revenue
earned from 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 Cdn$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 Cdn$500,168,
compared to Cdn$527,740 for the 1999 Fiscal Year, a decrease of Cdn$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 Cdn$675,532 for the 2000 Fiscal Year,
compared to Cdn$308,602 for the 1999 Fiscal Year, an increase of Cdn$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 Cdn$4,289,557 for the 2000
Fiscal Year, compared to Cdn$4,630,931 for the 1999 Fiscal Year, a decrease of
Cdn$341,374 or 7.4%. Of these revenues, Cdn$586,756 was earned by Interlynx, as
compared to Cdn$596,951 for the 1999 Fiscal Year, a decrease of Cdn$10,195 or
1.7%. Revenues from video and software sales earned by our Magic Lantern
subsidiary and its subsidiaries were Cdn$3,702,801 for the 2000 Fiscal Year,
compared to Cdn$4,033,980 for the 1999 Fiscal Year, a decrease of Cdn$331,179 or
8.2%. 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.
Revenues from video dubbing were Cdn$717,596 for the 2000 Fiscal Year
compared to
46
Cdn$691,156 for the 1999 Fiscal Year, an increase of Cdn$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 Cdn$539,815 for the 2000 Fiscal Year,
compared to Cdn$462,742 for the 1999 Fiscal Year, an increase of Cdn$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 Cdn$107,886, compared to
Cdn$191,556 for the 1999 Fiscal Year, a decrease of Cdn$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
Cdn$19,694,046, compared to Cdn$13,420,642 for the 1999 Fiscal Year, an increase
of Cdn$6,273,404 or 46.7%.
Cost of Sales. Cost of Sales for network services for the 2000 Fiscal Year
were Cdn$2,160,351, compared to Cdn$2,353,705 for the 1999 Fiscal Year, a
decrease of Cdn$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% for the 2000 Fiscal Year from 17.5% for
the 1999 Fiscal Year.
Pay-tv costs were Cdn$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 14.8%.
Event programming costs were Cdn$23,819, compared to Cdn$24,650 for the
1999 Fiscal Year, a decrease of Cdn$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.
Advertising sponsorship costs were Cdn$93,496, compared to Cdn$61,255 for
the 1999 Fiscal Year, an increase of Cdn$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 Cdn$2,078,926, compared to
Cdn$1,990,741 for the 1999 Fiscal Year, an increase of Cdn$88,185 or 4.4%. Of
these costs, Cdn$453,041 was
47
incurred by Interlynx, compared to Cdn$281,115 for the 1999 Fiscal Year, an
increase of Cdn$171,926 or 61.2%. The increase results from increased staffing
in the area of product development associated with the current revenue streams.
Costs attributable to video and software sales of our Magic Lantern subsidiary
and its subsidiaries for the 2000 Fiscal Year were Cdn$1,625,885, compared to
Cdn$1,709,626 for the 1999 Fiscal Year, a decrease of Cdn$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 10.6% in the 2000
Fiscal Year from 14.8% in the 1999 Fiscal Year.
Video dubbing costs were Cdn$157,289, compared to Cdn$353,983 for the 1999
Fiscal Year, a decrease of Cdn$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 2.6% in the 1999 Fiscal Year.
Digital encoding costs were Cdn$111,657 for the 2000 Fiscal Year, compared
to Cdn$11,738 for the 1999 Fiscal Year, an increase of Cdn$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 Cdn$113,005, compared to Cdn$359,811 for the 1999 Fiscal
Year, a decrease of Cdn$246,806 or 68.6%. As a percentage of our total revenues,
such costs decreased to 0.6% for the 2000 Fiscal Year from 2.7% 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 Cdn$7,657,960,
compared to Cdn$5,155,883 for the 1999 Fiscal Year, an increase of Cdn$2,502,077
or 48.5%. Total gross margins decreased to 61.1% in the 2000 Fiscal Year from
61.6% in the 1999 Fiscal Year.
Expenses. Selling, general and administrative expenses for the 2000 Fiscal
Year were Cdn$11,266,339, compared to Cdn$7,572,771 for the 1999 Fiscal Year, an
increase of Cdn$3,693,568 or 48.8%. The increase was caused by the following
factors; firstly, our GalaVu subsidiary's selling, general and administration
expenses for the 2000 Fiscal Year were Cdn$2,761,254 or 74.8% of the total
increase (There are no comparative figures for the 1999 Fiscal Year); secondly,
severance packages associated with executive restructuring ($643,250); thirdly,
a provision for certain investments ($179,265); fourthly, there were increased
legal and accounting fees ($60,273) associated with operations and items
pertaining towards our future; and finally, costs associated with the purchase
of the remaining 49% of Interlynx ($141,619). As a percentage of our total
revenues, total selling, general and administrative expenses increased to 57.2%
for the 2000 Fiscal Year from 56.4% for the 1999 Fiscal Year.
Bad debts expense was Cdn$140,090, compared to Cdn$136,888 for the 1999
Fiscal Year, an increase of Cdn$3,202 or 2.4%. The increase resulted from an
increase in the allowance for 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.
48
Interest and bank charges for the 2000 Fiscal Year were Cdn$297,654,
compared to Cdn$98,440 for the 1999 Fiscal Year, an increase of Cdn$199,214 or
202.4%. 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 Cdn$176,325 or 88.5% of the total increase. As a percentage of our
total revenues, such costs increased to 1.5% for the 2000 Fiscal Year from 0.7%
for the 1999 Fiscal Year.
Depreciation and amortization for the 2000 Fiscal Year were Cdn$2,347,321,
compared to Cdn$1,429,219 for the 1999 Fiscal Year, an increase of Cdn$918,102
or 64.2%. 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
Cdn$936,400. As a percentage of our total revenues, such costs increased to
11.9% for the 2000 Fiscal Year from 10.6% for the 1999 Fiscal Year.
Income Taxes. There was no provision for income taxes for the 2000 Fiscal
Year, compared to Cdn$150,000 for the 1999 Fiscal Year, a decrease of
Cdn$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, our net loss for the
2000 Fiscal Year was Cdn$1,985,842 compared to net loss Cdn$971,497 for the 1999
Fiscal Year, a change of Cdn$1,014,345. This represents a decrease in net income
as a percentage of total revenues to (10.1%) in the 1999 Fiscal Year from (7.2%)
in the 1999 Fiscal Year.
Year Ended August 31, 1999 Compared to Year Ended August 31, 1998
Revenues. Revenues from network services for the 1999 Fiscal Year were
Cdn$6,607,915, compared to Cdn$6,727,889 for our fiscal year ended August 31,
1998 (the "1998 Fiscal Year"), a decrease of Cdn$119,974 or 1.8%. These revenues
are relatively constant between years due to the number of hospitality sites
remaining at the same level between the 1999 and 1998 fiscal years.
Revenues from event programming for the 1999 Fiscal Year were Cdn$527,740,
compared to Cdn$602,571 for the 1998 Fiscal Year, a decrease of Cdn$74,831 or
12.4%. The decrease was due to a decreased number of corporate events hosted,
both in Canada and abroad, in 1999 when compared to the number of events hosted
in 1998.
Revenues from ad sponsorship were Cdn$308,602 for the 1999 Fiscal Year,
compared to Cdn$442,424 for the 1998 Fiscal Year, a decrease of Cdn$133,822 or
30.2%. 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 Cdn$4,630,931 for the 1999
Fiscal Year, compared to Cdn$5,456,738 for the 1998 Fiscal Year, a decrease of
Cdn$825,807 or 15.1%. Of these revenues, Cdn$596,951 was earned by Interlynx, as
compared to Cdn$1,367,430 for the
49
1998 Fiscal Year, a decrease of Cdn$770,479 or 56.3%. The sale of Interlynx's
subsidiary, Universal Content and a change in the focus of Interlynx away from
CD-ROM's to PROFIS, a corporate training software package, have resulted in the
decrease. Revenues from video and software sales earned by our Magic Lantern
subsidiary and its subsidiaries for the 1999 Fiscal Year were Cdn$4,033,980, a
decrease of Cdn$55,328 or 1.4% from the Cdn$4,089,308 earned in the 1998 Fiscal
Year. 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.
Revenues from video dubbing were Cdn$691,156, a decrease of Cdn$55,982 or
7.5% over the Cdn$747,138 earned in the 1998 Fiscal Year. The decrease can be
attributed to a loss of the local customer base due to our Magic Lantern
subsidiary and its subsidiaries move in late fiscal 1998.
Revenues from digital encoding were Cdn$462,742 for 1999 Fiscal Year
compared to Cdn$217,930 for the 1998 Fiscal Year, an increase of Cdn$244,812 or
112.3%. The increase can be attributed to increased demand for digital services
and the increased sales and marketing campaigns.
Other revenues, which consist primarily of revenue from internet services
and interest income, were Cdn$191,556, compared to Cdn$577,282 for the 1998
Fiscal Year, a decrease of Cdn$385,726 or 66.8%. Interest income decreased
($107,891) due to the decrease in short-term investments during the year. We are
no longer performing the services for which the revenue from internet services
was earned ($225,634 decrease in revenue). These services were no longer
consistent with our focus and strategy.
As a result of the foregoing, our total revenues in aggregate were
Cdn$13,420,642, compared to Cdn$14,771,972 for the 1998 Fiscal Year, a decrease
of Cdn$1,351,330 or 9.1%.
Cost of Sales. Cost of Sales for network services for the 1999 Fiscal Year
were Cdn$2,353,705, compared to Cdn$2,486,873 for the 1998 Fiscal Year, a
decrease of Cdn$133,168 or 5.4%. The number of hospitality sites outstanding in
1999 compared to the number outstanding in 1998 was constant. Since the amount
we are billed by Communications is a direct function of the number of sites
outstanding, the above-noted decrease results from a stronger Canadian dollar in
the 1999 Fiscal year. As a percentage of our total revenues, such costs increase
to 17.5% for the 1999 Fiscal Year from 16.8% for the 1998 Fiscal Year.
Event programming costs were Cdn$24,650, compared to Cdn$26,683 for the
1998 Fiscal Year, a decrease of Cdn$2,033 or 7.6%. The decrease was commensurate
with the decrease in the number events hosted in event programming revenues for
the reasons discussed above. As a percentage of our total revenues, such costs
remained constant at 0.2% for the 1999 Fiscal Year as compared to the 1998
Fiscal Year.
Advertising sponsorship costs were Cdn$61,255, compared to Cdn$32,517 for
the 1998 Fiscal Year, an increase of Cdn$28,738 or 88.4%. The increase was the
result of increased marketing campaigns and a greater use of advertising
agencies during the 1999 Fiscal Year.
50
Video and software costs in aggregate were Cdn$1,990,741 compared to
Cdn$2,212,985 for the 1998 Fiscal Year, a decrease of Cdn$222,244 or 10.0%. Of
these costs, Cdn$281,115 was incurred by Interlynx, compared to Cdn$484,639 for
the 1998 Fiscal Year, a decrease of Cdn$203,524 or 42.0%. The decrease
corresponds to the decrease in revenue discussed above. Costs attributable to
video and software sales of our Magic Lantern subsidiary and its subsidiaries
for the 1998 Fiscal Year were Cdn$1,709,626, a decrease of Cdn$18,720, or 1.1%,
over the Cdn$1,728,346 incurred in the 1998 Fiscal Year. The decrease
corresponds to the decrease in revenue as discussed above. As a percentage of
our total revenues, these costs have fallen to 14.8% in the 1999 Fiscal Year
from 15.0% in the 1998 Fiscal Year, with the decrease in costs of Interlynx,
accounting for 91.6% of the decrease.
Video dubbing costs were Cdn$353,983. These costs have decreased by
Cdn$266,659, or 43.0%, over the Cdn$620,642 incurred in the 1998 Fiscal Year.
The decrease also can be attributed to the decrease in customer base and more
efficient operations since the acquisition of Image Media Ltd.
Digital encoding cost were Cdn$11,738 for the 1999 Fiscal Year compared to
Cdn$8,441 for the 1998 Fiscal Year, an increase of Cdn$3,297 or 39.1%. The
increase is associated with the increased level of sales.
Other costs, were Cdn$359,811, compared to Cdn$127,100 for the 1998 Fiscal
Year, an increase of Cdn$232,711 or 183.1%. As a percentage of our total
revenues, such costs increased to 2.7% for the 1999 Fiscal Year from 0.9% for
the 1998 Fiscal Year. The increase ($192,812) relates primarily to Viewer
Services, which became a wholly-owned subsidiary on June 16, 1999.
As a result of the foregoing, our total cost of sales was Cdn$5,155,883,
compared to Cdn$5,515,241 for the 1998 Fiscal Year, a decrease of Cdn$359,358 or
6.5%. Total gross margins decreased to 61.6% in the 1999 Fiscal Year from 62.7%
in the 1998 Fiscal Year.
Expenses. Selling, general and administrative expenses for the 1999 Fiscal
Year were Cdn$7,572,771, compared to Cdn$6,591,941 for the 1998 Fiscal Year, an
increase of Cdn$980,830 or 14.9%. The increase was caused by the following
factors. Firstly, the purchase of the remaining 50% of Viewer Services. In prior
years, Viewer Services was accounted for on the equity basis; for the Fiscal
Year 1999, Viewer Services was consolidated as a wholly owned subsidiary
resulting in an increase in selling, general and administrative expenses of
Cdn$422,520 or 43.1% of the increase. Secondly, professional fees have increased
as a result of consultants aiding in the developing of Sonoptic's business plan
($150,000) and Networks North's strategic planning ($48,974). Thirdly, property
taxes increased ($24,311) as a result of the City of Toronto, retroactively
assessing property taxes. Fourthly, salaries and benefits have risen ($289,447)
due to both annual increases and additional staffing requirements. Finally, a
$69,811 cost associated with the purchase of the remaining 49% of Interlynx also
contributed to the increase. As a percentage of our total revenues, total
selling, general and administrative expenses increased to 56.4% for the 1999
Fiscal Year from 44.6% for the 1998 Fiscal Year.
51
Bad debts expense was Cdn$136,888, compared to Cdn$43,123 for the 1998
Fiscal Year, an increase of Cdn$93,765 or 217.4%. The increase resulted from an
increase in the allowance for doubtful accounts. As a percentage of our total
revenues, such costs increased to 1.0% for the 1999 Fiscal Year from 0.3% for
the 1998 Fiscal Year.
Interest and bank charges for the 1999 Fiscal Year were Cdn$98,440,
compared to Cdn$137,942 for the 1998 Fiscal Year, a decrease of Cdn$39,502 or
28.6%. The decrease was the result of decreased debt levels. As a percentage of
our total revenues, such costs decreased to 0.7% for the 1999 Fiscal Year from
0.9% for the 1998 Fiscal Year.
Depreciation and amortization for the 1999 Fiscal Year were Cdn$1,429,219,
compared to Cdn$1,310,689 for the 1998 Fiscal Year, an increase of Cdn$118,530
or 9.0%. This increase is the result of depreciation on the capital asset
additions in 1999. As a percentage of our total revenues, such costs increased
to 10.6% for the 1999 Fiscal Year from 8.9% for the 1998 Fiscal Year.
Income Taxes. Provision for income taxes was Cdn$150,000 for the 1999
Fiscal Year, compared to Cdn$419,084 for the 1998 Fiscal Year, a decrease of
Cdn$269,084 or 64.2%. The provision for taxes is lower in 1999 when compared to
the 1998 provision due to a lower level of taxable income experienced in 1999.
Net Income/Loss. As a result of all of the above, our net loss for the
1999 Fiscal Year was Cdn$971,497, compared to net income Cdn$618,065 for the
1998 Fiscal Year, a change of Cdn$1,589,562. This represents a decrease in net
income as a percentage of total revenues to (7.2%) in the 1999 Fiscal Year from
4.2% in the 1998 Fiscal Year.
Six Months ended February 28, 2001 compared to Six Months ended February 29,
2000
Our total revenues for the 2001 First Fiscal Half were $9,572,333,
compared to $9,961,496 for the 2000 First Fiscal Half, a decrease of $389,163 or
3.9%.
Revenues from network services for the 2001 First Fiscal Half were
$3,274,340, compared to $3,276,562 for the 2000 First Fiscal Half, a decrease of
$2,222 or 0.1%. These revenues are relatively constant between years due to the
number of Hospitality sites remaining at approximately the same level between
the 2001 and 2000 First Fiscal Halves.
Revenues from Pay-tv for the 2001 First Fiscal Half were $3,296,475 compared to
$3,245,900 for the 2000 First Fiscal Half, an increase of $50,575 or 1.6%. This
increase can be attributed to more popular movies.
52
Revenues from event programming for the 2001 First Fiscal Half were $197,699
compared to $209,151 for the 2000 First Fiscal Half, a decrease of $11,452 or
5.5%. The decrease was due to a decreased number of corporate events hosted in
the 2001 First Fiscal Half when compared to the number of events hosted in 2000
First Fiscal Half.
Revenues from ad sponsorship were $72,291 for the 2001 First Fiscal Half,
compared to $289,298 for the 2000 First Fiscal Half, a decrease of $217,007 or
75.0%. 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 for the 2001 First Fiscal Half were
$2,118,654, compared to $2,650,880 for the 2000 First Fiscal Half, a decrease of
$532,226 or 20.1%. In the First Fiscal Half of 2000, a one time large sale of
$294,600 was recorded that resulted in abnormally high revenue when year
compared to 2001 First Fiscal Half.
Revenues from digital encoding were $537,752 for the 2001 First Fiscal
Half, compared to $243,109 for the 2000 First Fiscal Half, an increase of
$294,643 or 121.2%. The increase can be attributed to increased demand for
digital services and the greater sales effort in this area.
Total cost of sales for the 2001 First Fiscal Half were $3,258,445,
compared to $3,529,538 for the 2000 First Fiscal Half, a decrease of $271,093.
The decrease is commensurate with the decreased sales levels experienced offset
by increased cable costs in the Pay-tv segment. As a percentage of revenues,
cost of sales decreased in the 2001 First Fiscal Half to 34.0% from 35.4% in the
2000 First Fiscal Half.
Included in the selling, general and administrative expenses for the 2001
First Fiscal Half were $10,627,987, compared to $5,515,497 for the 2000 First
Fiscal Half, an increase of $5,112,490 or 92.7%. The increase was caused mainly
by the addition of the ASP Services segment, which accounted for an increase of
$4,597,209, 90% of the selling, general and administrative expenses for the
year.
Total selling, general and administrative expenses for the 2001 First
Fiscal Half for the ASP Services segment are the following major items; salaries
$1,645,825, professional fees of $1,021,422, communication costs of $107,313,
travel of $778,991, advertising and promotion of $391,403, and investor and
public relation costs of $464,820.
As a percentage of our total revenues, selling, general and administrative
expenses increased to 111.0% for the 2001 First Fiscal Half from 55.4% for the
2000 First Fiscal Half.
During the 2001 First Fiscal Half, Chell Merchant Capital Group Inc.
vacated certain leased space and as a result we wrote off the net book value of
the related leasehold improvements in the amount of $355,560. There were no
similar transactions in the 2000 First Fiscal Half.
Interest and bank charges for the 2001 First Fiscal Half were $292,218,
compared to $148,469 for the 2000 First Fiscal Half, an increase of $143,749 or
96.8%. This increase results from an increase in debt related to the purchase of
the RWE assets and the sale of the convertible
53
debenture. As a percentage of our total revenues, interest and bank charges
increased to 3.1% for the 2001 First Fiscal Half from 1.5% for the 2000 First
Fiscal Half.
Total depreciation and amortization expense for the 2001 First Fiscal Half
was $1,648,130, compared to $1,108,342 for the 2000 First Fiscal Half, an
increase of $539,788 or 48.7%. This increase is primarily the result of
depreciation on the fixed assets acquired from RWE and Chell.com Ltd.
There was no provision of income taxes recorded in the 2001 First Fiscal
Half compared with a provision for income taxes of $223,000 for the 2000 First
Fiscal Half. As the tax provision is based upon the individual company's taxable
income, no provision was incurred, as the companies are not in a taxable
position.
The minority interest share in profit for the 2001 First Fiscal Half was
$35,506. This is compared to the minority interest share in losses for the 2000
First Fiscal Half of $2,931, an overall change of $38,437. This change results
from profitable operations in Sonoptic Technologies Inc., in which there is a
25% minority interest.
As a result of all of the above, the net loss for the 2001 First Fiscal
Half was $6,712,542, compared to net loss of $675,931 for the 2000 First Fiscal
Half, a decrease of $6,036,611. The 2001 First Fiscal Half loss resulted
primarily from the addition of Chell Merchant Capital Group Inc. and Chell.com
(USA) Inc. and their activities including the provision of services to
developing ASP companies in which we have invested.
Liquidity and Capital Resources
At February 28, 2001, we had a working capital deficit of $2,099,402, a
decrease of $4,521,072 from working capital of $2,421,670 at August 31, 2000.
For the 2001 First Fiscal Half, we had a net decrease of cash of
$1,133,938 compared to a net decrease of $1,042,032 in the 2000 First Fiscal
Half.
Cash used in operating activities for the 2001 First Fiscal Half was
$3,200,912, compared to $169,295 provided by operating activities in the 2000
First Fiscal Half. In 2001, the major items that contributed to cash being used
in operating activities were as follows: the net loss with non-cash expenses
added back of $3,667,428, the increase in income taxes receivable of $98,491 and
the increase in prepaid expenses of $69,752. The major items that contributed to
cash being provided by operating activities were as follows: the decrease in
accounts receivable of $99,011 a decrease in short-term investments of $250,195
and a decrease in other accounts receivable of $122,034. In 2000, the major
items that contributed to cash being provided by operating activities were as
follows: net income with non-cash expenses added back of $518,949, decreases in
income taxes receivable and inventory of $157,464 and $23,908 respectively, and
increases in accounts payable and accrued liabilities and income taxes payable
of $950,834 and $61,042 respectively. The major uses of operating funds included
increases in accounts receivable and prepaid expenses of $1,436,095 and $110,110
respectively.
54
Cash used in investing activities in the 2001 First Fiscal Half was
$2,955,039 compared to the $1,178,810 used in investing activities in the 2000
First Fiscal Half, an increase of $1,776,229. This increase was the result of an
increase in note receivable from Engyro and the deposit of $1,689,710 on the
purchase of shares in ApplicationStation.com, Inc.
Cash provided by financing activities in the 2001 First Fiscal Half was
$5,112,013, compared to the $32,517 used in the 2000 First Fiscal Half. The
increase is primarily due to the sale of the convertible debenture and the
bridge financing.
We are in the process of attempting to raise additional capital in order
to realize our ASP strategy and to repay our loan obligations that are currently
being negotiated. Our subsidiaries operating in the entertainment, education and
E-commerce segments create liquidity sufficient to fund their operations.
Management believes that the current negotiations for terms and financing will
be successful and that combined with the reorganizing of the ASP segment in the
first fiscal 2001 half, we will have the required liquidity for our planned
operating activities in the current year. Our President is not drawing a salary.
Our President has made this decision in order to conserve cash. We have invested
in Engyro, cDemo and Application Station in the ASP segment. We have no
obligation to fund these investments. Each of these companies is attempting to
raise capital.
Inflation
The rate of inflation has had little impact on our operations or financial
position during the six months ended February 28, 2001 and February 29, 2000 and
inflation is not expected to have a significant impact on our operations or
financial position during the 2001 Fiscal Year.
We pay a number of its suppliers, including its 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
its gross profit as well as its net income. If the value of the Canadian dollar
falls against the US dollar, our cost of sales will increase thereby reducing
its gross profit and net income. Conversely, if the value of the Canadian dollar
rises against the US dollar, its gross profit and net income will increase.
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
55
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. 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.
Quantitative and Qualitative Disclosures About Market Risk
N/A
56
Directors and Executive Officers
Director
Name Age Principal Positions with the Company Since
- ---- --- ------------------------------------ -----
Cameron Chell 32 Director, President and Chief
Executive Officer 2000
Don Pagnutti 50 Director, Vice President-Finance,
Chief Financial Officer 2000
Peter Rona 54 Director 1987
David Bolink 32 Director 2000
Gordon Herman 42 Director 2000
Adrian P. Towning 56 Director 1994
Robert Stone 57 Director 2000
Mark Truman 46 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 ASP 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 the Vice Chairman and founder of C MeRun Corp. and is a cofounder of JAWS
Technologies Inc., a provider of information security consulting services and
software solutions. 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
period, subjected to a Cdn25,000 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.
Peter Rona had been our President and Chief Executive Officer from
September 1987 until September 2000. In addition, he was our Principal Financial
and Accounting Officer from
57
September 1987 to August 1997. He has been President of NTN Interactive Network,
Inc. (formerly, NTN Sports, Inc. until 1993) from 1985 to 1991 and February 1993
to September 1999. Mr. Rona has also been the President, sole director and sole
shareholder of Anor Management, Ltd., a personal holding company, since 1987.
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).
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.
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. 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
58
Switzerland and West Kootenay Power & Light Company.
Mark Truman has been our Controller since December of 1994.
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, 2000 to those
individuals who served as our Chief Executive Officer during the 2000 Fiscal
Year and all our other executive officers or any of our subsidiaries at August
31, 2000 who received total annual salary and bonuses in excess of US$100,000
(Cdn$147,140) during the 2000 Fiscal Year (collectively, the "Named Executive
Officers").
Long-term
Annual Compensation Compensation
--------------------------------------------- ----------------
Bonus Other Annual Securities Under All Other
Salary(1) ------------- Compensation(1) Options/Granted Compensation
Name and Principal Position Year (Cdn$) (Cdn$) ($) (#) ($)
- --------------------------- ---- --------- ------------- --------------- --------------- ------------
Peter Rona 2000 192,334 -- -- 100,000 --
President and Chief 1999 167,665 30,755 -- 30,000 --
Executive Officer(2) 1998 168,426 32,963 -- 40,000 --
Donald Pagnutti (3) 2000 156,249 -- -- 22,500 --
Vice-President, Finance
and 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. Rona was our President and Chief Executive Officer from September
1, 1987 until September 19, 2000.
(3) 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, 2000, 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 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.
59
Option Grants Table
The following table sets forth (a) the number of shares underlying options
granted to each Named Executive Officer during the 2000 Fiscal Year, (b) the
percentage the grant represents of the total number of options granted to all of
our employees during the 2000 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.
Number of Percentage of Potential Realizable Value at
Shares Total Options Assumed Rates of Stock Price
Underlying Granted to Appreciation for Option Term
Options Employees in Exercise Expiration -----------------------------
Name Granted Fiscal Year Price Date 5% 10%
- ---- ------- ----------- ----- ---- -- ---
Peter Rona 75,000 9.7% US$2.00 October 14, 2004 US$41,442 US$91,577
President and 25,000 3.2% US$4.375 April 3, 2005 US$30,218 US$176,150
CEO(1)
Donald Pagnutti (2) 22,500 2.9% US$9.75 August 11, 2004 US$47,277 US$101,812
Vice-President,
Finance and Chief
Financial Officer
Notes:
(1) Mr. Rona was our President and Chief Executive Officer from September
1, 1987 until September 19, 2000.
(2) Mr. Pagnutti's title was changed to Vice President Finance and Chief
Financial Officer on September 19, 2000.
Options Exercised and Remaining Outstanding
Set forth in the table below is information, with respect to each of the
Named Executive Officers, as to the (a) number of shares acquired during the
2000 Fiscal Year upon each exercise of options granted to such individuals, (b)
the aggregate value realized upon each such exercise (i.e., the difference
between the market value of the shares at exercise and their exercise price),
(iii) the total number of unexercised options held on August 31, 2000,
separately identified between those exercisable and those not exercisable, and
(iv) the aggregate value of in-the-money, unexercised options held on August 31,
2000, separately identified between those exercisable and those not exercisable.
Securities Aggregate Value of Unexercised in the
Acquired on Value Unexercised Options at Money Options at August 31,
Exercise Realized August 31, 2000 2000
(#) ($) (#) ($)
------------ ------------ --------------------------- ----------------------------------
Exercisable Unexercisable Exercisable(1) Unexercisable(1)
----------- ------------- -------------- ----------------
Peter Rona Nil Nil 135,000 97,500(2) US$445,625 US$438,750
Donald Pagnutti Nil Nil 18,750 33,750 US$69,375 US$50,625
60
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$6.50 on August 31, 2000, and multiplying by the number of Common
Shares that may be acquired upon the exercise of the options.
(2) As at September 19, 2000, these options vested and were exercisable.
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 employee was eligible to receive 1,500 stock options
annually. During the fiscal year ended August 31, 2000, 45,000 options were
issued to Adrian Towning at a strike price of US$9.75 on August 11, 2000. The
vesting schedule for these options are one-third per year on each anniversary of
the grant date. On December 11, 2000, 45,000 options were issued to Robert Stone
at a strike price of US$3.06. The vesting schedule for these options are
one-third per year on each anniversary of the grant date. See "Stock Options".
As of December 11, 2000, the Board of Directors formally adopted a
standard arrangement pursuant to which only our outside directors are
compensated by us for their services in their capacity as directors. This
compensation arrangement is retroactive to September 19, 2000 (the date of the
closing of the Agreement of Purchase and Sale between Networks North Inc.,
Networks North Acquisition Corp., Chell.com Ltd. and Cameron Chell).
Outside Director's Compensation Schedule Cash Options
(US$)
1. Directorship Acceptance Options (one time 45,000
grant with a 3 year vesting schedule)
2. Annual Retainer-Chairman 20,000 10,000
3. Annual Retainer-Director 6,000
4. Annual Retainer-Committee Member (over 3,000
and above directorship retainer)
5. Annual Retainer-Committee Chair (over and 2,000
above directorship retainer and committee retainer)
6. Board Meeting Attendance Fee 750/mtg.
7. Committee Attendance Fee 500/mtg
Employment Contracts with Named Executive Officers
We entered into a new employment agreement, which we refer to as the Rona
Agreement, with Peter Rona, our President and Chief Executive Officer, for a
three-year period commencing April 1, 2000 and continuing until March 1, 2003.
The Rona Agreement provide for a base compensation of $225,000 with annual
increases to be subject to review by the Board of Directors. In September 2000,
we entered into an agreement with Mr. Rona to terminate the Rona Agreement which
we refer to as the Termination Agreement. Pursuant to the terms of the
61
Termination Agreement, we paid Mr. Rona $643,250 and all options then held by
Mr. Rona vested immediately. In addition, the Termination Agreement provided
that Mr. Rona shall exercise all options, repay his loan of US$70,000 and agree
not to sell any of his Common Shares without first consulting with our Chairman,
President or Chief Executive Officer.
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 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 $8400. 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.
On September 19, 2000, we entered into an employment agreement with Gord
Herman, pursuant to which Mr. Herman served as our Senior Managing Director. The
agreement provided for an initial base compensation of $175,000, together with
automobile expenses of $8,400. 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. Herman had reduced his salary to a level of
$120,000 and has eliminated the automobile allowance in an effort to reduce our
cash requirements. These were eliminated with the understanding that the
compensation of Mr. Herman would be mutually agreed upon between the parties. On
January 19, 2001, Mr. Herman was laid off as Senior Managing Director but
remains on the board of directors.
In September 2000, our Merchant Capital Group subsidiary assumed an
employment agreement from Chell.com, which had been entered into on November 29,
1999 with David Bolink, pursuant to which Mr. Bolink served as our Merchant
Capital Group subsidiary's Managing Director and General Manager. The agreement
provided for an initial base
62
compensation of $150,000. Since the assumption of this agreement, Mr. Bolink had
reduced his salary to $120,000 in an effort to reduce cash requirements of our
Merchant Capital Group subsidiary. This was reduced on the understanding that
the compensation of Mr. Bolink would be mutually agreed upon between the
parties. On January 19, 2001, Mr. Bolink was laid off as Managing Director but
remains on the board of directors.
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 officers or our
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 our Audit and Compensation Committee or as one of
our directors.
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 May 4, 2001, of the common stock by each person who
is known to 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) ............................ 5,325,049 59.7%
Cameron Chell (Director, President
and Chief Executive Officer)(4) ............... 5,326,649 59.8%
Peter Rona (Director)(5) ...................... 562,500 6.6%
Gordon Herman (Director)(6) ................... 166,118 2.0%
David Bolink (Director)(7) .................... 155,707 1.9%
Don Pagnutti (Director, Vice-President-Finance,
and Chief Financial Officer)(8) ............... 22,500 0.3%
Adrian Towning (Director)(9) .................. 9,000 0.1%
Robert Stone (Director) ....................... 0 0%
All directors and executive officers as a group
(8 persons)(10) ..................... 6,242,474 70%
(1) Unless otherwise stated, the address of the directors and executive
officers of the corporation is c/o Chell Group Corporation, 14
Meteor Drive, Toronto, Ontario, Canada M9W 1A4.
63
(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 5,325,049 Common Shares held by Chell.com Ltd.
(5) The address for Mr. Rona is 2205-39 Old Mill Road, Toronto, Ontario,
Canada, M8X 1G6. Includes (a) 300,000 shares of common stock; (b)
86,500 Common Shares owned by Mr. Rona; and (c) 176,000 options to
purchase our common stock all of which have vested.
(6) Represents the vested portion of an option in Chell.com Ltd. held by
Mr. Herman, for the purchase of our shares which are owned by
Chell.com Ltd.
(7) Represents the vested portion of an option in Chell.com Ltd. held by
Mr. Bolink, for the purchase of our shares which are owned by
Chell.com Ltd.
(8) Represents options, which have vested and are available for
exercise.
(9) Includes 3,000 of our Common Shares and 6,000 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 is 8,906,236 Shares.
Certain Relationships and Related Transactions
Set forth below is a description of certain transactions between us and
our directors,
64
executive officers, beneficial owners of five percent or more of the outstanding
common stock, or member of the immediate family of any of the foregoing persons,
as well as certain business relationships between us and our directors, which
occurred or existed during the 2000 Fiscal Year and subsequent thereto. We
believe that the transactions described in this section were made on terms no
more 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. Chell.com holds 200,000 options to purchase shares
of Engyro for $5.00 and warrants for 97,500 shares at $5.00.
b) Frank Killoran was until February 28, 2001 a director and
shareholder of cDemo and he and members of his immediate family hold
264,000 Common Shares in such company. He holds an option from
Chell.com to acquire 370,428 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).
c) Gordon Herman is interim President of cDemo. He holds an option in
Chell.com to acquire 498,354 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) David Bolink holds an option in Chell.com to acquire 467,121 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).
e) Pursuant to the Purchase and Sale Agreement between us, Chell
Merchant Capital Group, Cameron Chell and Chell.com Ltd., 5,369,733
of our shares were issued and 1,928,268 Exchangeable Shares of Chell
Merchant Capital Group were issued to Cameron Chell and Chell.com
Ltd. Our shares that were issued in exchange for shares of C Me Run
had been held in escrow pending the outcome of certain conditions,
which were not met, resulting in the return of those shares to us.
In addition, 1,476,398 of our shares in our wholly-owned subsidiary,
Chell Merchant Capital Group Inc., that were issued in exchange for
shares of eSupplies had been held in escrow pending our
determination that the business of eSupplies fit with our business
model and provides similar value to us. Since that determination
regarding eSupplies had not been made, these shares were also
returned to us.
f) Escrow Agreement dated October 11, 2000 among us, Cameron Chell,
Chell Merchant Capital Group Inc. and Wolff Leia Huckell (as escrow
agent). The Exchangeable Shares of our Merchant Capital Group
subsidiary were released from escrow after receiving written notice
from our board of directors that the new course of business being
taken by eSupplies including potential new acquisitions in the
e-business
65
field, did not fit within our business model. The Exchangeable
Shares of our Merchant Capital Group subsidiary were cancelled and
the shares of eSupplies held by the escrow agent were returned to
Mr. Chell. Mr. Chell is a major shareholder in eSupplies.
g) 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.
h) 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 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.
i) License Agreement between Cameron Chell, us and Chell Merchant
Capital Group dated August 31, 2000 whereby Mr. Chell, us and Chell
Merchant Capital Group have 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.
j) Securities Purchase Agreement with VC Advantage Fund, on October 3,
2000, for a loan to us of up to US$3,000,000. VC Advantage Fund
received a Convertible Debenture, which is convertible into our
common stock, 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 II, and a total
of US$1,700,000 has been advanced us. Cameron Chell is a Director
and shareholder of VC Advantage Limited, the general partner of VC
Advantage Fund. Pursuant to the assignment of this agreement to
Canadian Advantage Limited Partnership II, this is no longer a
related transaction as Mr. Chell has no interests in Canadian
Advantage Limited Partnership II.
66
Disclosure of Commission Position on Indemnification for Securities Act
Liabilities
Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to directors, officers or persons controlling the
registrant pursuant to the foregoing provisions, we have been informed that in
the opinion of the Securities and Exchange Commission such indemnification is
against public policy as expressed in the Act and is therefore unenforceable.
No dealer, salesperson or any other person has been authorized to give any
information or to make any representations other than those contained in this
Prospectus, and, if given or made, such information or representations must not
be relied upon as having been authorized by us or the Selling Shareholders.
Neither the delivery of this Prospectus, nor any sale made hereunder shall,
under any circumstances, create any implication that there has been no change in
our affairs since the date hereof or that the information contained herein is
correct as of any date subsequent to the date hereof. This Prospectus does not
constitute an offer to sell or a solicitation of an offer to buy any securities
offered hereby by anyone in any jurisdiction in which such offer or solicitation
is not authorized or in which the person making such offer or solicitation is
not qualified to do so or to anyone to whom it is unlawful to make such offer or
solicitation.
67
8,112,053 Shares of
Common Stock
CHELL GROUP CORPORATION
f/k/a Networks North, Inc.
PROSPECTUS
___________, 2001
PART II -- INFORMATION NOT REQUIRED IN PROSPECTUS
68
Other Expenses of Issuance and Distribution.
Expenses payable in connection with the issuance and distribution of the
securities being registered (estimated except in the case of the registration
fee) are as follows:
Registration Fee $ 3,314.20
Legal and Accounting Fees
and Expenses 90,000.00*
Offering Commissions and Fees 100,000.00
Miscellaneous 6,685.80
Total $ 200,000.00
The above fees will be paid by us.
* Estimate
Indemnification of Directors and Officers.
Article Tenth of our Amended Certificate of Incorporation provides for the
elimination of personal liabilities of directors of the registrant for breaches
of certain of their fiduciary duties to the full extent permitted by Sections
717 and 719 of the New York Business Corporation Law ("BCL"). Specifically, it
states that no director of the Registrant shall be personally liable to the
corporation or any of its shareholders for damages of any breach of duty in any
such capacity except if a judgment or other final adjudication adverse to them
establishes that their acts or omissions were in bad faith or involved
intentional misconduct or a knowing violation of the law, or that they
personally gained in fact a financial profit or other advantage to which they
were not legally entitled or that their acts violated Section 719 of the BCL.
Section 801(b)(14) of the BCL enables a corporation in its certificate of
incorporation to strike out, change or add any provision not inconsistent with
the BCL or any other statute, relating to the business of the corporation, its
affairs, its rights or powers or the rights or powers of its shareholders, or
directors or officers. Section 717 provides for the elimination of personal
liabilities of directors provided they act in good faith and with the degree of
care used by an ordinary prudent person under like circumstances. Thus, no such
provision may eliminate or limit the liability of a director for breaching their
duty of loyalty, failing to act in good faith, engaging in intentional
misconduct or knowingly violating the law, paying an unlawful dividend,
approving an illegal stock repurchase or obtaining an improper personal benefit.
69
Recent Sales of Unregistered Securities
As of the close of business on May 4, 2001, the following Common Shares
have been issued by us in the last twelve months:
1. Pursuant to the Purchase and Sale Agreement between us, Chell Merchant
Capital Group, Cameron Chell and Chell.com Ltd., 5,369,733 of our shares were
issued and 1,928,267 Exchangeable Shares of Chell Merchant Capital Group were
issued to Cameron Chell and Chell.com Ltd.
Our shares that were issued in exchange for shares of cMeRun and had been
held in escrow pending the fulfillment of certain conditions were refunded to us
as a result of the cancellation of this transaction due to the non-fulfillment
of those conditions.
In addition, the 1,476,398 shares of our wholly-owned subsidiary, Chell
Merchant Capital Group Inc., that were issued in exchange for shares of
eSupplies had been held in escrow pending our Board of Directors' reviewing a
new business plan. Due to the Board's determination that the planned acquisition
of eSupplies did not fitwith our business model or add value to our operations,
this planned acquisition was cancelled and the shares of our Chell Merchant
Capital were returned to us.
2. On January 18, 2001, pursuant to a subscription agreement dated January
17, 2001, we issued 21,974 shares of our common stock to Mr. Bruce Elliot.
3. 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
- ----------------- --------------------
February 2000 1,500
March 2000 22,750
April 2000 13,015
May 2000 250
June 2000 500
July 2000 6,750
August 2000 23,735
October 2000 250
November 2000 6,000
January 2001 56,500
70
Exhibits and Financial Statement Schedules
(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
Registration Statement on Form S-1:
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.*
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
71
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.*
10.27 Asset Purchase Agreement, dated September 1, 2000, by and among
Magic Lantern Communications Ltd. and Richard Wolff Enterprises,
Inc.*
10.28 Securities Purchase Agreement, dated October 3, 2000, by and among
Chell Group Corporation and VC Advantage Limited Partnership.*
10.29 Stock Purchase Agreement, dated January 17, 2001, by and among
Chell Group Corporation and ApplicationStation.com Inc. *
10.30 Securities Purchase Agreement dated October 3, 2000 by and between
Chell Group corporation and VC Advantage Limited Partnership
10.31 License Agreement dated August 31, 2000 by and among Cameron Chell
and Networks North Inc. and Networks North Acquisition Corp.
10.32 Consulting Agreement dated November 26, 1999 by and between
Chell.com Inc. and R Home Funding Co. Ltd.
10.33 Consulting Agreement dated January 15, 2000 by and between
Chell.com Ltd and Buyersangel.com, Inc.
22 List of Subsidiaries*
23.2 Opinion of Mintz & Fraade, P.C.
23.3 Consent of Lazar, Levine & Felix, LLP
23.4 Consent of Ernst & Young LLP
23.5 Consent of Simione Scillia Larrow & Dowling
23.6 Consent of Lazar, Levine & Felix, LLP with respect to eSupplies
(Alberta) Ltd. and cDemo Inc.
27 Financial Data Schedule*
99.1 Business Sector Data*
*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:
December 14,2000) (File No. 000-18066)
72
Undertakings
The undersigned registrant hereby undertakes:
(1) to file, during any period in which it offers or sells securities, a
post-effective amendment to this registration statement;
(i) to include any prospectus required by Section 10(a)(3) of the
Securities Act of 1933, as amended;
(ii) to reflect in the Prospectus any facts or events arising after
the effective date of the registration statement (or the most recent
post-effective amendment thereof) which, individually or in the aggregate,
represent a fundamental change in the information set forth in the registration
statement. Notwithstanding the foregoing, any increase or decrease in volume of
securities offered (if the total dollar value of securities offered would not
exceed that which was registered) and any deviation from the low or high end of
the estimated maximum offering range may be reflected in the form of prospectus
filed with the Securities and Exchange Commission, or SEC pursuant to Rule
424(b) if, in the aggregate, the changes in volume and prices represent no more
than 20 percent change in the maximum aggregate offering price set forth in the
"Calculation of Registration Fee" table in the effective registration statement;
and (iii) to include any material information with respect to the plan of
distribution not previously disclosed in the registration statement or any
material change to such information in the registration statement.
Provided, however, that paragraphs (1)(i) and (1)(ii) do not apply
if the information required to be filed with a post-effective amendment by those
paragraphs is contained in periodic reports filed with or furnished to the
Commission by the registrant pursuant to Section 13 or 15(d) of the Securities
Exchange of Act of 1934 that are incorporated by reference in the registration
statement.
(2) that for the purpose of determining any liability under the Securities
Act of 1933, each post-effective amendment shall be deemed a new registration
statement relating to the securities offered therein, and the offering of such
securities at that time shall be deemed the initial bona fide offering thereof.
(3) to remove by means of a post-effective amendment any of the securities
being registered which remain unsold at the termination of the offering.
(4) that for the purpose of determining any liability under the Securities
Act, each filing of the registrant's annual report pursuant to Section 13(a) or
15(d) of the Securities Exchange Act of 1934 (and, where applicable, each filing
of an employee benefit plan's annual report pursuant to Section 15(d) of the
Securities Exchange Act of 1934) that is incorporated by reference in the
registration statement shall be deemed to be a new registration statement
relating to the securities offered therein, and the
73
offering of such securities at that time shall be deemed to be the initial bona
fide offering thereof.
Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to directors, officers, and controlling persons of
the registrant pursuant to the foregoing provisions, or otherwise, the
registrant has been advised that in the opinion of the SEC such indemnification
is against public policy as expressed in the Securities Act and is therefore,
unenforceable.
In the event that a claim for indemnification against such liabilities
(other that the payment by the registrant of expenses incurred or paid by a
director, officer, or controlling person of the registrant in the successful
defense of any action, suit, or proceeding) is asserted by such director,
officer, or controlling person in connection with the securities being
registered, the registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Securities Act of 1933 and will be governed by the
final adjudication of such issue.
74
SIGNATURES
In accordance with the requirements of the Securities Act of 1933, we
certify that we have reasonable grounds to believe that we meet all of the
requirements of filing on Form S1-A and authorize this registration statement to
be signed on our behalf by the undersigned, in the City of Toronto, Province of
Ontario, on this 16th day of May 2001.
Chell Group Corporation
By: /s/ Don Pagnutti
-----------------------------------
Don Pagnutti, Director, Vice President-
Finance, Chief Financial Officer
75
In accordance with the requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following persons in the
capacities and on the dates stated.
Signature Title(s) Date
- --------- -------- ----
/s/ David Bolink Director May 16, 2001
- -----------------------
David Bolink
/s/ Cameron Chell Director, President & Chief
- ----------------------- Executive Officer May 16, 2001
Cameron Chell
/s/ Gordon Herman Director May 16, 2001
- -----------------------
Gordon Herman
/s/ Don Pagnutti Director, Vice President-Finance, May 16, 2001
- ----------------------- Chief Financial Officer
Don Pagnutti
/s/ Peter Ron Director May 16, 2001
- -----------------------
Peter Ron
/s/ Robert Stone Director May 16, 2001
- -----------------------
Robert Stone
/s/ Adrian P. Towning Director May 16, 2001
- -----------------------
Adrian P. Towning
76
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Chell Group Corporation
Toronto, Ontario
We have audited the accompanying consolidated balance sheet of Chell Group
Corporation and subsidiaries (formerly known as Networks North Inc.) as of
August 31, 2000 and the related consolidated statements of operations and
retained earnings and cash flows for the year then ended. 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 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, 2000, and the results of their
operations and their cash flows for the year then ended in conformity with
accounting principles generally accepted in the United States.
/s/LAZAR LEVINE & FELIX LLP
- ---------------------------
New York, New York
November 22, 2000
F - 1
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Shareholders of Chell Group Corporation (formerly
known as Networks North Inc.)
We have audited the accompanying consolidated balance sheet of Chell Group
Corporation and subsidiaries as of August 31, 1999 and the related consolidated
statements of operations and retained earnings and cash flows for each of the
two years in the period 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 audits.
We conducted our audits 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 audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Chell Group
Corporation and subsidiaries as of August 31, 1999, and the consolidated results
of their operations and their cash flows for each of the two years in the period
ended August 31, 1999 in conformity with accounting principles generally
accepted in the United States.
Toronto, Canada, /s/ Ernst & Young LLP
November 12, 1999. Chartered Accountants
F - 2
Chell Group Corporation
(formerly known as Networks North Inc.)
CONSOLIDATED BALANCE SHEETS
[Expressed in Canadian dollars]
As at August 31
2000 1999
$ $
- -------------------------------------------------------------------------------------------------------------------------------
ASSETS
Current
Cash and cash equivalents 1,355,613 2,018,122
Short-term investments [note 4] 269,727 261,926
Accounts receivable - trade [net of allowance for doubtful
accounts of $178,000; 1999 - $119,000] 3,154,134 2,534,459
Income taxes and other receivables [note 17] 360,217 186,194
Inventory 206,216 260,868
Prepaid expenses 636,726 647,612
- -------------------------------------------------------------------------------------------------------------------------------
Total current assets 5,982,633 5,909,181
- -------------------------------------------------------------------------------------------------------------------------------
Property and equipment, net [note 6] 7,721,769 5,151,755
Software development costs [note 7] 200,000 250,000
Licenses, net of accumulated amortization 250,248 270,596
Goodwill, net of accumulated amortization 2,863,146 3,060,489
Note receivable [note 5] 160,000 160,000
Other assets 202,799 --
- -------------------------------------------------------------------------------------------------------------------------------
17,380,595 14,802,021
===============================================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current
Bank indebtedness [note 8] 133,000 157,000
Accounts payable - trade 1,375,414 912,361
Accrued liabilities 1,654,917 723,218
Current portion of long-term debt [note 10] 397,632 79,542
- -------------------------------------------------------------------------------------------------------------------------------
Total current liabilities 3,560,963 1,872,121
- -------------------------------------------------------------------------------------------------------------------------------
Long-term debt [note 10] 4,377,040 2,077,960
Deferred income taxes [note 9] 59,173 59,173
- -------------------------------------------------------------------------------------------------------------------------------
Total liabilities 7,997,176 4,009,254
- -------------------------------------------------------------------------------------------------------------------------------
Commitments and contingent liabilities [notes 2, 11, 14 and 15]
SHAREHOLDERS' EQUITY
Share capital [note 12]
900,000 preferred shares with no liquidation preference [1999 - 900,000] 10,917 10,917
2,925,141 common shares [1999 - 2,756,641] 183,235 171,635
Capital in excess of par value 10,124,777 9,559,883
Retained earnings (deficit) (935,510) 1,050,332
- -------------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 9,383,419 10,792,767
- -------------------------------------------------------------------------------------------------------------------------------
17,380,595 14,802,021
===============================================================================================================================
See accompanying notes
On behalf of the Board:
Director Director
F - 3
Chell Group Corporation
(formerly known as Networks North Inc.)
CONSOLIDATED STATEMENTS OF OPERATIONS AND RETAINED EARNINGS
[Expressed in Canadian dollars]
Years ended August 31
2000 1999 1998
$ $ $
- --------------------------------------------------------------------------------------------------------------------------------
REVENUE
Network services 6,345,552 6,607,915 6,727,889
Pay-tv 6,517,940 -- --
Event programming 500,168 527,740 602,571
Advertising sponsorship 675,532 308,602 442,424
Video and software sales 4,289,557 4,630,931 5,456,738
Video dubbing 717,596 691,156 747,138
Digital encoding 539,815 462,742 217,930
Other 107,886 191,556 577,282
- --------------------------------------------------------------------------------------------------------------------------------
19,694,046 13,420,642 14,771,972
- --------------------------------------------------------------------------------------------------------------------------------
COST OF SALES [does not include depreciation]
Network services [note 11] 2,160,351 2,353,705 2,486,873
Pay-tv 2,919,417 -- --
Event programming 23,819 24,650 26,683
Advertising sponsorship 93,496 61,255 32,517
Video and software sales 2,078,926 1,990,741 2,212,985
Video dubbing 157,289 353,983 620,642
Digital encoding 111,657 11,738 8,441
Other 113,005 359,811 127,100
- --------------------------------------------------------------------------------------------------------------------------------
7,657,960 5,155,883 5,515,241
- --------------------------------------------------------------------------------------------------------------------------------
EXPENSES
Selling, general and administrative 11,266,339 7,572,771 6,591,941
Bad debts 140,090 136,888 43,123
Interest and bank charges 297,654 98,440 137,942
Depreciation and amortization 2,347,321 1,429,219 1,310,689
- --------------------------------------------------------------------------------------------------------------------------------
14,051,404 9,237,318 8,083,695
- --------------------------------------------------------------------------------------------------------------------------------
Income (loss) before the undernoted items (2,015,318) (972,559) 1,173,036
Gain on sale of subsidiary [note 18] -- 77,710 --
Income (loss) from investment in Viewer Services [note15[b]] -- 28,576 (25,658)
Income (loss) before income taxes and minority interest (2,015,318) (866,273) 1,147,378
Provision for income taxes [note 9] -- 150,000 419,084
- --------------------------------------------------------------------------------------------------------------------------------
Income (loss) before minority interest (2,015,318) (1,016,273) 728,294
Minority interest 29,476 44,776 (110,229)
- --------------------------------------------------------------------------------------------------------------------------------
Net income (loss) and comprehensive income (loss) (1,985,842) (971,497) 618,065
Retained earnings, beginning of year 1,050,332 2,021,829 1,403,764
- --------------------------------------------------------------------------------------------------------------------------------
Retained earnings (deficit) , end of year (935,510) 1,050,332 2,021,829
- --------------------------------------------------------------------------------------------------------------------------------
Earnings (loss) per share [note 13]
Basic $(0.69) $(0.36) $0.24
Diluted $(0.69) $(0.36) $0.22
- --------------------------------------------------------------------------------------------------------------------------------
See accompanying notes
F - 4
Chell Group Corporation
(formerly know as Networks North Inc.)
CONSOLIDATED STATEMENTS OF CASH FLOWS
[Expressed in Canadian dollars]
Years ended August 31
2000 1999 1998
$ $ $
- --------------------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income (loss) for the year (1,985,842) (971,497) 618,065
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Depreciation and amortization 2,347,321 1,429,219 1,310,689
Accretion of interest on non-interest bearing long-term debt 173,076 31,084 36,346
Loss (income) from investment in Viewer Services -- (28,576) 25,658
Amortization of discount on notes and loans payable -- -- 107,286
Changes in assets and liabilities
Decrease (increase) in short-term investments (7,801) 1,780,407 (337,319)
Decrease (increase) in accounts receivable (619,676) 277,990 (1,034,931)
(Increase) in income taxes receivable and other accounts receivables (174,023) (101,153) (385,335)
Decrease in inventory 54,652 94,488 316,740
Decrease (increase) in prepaid expenses 10,886 (59,577) (120,464)
Increase in other assets (202,799) -- --
Increase (decrease) in accounts payable and accrued liabilities 692,237 (701,392) 260,060
Decrease in deferred revenue -- -- (321,452)
- --------------------------------------------------------------------------------------------------------------------------------
Cash provided by operating activities 288,031 1,750,993 475,343
- --------------------------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES
Purchase of property and equipment (1,162,146) (601,633) (2,012,543)
Proceeds on disposal of property and equipment -- 23,557 --
Software development costs [note 7] -- (250,000) --
Increase in licenses -- -- (78,401)
Investment in Viewer Services -- (36,054) 16,154
Proceeds from sale of subsidiary [note 18] -- 110,813 --
Acquisition of Viewer Services [note 15[b]] -- (1) --
Acquisition of Interlynx Multimedia Inc. [note 15[a]] -- -- (380,001)
- --------------------------------------------------------------------------------------------------------------------------------
Cash used in investing activities (1,162,146) (753,318) (2,454,791)
- --------------------------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES
Bank indebtedness (24,000) 28,854 (577,982)
Increase in notes and loans payable 21,908 38,485 1,309,246
Repayment of notes and loans payable (67,436) (48,007) (273,963)
Proceeds from exercise of options and warrants 281,134 -- 101,465
- --------------------------------------------------------------------------------------------------------------------------------
Cash provided by financing activities 211,606 19,332 558,766
- --------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents
during the year (662,509) 1,017,007 (1,420,682)
Cash and cash equivalents, beginning of year 2,018,122 1,001,115 2,421,797
- --------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of year 1,355,613 2,018,122 1,001,115
================================================================================================================================
- --------------------------------------------------------------------------------------------------------------------------------
Income Taxes Paid 59,956 265,771 795,669
Interest Paid 121,579 67,356 101,596
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 and the issuance
of shares amounting to $295,360.
See accompanying notes
1. DESCRIPTION OF BUSINESS
Chell Group Corporation [f/k/a/ Networks North Inc.] [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
F - 5
Network Inc. ["Interactive"], GalaVu Entertainment Network Inc. ["GalaVu"] and
Networks North Acquisition Corp. ["NNAC"], 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. Interactive owns all of the outstanding
stock of Interlynx Multimedia Inc. ["Interlynx"]. Interlynx operates in the
e-commerce industry and designs and develops educational and corporate
multimedia, web-based training programs. 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.
NNAC is incorporated under the Ontario Business Corporations Act and is in the
business of defining, building and re-engineering businesses using new economy
technologies to maximize market value.
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.
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, 2000, NTN Communications, Inc. had shareholders'
equity of $6,108,000 and working capital of $35,000 according to its unaudited
balance sheet included in its quarterly report. NTN Communications, Inc. has
reported a quarterly net loss for September 2000 of $1,208,000, a quarterly net
loss for June 2000 of $2,469,000 and a quarterly net loss for March 2000 of
$194,000. It reported a net loss for the year ended December 31, 1999 of
$2,498,000. All such amounts are quoted in U. S. dollars [note 11].
F - 6
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. These
consolidated financial statements have been 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, NNAC and Chell.com USA Inc. Magic conducts its operations directly
and through its wholly-owned subsidiaries, 745695 Ontario Ltd. ["Custom Video"],
1113659 Ontario Ltd. ["Viewer Services"] and B.C. Learning Connection ["BCLC"],
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 August 31, 2000,
Custom Video and BCLC were wound-up into Magic. The operations carried on by
these companies will continue as divisions 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. The Company accounts for investments in
businesses in which it owns less than 51% using the equity method, if the
Company has the ability to exercise significant influence over the investee
company. 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
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.
F - 7
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, 2000 and 1999 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.
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 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.
F - 8
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 $125,010 [1999 -
$112,508].
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 U.S.$1.75 per share. 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 $15,693 [1999 - $7,746].
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 $902,483 [1999 - $662,140].
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.
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.
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. [see note 9].
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. 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
F - 9
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 note
12[c]].
Recent pronouncements
In March 2000, the Financial Accounting Standards Board (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 will adopt the provisions of SAB No. 101 in the first
quarter of fiscal 2001 and expects that its adoption will have 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 is required to adopt this standard in the
first quarter of fiscal year 2001 pursuant to SFAS No. 137 (issued in June
1999), which delays the adoption of SFAS No. 133 until that time. The Company
expects that the adoption of SFAS No. 133 will not have a material impact on the
its financial position or its results of operations.
4. SHORT-TERM INVESTMENTS
Short-term investments consist of the following:
2000 1999
$ $
- --------------------------------------------------------------------------------
Money market funds 166,175 155,459
Debt securities
U.S. treasury securities 103,552 106,467
- --------------------------------------------------------------------------------
269,727 261,926
================================================================================
5. NOTE RECEIVABLE
The details of the note receivable are as follows:
2000 1999
$ $
------------------------------------------------------------------------------
Long-term
Connolly-Daw Holdings Inc. 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,
F - 10
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 7.5% at August 31, 2000
[1999 - 6.25%].
6. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
2000 1999
-------------------------------------------------- -----------------------------------------------
Accumulated Net book Accumulated Net book
Cost depreciation value Cost depreciation value
$ $ $ $ $ $
- --------------------------------------------------------------------------------------------------------------------------------
Land 785,500 -- 785,500 785,500 -- 785,500
Buildings 1,480,401 227,505 1,252,896 1,480,401 172,703 1,307,698
Rental Equipment 3,880,304 2,886,104 994,200 3,869,029 2,183,229 1,685,800
Equipment 5,371,710 1,591,093 3,780,617 1,542,827 676,667 866,160
Software 594,953 151,069 443,884 54,103 36,652 17,451
Automobiles 13,383 8,829 4,554 43,290 39,926 3,364
Computer Equipment 467,602 324,598 143,004 413,435 209,536 203,899
Masters and Libraries 545,949 281,560 264,389 408,644 197,705 210,939
Leasehold improvements 113,301 60,576 52,725 104,394 33,450 70,944
- --------------------------------------------------------------------------------------------------------------------------------
13,253,103 5,531,334 7,721,769 8,701,623 3,549,868 5,151,755
================================================================================================================================
During the year, depreciation of property and equipment was $2,035,985 [1999 -
$1,212,038; 1998 - $1,102,607].
7. SOFTWARE DEVELOPMENT COSTS
Software development costs have been incurred totaling $250,000. These costs
comprise direct salaries and wages involved in the development of a web-based
training software product. During the year, amortization of software development
costs was $50,000, [1999 - none]
8. BANK INDEBTEDNESS
Bank indebtedness consists of the following:
[a] The Company has a demand operating loan facility with a maximum amount of
$500,000 bearing interest at the bank's prime rate. The Company has not
utilized this facility. The bank's prime rate was 7.5% at August 31, 2000
[1999 - 6.25%]. This loan facility is collateralized by a general security
agreement covering all assets of Interactive, other than real property.
[b] Interlynx has a demand operating loan facility, with a maximum amount of
$100,000, bearing interest at the bank's prime rate plus 0.75%. At August
31, 2000, the facility was fully drawn [1999 - $100,000]. The amount is
due on demand to the Royal Bank of Canada and interest is payable monthly.
Interlynx also has a demand installment loan facility with a maximum
amount of $85,000. At August 31, 2000, the balance outstanding is $33,000
[1999 - $57,000] and bears interest at the bank's prime rate plus 1%. The
amount is due on demand to the Royal Bank of Canada and is repayable in
monthly principal amounts of $2,000 plus interest. The weighted average
interest rate for fiscal 2000 was 6.84% [1999 - 6.67%]. The fair value of
the demand operating and demand installment loans approximates their
carrying values. These demand loans are collateralized by a general
security agreement covering all assets of Interlynx, other than real
property, as well as a guarantee and postponement of claim signed by
Interactive, limited to $185,000.
F - 11
9. INCOME TAXES AND DEFERRED INCOME TAXES
The provision for income taxes consists of the following:
2000 1999 1998
$ $ $
-----------------------------------------------------------
Current
Federal -- 98,000 273,503
Provincial -- 52,000 145,581
-----------------------------------------------------------
-- 150,000 419,084
===========================================================
The difference between the provision for income taxes and the amount computed by
applying the combined basic federal and provincial income tax rate of 43.9%
[1999 - 44.6%; 1998 - 44.6%] to income before income taxes is as set out below:
2000 1999 1998
$ $ $
------------------------------------------------------------------------------
Statutory rate applied to pre-tax income (885,531) (386,358) 511,960
Benefit of prior year's losses not
previously recognized -- -- (77,537)
Benefit of current year's losses not
recognized 781,969 446,139 --
Expenses not deductible for tax purposes 117,745 167,333 105,414
Non-taxable accounting income -- (42,482) (154,810)
Other (14,183) (34,632) 34,057
------------------------------------------------------------------------------
-- 150,000 419,084
==============================================================================
As at August 31, 2000, the Company's deferred tax assets primarily related to
the benefit of realizing losses carried forward, net of a valuation allowance of
$1,600,000 [1999- $987,000], was nil [1999 - nil], and the deferred tax
liability, substantially related to property and equipment, was $59,173 [1999 -
$59,173].
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 Magic did not have taxable income.
At September 1, 1997, Interlynx and its subsidiary had aggregate operating
losses of $677,000. The purchase price of Interlynx has not been allocated to
the operating losses since a valuation allowance has been charged against the
entire amount.
Accordingly, when realized, the tax benefit of the unrecognized loss
carryforwards will be applied to reduce goodwill related to the acquisitions of
Magic and Interlynx. The goodwill related to Magic was reduced by $51,687 as a
result of utilizing pre-acquisition losses during 1999.
At August 31, 2000, certain subsidiaries of the Company have loss carryforwards
of approximately $4,000,000. These losses begin to expire in 2002.
F - 12
10. LONG-TERM DEBT
Long-term debt consists of the following:
2000 1999
$ $
- --------------------------------- ----------------------------------------------
Loans Payable
Provincial Holdings Ltd. ["PHL"] [i] 750,000 750,000
Province of New Brunswick ["PNB"] [ii] 19,381 19,381
Atlantic Canada Opportunities Agency ["ACOA"] [iii] 36,930 51,010
ACOA [iv] 38,485 38,485
ACOA [v] 21,908 --
Royal Bank of Canada [vi] 1,243,151 1,277,351
- --------------------------------------------------------------------------------
2,109,855 2,136,227
- --------------------------------------------------------------------------------
Notes Payable
Promissory notes - GalaVu [note 15] 2,662,698 --
- --------------------------------------------------------------------------------
2,662,698 --
Lien notes [vi] 2,119 21,275
- --------------------------------------------------------------------------------
2,664,817 21,275
- --------------------------------------------------------------------------------
4,774,672 2,157,502
================================================================================
[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 will bear 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 11[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 is subject to a loan
agreement dated May 25, 1995 and is 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 is 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. No interest or principal repayments have been made and
PNB has not demanded any payments. It is anticipated that PNB will amend
the forgiveness agreement by reducing the number of full-time employees
required and extending the period during which they must be employed.
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. An
amount of $80,619 was recorded as forgiven in prior periods. The recorded
loan approximates the fair value of the debt at August 31, 2000 and 1999.
[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, 2000 is $38,485.
F - 13
Commencing on October 1, 2000, the loan would be 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, 2000 is $21,908. 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] The lien notes are collateralized by charges against certain capital
assets held by Magic and are repayable in monthly blended payments of
principal and interest. The interest rate on the remaining lien note is
13%. The carrying value of the lien notes approximates the fair value of
the debt at August 31, 2000. Approximate annual principal payments
required pursuant to these obligations are as follows:
$
- ----------------------------------------------------------
2001 2,119
- ----------------------------------------------------------
2,119
==========================================================
Approximate future annual principal payments for long-term debt, exclusive of
the above lien notes, are as follows:
$
- --------------------------------------------------------------------------------
2001 395,513
2002 493,951
2003 2,551,910
2004 683,608
2005 and thereafter 647,571
================================================================================
11. COMMITMENTS
F - 14
[a] Commissions expense to NTN Communications, Inc.
Pursuant to an agreement dated March 23, 1990, the Company pays
commissions to NTN Communications, Inc. when the related revenues are
earned at the rate of U.S. $2,205 per year per subscriber. The Company
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 the Company 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 $1,822,684
[1999 - $2,011,202; 1998 - $1,792,002].
[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 $
------------------------------------------------------------------
2001 8,504
2002 4,252
------------------------------------------------------------------
12,756
==================================================================
Office Equipment $
------------------------------------------------------------------
2001 133,370
2002 26,606
------------------------------------------------------------------
159,976
==================================================================
Premises $
------------------------------------------------------------------
2001 477,818
2002 482,749
2003 424,417
------------------------------------------------------------------
1,384,984
==================================================================
Operating lease expenses were $382,610 for 2000, $201,366 for 1999, and $190,792
for 1998.
F - 15
[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, 2000.
As at August 31, 2000, the value of the shares, if redeemed, totaled a
nominal amount.
[e] Standby letters of credit
Magic has a $75,000 standby letter of credit facility in favour of one of
its suppliers. GalaVu also has a $50,000 standby letter of credit in
favour of one of its suppliers. Any amounts drawn on these facilities are
charged to the Company's bank account. These facilities have not been used
in 2000, 1999 or 1998.
[f] Employment agreements
The Company and its subsidiaries have entered into employment agreements
with certain executive management employees with terms of between one and
two years. The earliest of these agreements commenced November 19, 1999
and the most recent commenced November 19, 2000. The annualized
commitments in these agreements aggregate $970,000.
F - 16
12. SHARE CAPITAL
[a] Authorized shares
The Company's authorized share capital comprises 20,000,000 common shares
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, with no
liquidation preference, such that 3 preferred shares are exchanged 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, 2000, 900,000 preferred shares [1999 - 900,000]
aggregating $10,917 [1999 - $10,917] were issued and outstanding.
Common shares issued and outstanding for accounting purposes are as
follows:
Common shares
-------------------- Capital in excess
Number Amount of par value Total
# $ $ $
-------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------
Balance as at August 31, 1997 2,441,992 150,211 7,923,150 8,073,361
Conversion of promissory notes [i] 87,255 6,066 553,934 560,000
Interlynx acquisition [note 15[a]] 55,209 3,570 261,430 265,000
Conversion of preferred shares 10,714 606 -- 606
Exercise of 30,000 stock options 30,000 2,031 99,434 101,465
-------------------------------------------------------------------------------------------------------
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 15[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 15 [e]] 100,000 6,897 288,463 295,360
Exercise of 68,500 stock options 68,500 4,703 276,431 281,134
-------------------------------------------------------------------------------------------------------
Balance as at August 31, 2000 2,925,141 183,235 10,124,777 10,308,012
=======================================================================================================
[i] The consideration for the acquisition of Magic [note 15[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
The Company has adopted a Long-Term Incentive Plan [the "Plan"] designed
to compensate key employees of the 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
F - 17
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
- -----------------------------------------------------------
exercise price Total
U.S. $ #
- -------------------------------------------------------------------------
Balance as at August 31, 1997 363,000
Issued 4.00 156,500
Forfeited 4.40 (29,500)
Exercised 2.33 (30,000)
- -------------------------------------------------------------------------
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
=========================================================================
Exercise price Expiry date Total
U.S. $ #
- -------------------------------------------------------------------------
3.00 January 5, 2001 [i] 37,500
3.00 April 29, 2001 [i] 3,000
3.00 November 20, 2001 47,000
3.00 November 25, 2001 [i] 56,750
3.00 April 8, 2002 [i] 3,000
3.00 November 17, 2002 [i] 115,500
3.00 November 20, 2002 15,000
2.00 November 23, 2003 164,250
3.50 February 25, 2004 3,000
3.00 June 11, 2004 [note 15[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
- -------------------------------------------------------------------------
Balance as at August 31, 2000 1,297,000
=========================================================================
[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 choice of keeping their existing option pricing in lieu of
agreeing not to exercise such options for six months. All option holders
chose to
F - 18
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, 2000 is 363,666
[1999 - 279,000]
The weighted average fair value of options granted during 2000 was U.S. $5.51
[1999 - U.S $1.45].
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 Company's 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 the Company 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 2000,
1999 and 1998: risk-free interest rate of 5.84% [1999 - 5.32%; 1998 - 5.47%];
dividend yield of 0% [1999 - 0%; 1998 - 0%]; volatility factor of 0.848 [1999 -
0.819; 1998 - 0.709]; and a weighted average expected life of the options of 4
years [1999 - 4 years; 1998 - 3 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
the Company's 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 income (loss) and earnings (loss) per share follows:
2000 1999 1998
$ $
- --------------------------------------------------------------------------------
Pro forma net income (loss) (2,180,531) (1,399,105) 264,011
================================================================================
Pro forma earnings (loss) per share
Basic (0.76) (0.53) 0.10
Diluted (0.76) (0.53) 0.09
================================================================================
F - 19
13. 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:
2000 1999 1998
---- ---- ----
$ $ $
=======================================================================================================
Numerator
Net income (loss) [numerator for basic earnings $(1,985,842) $(971,497) $618,065
(loss) per share]
Accretion of interest on non-interest bearing $173,076 $31,084 $36,346
convertible promissory notes
Numerator for diluted earnings (loss) per share $(1,812,766) $(940,413) $654,411
Denominator
For basic weighted average number of shares 2,873,042 2,635,050 2,550,805
Effect of dilutive securities
Convertible preferred shares -- -- 196,673
Convertible promissory notes -- -- 147,290
Employee stock options -- -- 28,000
Denominator for diluted earnings (loss) per share -
adjusted weighted average number of shares and
assumed conversions 2,873,042 2,635,050 2,922,768
Basic earnings (loss) per share $(0.69) $(0.36) $0.24
Diluted earnings (loss) per share $(0.69) $(0.36) $0.22
=======================================================================================================
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.
Options to purchase 460,000 shares of common stock at $3.00 per share were
outstanding during 1998, but were not included in the computation of diluted
earnings per share because the exercise price of the options was greater than
the average market price of the common shares, and therefore the effect would be
anti-dilutive.
14. 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.
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 the Company's management that this
patent infringement claim will be successfully defended.
F - 20
The 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. No assessment has been made to date by
Canada Customs and Revenue Agency. However, management believes that it has
valid defenses with respect to these matters and, accordingly, no amount has
been recorded in these consolidated financial statements. The withholding tax
assessment could be between $0 and $460,000. In the event that such matters are
settled in favour of the Canada Customs and Revenue, the amounts could be
material and would be recorded in the period in which they become determinable.
Communications would be responsible for paying such taxes.
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 the Company no other proceedings of a material
nature have been or are contemplated against the Company.
15. BUSINESS ACQUISITIONS
[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 tangible assets 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 the Company's 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 and the issuance of options to
purchase 80,000 common shares of the Company at a strike price of U.S.
$3.00 [note 12[c]]. These options were issued out of the existing employee
stock option plan [note 12[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 2000. If annual operating profits for the year
ending August 31, 2002, are at least $700,000, an additional 26,667 of the
options will be deemed earned. If annual operating profits in any of these
three fiscal years are less than the required level, the options will be
deemed earned if the cumulative amounts for operating profits are
achieved. Any options that have not been earned in accordance with these
provisions will expire. Notwithstanding that only 25% of options are
vested each year pursuant to the provisions of the employee stock option
plan, the Company will, at the end of the fiscal year ending August 31,
2002, waive the four year vesting period and deem all the options fully
vested if operating profits for the three fiscal years are at least
$1,590,000 and the President of Interlynx has not resigned from his
employment or been terminated for cause prior to August 31, 2002 and that
the consulting agreement with the Vice-President of Interlynx has not been
terminated
F - 21
prior to August 31, 2002. Management has determined that the options
granted represent contingent purchase consideration and accordingly will
be recorded as part of the purchase price when determinable.
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:
--------------------------------------------------------------------------
$
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 the Company's consolidated statements of operations and
retained earnings from the date of acquisition.
[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)
--------------------------------------------------------------------------
Total purchase price 1,553,315
==========================================================================
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 the Company
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.
F - 22
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
12[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 12[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
--------------------------------------------------------------------------
Total 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 and the issuance
of a 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
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, 2000 approximated its
carrying value. The interest accretion on the discounted note amounted to
$173,076 during fiscal 2000. This acquisition was recorded using the
purchase method of accounting and accordingly the purchase price has been
allocated as follows:
For the year ended August 31, 2000, GalaVu's gross revenue and loss before
taxes were as follows:
F - 23
Gross Revenue $6,517,940
Loss before taxes ($441,636)
Per share data:
Basic loss (0.15)
Diluted (0.15)
$
--------------------------------------------------------------------------
Property and equipment 3,487,498
Assumption of liabilities (529,440)
--------------------------------------------------------------------------
Total purchase price 2,958,058
==========================================================================
F - 24
16. SEGMENTED INFORMATION
The Company operates in the entertainment, education and e-commerce industries.
The entertainment segment includes the provision of entertainment products to
the hospitality and lodging industries. The education segment includes the
provision of educational videos and software to the educational market. The
E-commerce segment includes the provision of web-based training products and
services to corporations. Business segment information for the years ended
August 31, 2000, 1999 and 1998 are as follows:
2000
----
Inter-segment
Entertainment Education E-commerce Unallocated adjustments Total
$ $ $ $ $
- ------------------------------------------------------------------------------------------------------------------------------------
Total revenue 14,320,649 5,247,764 586,756 -- (461,123) 19,694,046
Operating loss 346,301 (645,208) (914,315) (822,515) 20,419 (2,015,318)
Identifiable assets 8,592,258 3,492,952 396,652 --- -- 12,481,862
Corporate assets 4,975,030 68,644 (144,941) -- -- 4,898,733
Capital expenditures 842,955 289,236 29,955 -- -- 1,162,146
Depreciation and amortization 1,733,473 408,856 204,992 -- -- 2,347,321
Income from equity investment -- -- -- -- -- --
====================================================================================================================================
1999
----
Inter-segment
Entertainment Education E-commerce Unallocated adjustments Total
$ $ $ $ $
- ------------------------------------------------------------------------------------------------------------------------------------
Total revenue 8,115,127 5,192,378 596,951 -- (483,814) 13,420,642
Operating profit (loss) 204,843 (594,824) (229,599) -- (246,693) (866,273)
Identifiable assets 4,389,308 4,290,025 351,555 -- -- 9,030,888
Corporate assets 4,923,498 (182,367) 1,030,002 -- -- 5,771,133
Capital expenditures 350,836 147,761 103,036 -- -- 601,633
Depreciation and amortization 900,770 428,376 100,073 -- -- 1,429,219
Income from equity investment -- 28,576 -- -- -- 28,576
====================================================================================================================================
1998
----
Inter-segment
Entertainment Education E-commerce Unallocated adjustments Total
$ $ $ $ $
- ------------------------------------------------------------------------------------------------------------------------------------
Total revenue 8,498,545 5,054,376 1,367,430 -- (148,379) 14,771,972
Operating profit (loss) 1,266,418 (389,046) 418,385 -- (148,379) 1,147,378
Identifiable assets 4,887,935 4,170,474 280,908 -- -- 9,339,317
Corporate assets 4,794,976 720,784 1,192,830 -- -- 6,708,590
Capital expenditures 1,787,043 223,700 1,800 -- -- 2,012,543
Depreciation and amortization 784,113 434,449 92,127 -- -- 1,310,689
Income from equity investment -- (25,658) -- -- -- (25,658)
====================================================================================================================================
Operating income is equal to income 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 the
Company's operations in each industry. Corporate assets are principally cash and
cash equivalents, short-term investments and intangible assets. The Company now
has a 100% interest in Viewer Services [1999 - 100%, 1998 - 50%]. The investment
was accounted for on the equity basis until June 30, 1999 when the Company
purchased the remaining 50% of Viewer Services. The Company's equity in the
income of Viewer Services was $28,576 in 1999 [1998 loss - $25,658].
The unallocated items in the above table represent one-time costs that are not
associated with any of the business segments. The inter-segment adjustments
represent eliminations of inter-segment revenues and costs.
The Company's business segments all operate primarily in Canada.
Revenues from one customer of the Company's e-commerce segment represent
$124,500 [$226,920 - 1999, $240,000 - 1998] of the e-commerce segment revenue.
F - 25
The 1999 and 1998 comparative segmented information has been reclassified from
statements previously presented to conform with the presentation of the 2000
segmented information.
17. RELATED PARTY TRANSACTIONS
Included in other receivables is approximately $155,000 [1999 - $160,000] of
amounts due from employees and shareholders. The amounts are non-interest
bearing and are due on demand.
18. SALE OF SUBSIDIARY
Effective June 1, 1999, the Company through its wholly-owned subsidiary,
Interlynx, sold its 60% interest in Universal Content Inc. ["UCI" - formerly
known as Interlynx International Inc] for cash consideration of $110,813. UCI
served as a marketing and sales arm of Interlynx for CD-ROM products. The
operations of UCI were not significant to the Company and the marketing and
sales of Interlynx CD-ROM products have been assumed by Interlynx.
19. SUBSEQUENT EVENTS
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 US$200,000. As a result,
Magic Lantern has expanded its 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
US$300,000 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. 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 September 19, 2000 pursuant to an Agreement of Purchase and Sale dated as of
August 4, 2000, the Company and its subsidiary NNAC acquired, effective August
31, 2000, certain shares and net assets from Cameron Chell and Chell.com Ltd.
("Chell.com"). Pursuant to the Agreement, the Company acquired: (a) 480,000
common shares of cDemo Inc. (23%); (b) 875,000 common shares of Engyro, Inc.
(34%); (c) 150,000 common shares of C Me Run Corp. (1%); and (d) 60,000 common
shares Chell.com USA (100%). In addition, NNAC acquired 962,500 common shares of
eSupplies (Alberta) Ltd. (27%) as well as certain net assets from Chell.com.
This acquisition has not been reflected in the accompanying financial statements
since shareholder approval to ratify the above purchase transaction was not
voted on and approved until September 8, 2000. The accounting treatment for this
transaction is described on page F-32.
In consideration for this acquisition, the Company issued 5,396,733 shares of
its common stock and NNAC issued 1,928,267 special convertible shares to Cameron
Chell, Chell.com and others. Each share issued by NNAC is convertible into one
share of common stock of the Company. Pursuant to a Voting and Exchange Trust
Agreement entered into with a trustee, whereby voting privileges have been
granted, such shares issued by NNAC can be voted by the trustee immediately. The
amount of shares issued was determined based upon an appraisal valuation of the
investments and assets acquired which aggregated US $28,652,086.
F - 26
Cameron Chell is the sole director and shareholder of Chell.com. Mr. Chell is
also the President of Chell Group Corporation
The shares of the Company that were issued in exchange for shares of C Me Run
Corp. (421,829) and eSupplies (Alberta) Inc. (1,476,398) have been placed in
escrow until such time as certain conditions are met.
On October 10, 2000, the Company closed the sale of US$3,000,000 of a
Convertible 10% Debenture to the VC Advantage Limited Partnership ("Holder").
The principal amount of the Debenture will be advanced in three consecutive
monthly installments of US$1,000,000 each, on or about the tenth day of each
month beginning October 10, 2000. This unsecured convertible debenture is due
three years from issue. 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 the Company's option. The
Convertible Debenture is convertible into common stock of the Company, at
US$3.00 per share, in amounts specified by the Holder. The Holder is entitled to
convert at any time, all or any part of the principal amount of the Debenture,
plus accrued interest. The maximum number of common shares the Holder will
receive is one million. On the close date, the Company issued 50,000 warrants to
purchase 50,000 common shares at US$3.00 per share. The warrants have a term of
four years. The President of the Company is the Chairman, a Director and a
shareholder of the General Partner of the Holder.
On September 8, 2000 the Company changed its name from Networks North Inc. to
Chell Group Corporation. On September 25, 2000 the Company's wholly-owned
subsidiary, Networks North Acquisition Corporation changed its name to Chell
Merchant Capital Group Inc.
20. COMPARATIVE CONSOLIDATED FINANCIAL STATEMENTS
The 1999 and 1998 comparative consolidated financial statements have been
reclassified from statements previously presented to conform to the presentation
of the 2000 consolidated financial statements.
F - 27
ENGYRO, INC.
(A Company in the Development Stage)
AUDITED FINANCIAL STATEMENTS
Period from Inception (November 4, 1999)
through August 31, 2000
F - 28
ENGYRO, INC.
(A Company in the Development Stage)
TABLE OF CONTENTS
Page
REPORT OF INDEPENDENT AUDITORS 1
FINANCIAL STATEMENTS
Balance Sheet 2
Statement of Operations 3
Statement of Deficiency in Assets 4
Statement of Cash Flows 5
Notes to Financial Statements 6
F - 29
REPORT OF INDEPENDENT AUDITORS
To the Stockholders
Engyro, Inc.
Shelton, Connecticut
We have audited the accompanying balance sheet of Engyro, Inc. (formerly R Home
Funding Co. Ltd.) as of August 31, 2000 and the related statements of operations
and retained earnings, and cash flows for the period from November 4, 1999 (date
of inception) through August 31, 2000. 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 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 audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Engyro, Inc. (formerly R Home
Funding Co. Ltd.) as of August 31, 2000, and the results of its operations and
cash flows for the period from November 4, 1999 (date of inception) through
August 31, 2000 in conformity with generally accepted accounting principles.
New Haven, Connecticut
December 27, 2000
F - 30
ENGYRO, INC.
(formerly R Home Funding Co. Ltd.)
(A Company in the Development Stage)
BALANCE SHEET
August 31, 2000
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 1,293,146
Other current assets 258,942
-----------
Total current assets 1,552,088
LONG-TERM ASSETS
Certificate of deposit 255,000
Property and equipment, net 532,423
-----------
Total long-term assets 787,423
-----------
$ 2,339,511
===========
LIABILITIES AND DEFICIENCY IN ASSETS
CURRENT LIABILITIES
Accounts payable and accrued expenses $ 352,462
-----------
Total current liabilities 352,462
-----------
CONVERTIBLE PREFERRED STOCK, SERIES A 3,419,944
-----------
DEFICIENCY IN ASSETS
Common stock, $.001 par value per share; authorized
20,000,000 shares; issued and outstanding 1,585,000 shares 1,585
Paid - in capital 100
Accumulated accretion of value of preferred stock (22,917)
Deficit accumulated during development stage (1,411,663)
-----------
(1,432,895)
-----------
$ 2,339,511
===========
See notes to financial statements.
F - 31
ENGYRO, INC.
(formerly R Home Funding Co. Ltd.)
(A Company in the Development Stage)
STATEMENT OF CHANGES IN OPERATIONS
Period from May 19, 2000 (date of inception)
through August 31, 2000
REVENUES $ --
COST OF SALES --
------------
GROSS MARGIN ON SALES --
------------
OPERATING EXPENSES
Product development 587,748
Marketing and selling 70,996
General and administrative 747,242
------------
Total operating expenses 1,405,986
------------
LOSS FROM OPERATIONS (1,405,986)
OTHER INCOME (EXPENSE)
Interest income 4,220
Interest expense (9,897)
------------
Net other income (expense) (5,677)
------------
NET LOSS $ (1,411,663)
============
See notes to financial statements.
F - 32
ENGYRO, INC.
(formerly R Home Funding Co. Ltd.)
(A Company in the Development Stage)
STATEMENT OF CHANGES IN DEFICIENCY IN ASSETS
Accumulated Deficit
Common Stock Accretion Accumulated
----------------------------- of Value of During
Amount Paid-In Preferred Development
Shares at Par Capital Stock Stage Total
------------- ------------ ------------ ---------------- ---------------- -------------
Balance, January 1, 2000 -- $ 875 $ -- $ -- $ -- $ --
Issuance of common stock, to
individual investors 1,585,000 710 100 -- -- 1,685
Accretion of value of
preferred stock -- -- -- (22,917) -- (22,917)
Net loss -- -- -- -- (1,411,663) (1,411,663)
------------- ------------ ------------ ---------------- ---------------- -------------
Balance, August 31, 2000 1,585,000 $ 1,585 $ 100 $ (22,917) $(1,411,663) $(1,432,895)
============= ============ ============ ================ ================ =============
See notes to financial statements.
F - 33
ENGYRO, INC.
(formerly R Home Funding Co. Ltd.)
(A Company in the Development Stage)
STATEMENT OF CASH FLOWS
Period from November 4, 1999 (date of inception)
through August 31, 2000
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (1,411,663)
Adjustments to reconcile net loss to
cash used in operating activities:
Depreciation and amortization 9,030
Changes in assets and liabilities:
Other current assets (258,942)
Accounts payable and accrued expenses 352,462
--------------
Net cash used in operating activities (1,309,113)
--------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of certificate of deposit (255,000)
Purchases of property and equipment (534,219)
--------------
Net cash used in investing activities (789,219)
--------------
CASH FLOWS FROM FINANCING ACTIVITIES
Issuance of capital stock and receipt of paid-in capital 1,685
Proceeds from issuance of preferred stock, Series A 3,389,793
--------------
Net cash provided by financing activities 3,391,478
--------------
NET INCREASE IN CASH 1,293,146
CASH AND CASH EQUIVALENTS, Beginning --
--------------
CASH AND CASH EQUIVALENTS, Ending $ 1,293,146
==============
See notes to financial statements.
F - 34
ENGYRO, INC.
(formerly R Home Funding Co. Ltd.)
(A Company in the Development Stage)
NOTES TO FINANCIAL STATEMENTS
NOTE 1 -- ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Organization
R Home Funding Co. Ltd., was incorporated on November 4, 1999 as a Nevada
Corporation and was a wholly owned subsidiary of Chell.com Inc. On May 19, 2000,
Engyro, Inc. (Engyro or the Company) was incorporated as a subsidiary of R Home
Funding Co. Ltd. On July 31, 2000, R Home Funding Co. Ltd., was merged
"downstream" into Engyro, with Engyro as the surviving corporation.
Since the entities were under common control at the time of the merger,
Accounting Principle Opinion No. 16 Accounting for Business Combination does not
apply, however, the transaction was accounted for similar to a pooling of
interests in that there was no change in the reporting entity.
Subsequent to the merger, Engyro, Inc. issued 1,585,000 shares of stock for
$1,585 including 875,000 for $875 to Chell.com Ltd. which was the amount
subscribed and unpaid to R Home Funding Co. Ltd.
On November 26, 1999, R Home Funding Co. Ltd. entered into a consulting
agreement with Chell.com Inc., an affiliate of Chell.com Ltd., whereby R Home
Funding would receive certain corporate strategic services and advice for
consideration. As a result of the merger, Engyro assumed this consulting
agreement, which expires during January 2001. The amount prepaid shown on the
balance sheet is the unamortized portion of the contract.
Nature of Operations
Engyro provides payment and transaction settlement solutions focused on the
Application Service Provider (ASP) industry. Engyro provides data consolidation,
reconciliation, transaction settlement, and payment processing and revenue
assurance services for the new economy sector, currently serving the Application
Service Provider industry, the software industry and evolving m-commerce
applications. Engyro's management believes that the Company has developed
leading edge technologies based on an open architecture Java software and ultra
sophisticated Online Analytical Processing (OLAP) software. Engyro partners with
metering, billing and ASP infrastructure providers to complement its services.
Significant Accounting Policies
Use of Estimates -- 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 liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period. The
Company's actual results in subsequent periods may differ from the estimates and
assumptions used in the preparation of the accompanying consolidated financial
statements.
Cash and Cash Equivalents -- Cash is invested in overnight sweep accounts on a
nightly basis. Deposits in banks may exceed the amount of insurance provided on
such deposits. The Company performs reviews of the credit worthiness of its
depository banks. The Company has not experiences any losses on its deposits of
cash.
Certificate of Deposit -- The Company was required to deliver a security deposit
to the We Progress Drive, L.L.C. (Landlord) representing one year's lease
payment. In lieu of cash, the Company issued a Letter of Credit to the Landlord.
The Letter of Credit is secured by a $255,000 Certificate of Deposit with First
Union National Bank. The amount of this deposit decreases monthly during the
second year of the lease until the obligation is eliminated at the end of the
second year.
F - 35
ENGYRO, INC.
(formerly R Home Funding Co. Ltd.)
(A Company in the Development Stage)
NOTES TO FINANCIAL STATEMENTS
Other Current Assets -- Other current assets consist primarily of advances to
shareholders for contractual consulting services to be provided through January
15, 2001. Consulting costs are expensed as incurred. The consulting expense
through August 31, 2000 was approximately $462,000.
Property and Equipment -- Property and equipment are recorded at cost. The
Company provides for depreciation using the straight-line method over the
estimated useful lives for equipment and the shorter of the useful lives or the
related lease term for leasehold improvements.
Accounting for Stock-Based Compensation -- As permitted under Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation," the Company has elected to measure costs for its employee stock
compensation plans by using the accounting methods prescribed by Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees,"
which allows that no compensation cost be recognized unless the exercise price
of options granted is less than the fair market value of the Company's stock at
date of grant. Reference is made to Note 5 of the Financial Statements for
further information.
Deferred Income Taxes -- Deferred income taxes are provided on the differences
between the financial statement and tax bases of assets and liabilities and
operating loss carryovers using enacted tax rates in which the differences are
expected to reverse.
NOTE 2 -- CONCENTRATION OF CREDIT RISK
The Company has cash in various financial institutions that insure deposits up
to $100,000 per depositor through the Federal Deposit Insurance Corporation
(FDIC). Deposits in excess of FDIC coverage are not insured and thereby
represent a credit risk to the Company. At August 31, 2000, there was $1,535,803
of uninsured deposit amounts.
NOTE 3 -- PROPERTY AND EQUIPMENT
Property and equipment at August 31, 2000 consisted of the following:
Furniture and fixtures $ 6,025
Computer equipment 39,715
Software 488,479
----------
534,219
Less accumulated depreciation 1,796
----------
Property and equipment, net $ 532,423
==========
F - 36
ENGYRO, INC.
(formerly R Home Funding Co. Ltd.)
(A Company in the Development Stage)
NOTES TO FINANCIAL STATEMENTS
NOTE 4 -- PREFERRED STOCK
In August 2000, Engyro issued 975,000 shares of Series A preferred stock at
$3.84 (preference value) per share. Proceeds from the sale were used to finance
the development of its financial transaction technology and to fund daily
operations.
The following is a summary of convertible redeemable preferred stock at August
31, 2000:
Series A cumulative convertible preferred
stock, par value $0.01; 20,000,000
shares authorized: 975,000 shares
issued and outstanding (redeemable at
$4.61 at August 31, 2000) $ 3,749,900
Accumulated accretion of value of preferred stock 22,917
Less financing costs, net of accumulated
amortization of $7.235 (352,873)
------------
Net preferred stock $ 3,419,944
============
Holders of the preferred stock are entitled to a cumulative annual dividend at
the rate of 10 percent of the lower of (a) the preference value ($3.84 per
share); and (b) once the common stock of the Company is publicly traded on a
national securities exchange or an established over the counter trading market
in the United States (publicly traded), 80 percent of the average closing bid
price, for 15 consecutive trading days prior to December 31 of the preceding
year provided such price shall not be less than $1.92 per share, payable
quarterly in cash or shares of common stock, at the election of the Company,
commencing September 30, 2000.
For purposes of determining aggregate redemption value, it is assumed redemption
does not occur until August 8, 2003 with dividends accumulating until such time.
This will result in a redemption amount of $5,616,000. Additionally, these same
assumptions are used to record accretions in value using the interest method.
If, on or after August 8, 2003 (redemption date), the Series A convertible
preferred stock has not been converted to common stock, the Company shall redeem
all shares of Series A convertible preferred stock outstanding on that date out
of funds legally available for such payment at a per share redemption price
equal to the redemption price described below. Any holder of the Series A
convertible preferred stock shall have the right to convert his shares to shares
of common stock until August 8, 2003 (redemption date). The redemption price of
the convertible preferred stock shall be the sum of 120 percent of the
preference value ($3.84) plus 100 percent of all accumulated and unpaid
dividends accrued as of the redemption date.
If the Company fails to discharge all or any part of its preferred stock
redemption obligations because sufficient funds are not available, the holders
of the preferred stock shall share ratably in any distribution of cash legally
available.
F - 37
ENGYRO, INC.
(formerly R Home Funding Co. Ltd.)
(A Company in the Development Stage)
NOTES TO FINANCIAL STATEMENTS
NOTE 5 -- STOCK OPTIONS AND WARRANTS
The Company has a fixed stock option plan under which officers and key employees
may be granted options to purchase shares of the Company's authorized but
unissued common stock. From November 4, 1999 (date of inception) through August
31, 2000, the Company issued 675,000 options to officers and key employees.
These options vest at 25 percent each anniversary date (August 8) over the next
4 years at an exercise price of $5.00 per share. From inception November 4, 1999
through August 31, 2000, no options were vested or exercised. The option price
for all options granted equaled or exceeded the fair value of the Company's
stock at the time of issue. Accordingly, the Company did not recognize any
compensation expense in relation to options granted to employees during the
period from inception November 4, 1999 through August 31, 2000.
The following is a summary of the status of the stock option plan for the period
from inception November 4, 1999 through August 31, 2000:
Shares Exercise Price
--------------- -----------------
Outstanding at beginning of year -- $ --
Granted 675,000 5.00
Exercised -- --
Forfeited -- --
--------------- -----------------
Outstanding at end of year 675,000 $ 5.00
=============== =================
During the period from inception November 4, 1999 to August 31, 2000, Engyro
issued warrants for the purchase of 292,500 shares of common stock at $5.00 per
share, in connection with the issuance of the convertible redeemable preferred
stock. The warrants become exercisable commencing August 9, 2000 and ending
August 9, 2003. As of August 31, 2000, 292,500 shares of common stock were
reserved for that purpose.
NOTE 6 -- PROVISION FOR INCOME TAXES
At August 31, 2000, the Company has available net operating losses for federal
and state corporation income tax purposes of approximately $1,424,000, which can
be carried forward for up to 15 years (federal) and 5 years (state). Anticipated
corporate tax benefits related to these loss carryforwards amounting to $576,000
are fully reserved by the Company because as a development stage company, it is
not more likely than not that the asset will be realizable.
F - 38
ENGYRO, INC.
(formerly R Home Funding Co. Ltd.)
(A Company in the Development Stage)
NOTES TO FINANCIAL STATEMENTS
NOTE 7 -- LEASE COMMITMENT
At August 31, 2000, the Company leases temporary office space in Shelton,
Connecticut through December 31, 2000. Rent expense for the period from November
4, 1999 (date of inception) through August 31, 2000 amounted to $3,310.
In August 2000, the Company entered into an agreement to lease its office space
at another location in Shelton, Connecticut at an annual rental of $257,907,
subject to escalating rates expiring June 30, 2005. The lease allows the Company
to occupy the space starting in January 2001.
At August 31, 2000, future minimum payments under the noncancellable operating
leases were as follows:
2000 $ 31,492
2001 259,171
2002 274,342
2003 289,513
2004 303,420
Thereafter 278,135
----------
Total minimum lease payments $1,436,073
==========
NOTE 8 -- UNCERTAINTIES
The accompanying financial statements have been prepared in conformity with
generally accepted accounting principles, which contemplates continuation of the
Company as a going concern. However, the Company has sustained substantial
operating losses since inception.
As the Company is in its development state, it needs to continue to conduct
significant development and testing, and incur general and administrative
expenses. It expects these activities will result in substantial operating
losses through December 31, 2001. Accordingly, the Company will not be
generating its own capital and will remain dependent on outside sources of
financing during that time.
The Company expects that its existing capital resources and the interest earned
thereon will enable it to maintain its current and planned operations through
March 31, 2001. The Company expects that it will need to raise additional funds
to continue the development of its technologies and complete the
commercialization of services, if any, resulting from such technologies. It will
require substantial funds to continue research and development programs, license
or acquire technologies; and conduct beta testing. The Company may further need
to raise additional capital to fund operations from time to time in the future.
It may raise such capital through public or private equity financing,
partnerships, debt financings bank, borrowings, or other sources. Capital
requirements depend upon numerous factors including the development of competing
technologies on products, changing market conditions, the cost of protecting
intellectual property rights, progress of research and development, and
licensing and acquisition opportunities.
F - 39
cDEMO INC.
(a Development Stage Company)
FINANCIAL STATEMENTS
FOR THE PERIOD JANUARY 14, 2000 (INCEPTION) TO AUGUST 31, 2000
F - 40
cDEMO INC.
(a Development Stage Company)
FOR THE PERIOD JANUARY 14, 2000 (INCEPTION) TO AUGUST 31, 2000
- INDEX -
Page(s)
-------
Independent Auditors' Report 1.
Financial Statements:
Balance Sheet - August 31, 2000 2.
Statement of Operations - For the Period from
January 14, 2000 (Inception) to August 31, 2000 3.
Statement of Shareholders' Equity (Deficiency) -
For the Period from January 14, 2000 (Inception) to August 31, 2000 4.
Statement of Cash Flows - For the Period from
January 14, 2000 (Inception) to August 31, 2000 5.
Notes to Financial Statements 6. - 12.
F - 41
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders
cDemo Inc.
Calgary, Alberta
We have audited the accompanying balance sheet of cDemo Inc. (a Development
Stage Company) as of August 31, 2000 and the related statements of operations,
shareholders' equity (deficit) and cash flows for the period from January 14,
2000 (Inception) to August 31, 2000. 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 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 audit provides a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of cDemo Inc. (a Development Stage
Company) and the results of its operations and cash flows for the period from
January 14, 2000 (Inception) to August 31, 2000 in conformity with accounting
principles generally accepted in the United States of America.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 2 to the
financial statements, operations have generated losses from inception and, as of
August 31, 2000, the Company has an accumulated deficit. Such matters raise
substantial doubt about the Company's ability to continue as a going concern.
Management's plans concerning these matters are also described in Note 2. The
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
---------------------------
LAZAR LEVINE & FELIX LLP
New York, New York
January 25, 2001
F - 42
cDEMO INC.
(a Development Stage Company)
BALANCE SHEET
AS OF AUGUST 31, 2000
(Expressed in Canadian Dollars)
- ASSETS - (Note 5)
CURRENT ASSETS:
Cash and cash equivalents $ 1,779,226
Prepaid expenses - related party (Note 9) 710,400
Other current assets 28,939
-----------
TOTAL CURRENT ASSETS 2,518,565
FIXED ASSETS - net of accumulated depreciation and amortization (Note 4) 106,969
OTHER ASSETS:
Deferred financing costs -net of accumulated amortization (Note 5) $ 443,868
Non-competition costs (Note 6) 149,000 592,868
----------- -----------
$ 3,218,402
===========
- LIABILITIES AND SHAREHOLDERS' (DEFICIENCY) -
CURRENT LIABILITIES:
Accounts payable and accrued liabilities $ 90,300
-----------
TOTAL CURRENT LIABILITIES 90,300
LONG-TERM DEBT:
Convertible debentures (Note 5) 4,277,000
COMMITMENTS AND CONTINGENCIES (Notes 6, 9, 10 and 11)
SHAREHOLDERS' EQUITY (DEFICIENCY) (Note 7):
Common shares - authorized 20,000,000 shares, $.001 par value;
2,088,000 shares issued and outstanding $ 2,088
Additional paid-in capital 210,107
Deficit accumulated during the development stage (1,361,093) (1,148,898)
----------- -----------
$ 3,218,402
===========
The accompanying notes are an integral part of these financial statements.
F - 43
cDEMO INC.
(a Development Stage Company)
STATEMENT OF OPERATIONS
FOR THE PERIOD FROM JANUARY 14, 2000 (INCEPTION) TO AUGUST 31, 2000
(Expressed in Canadian Dollars)
REVENUES $ --
EXPENSES:
General and administrative $ 1,273,680
Computer development costs 52,219
Amortization 24,543
Foreign exchange 10,651 1,361,093
----------- -----------
NET LOSS (Note 8) $(1,361,093)
===========
The accompanying notes are an integral part of these financial statements.
F - 44
cDEMO INC.
(a Development Stage Company)
STATEMENT OF SHAREHOLDERS' EQUITY (DEFICIENCY)
FOR THE PERIOD FROM JANUARY 14, 2000 (INCEPTION) TO AUGUST 31, 2000
(Expressed in Canadian Dollars)
Deficit
accumulated
Additional during the
Common paid-in development Total
Shares Amount capital stage (Deficit)
--------- ------- ---------- ------------ -----------
Subscription of common stock
Cash:
Common stock issued 174,000 $ 195 $ -- $ -- $ 195
12 for 1 stock split (Note 7) 1,914,000 1,893 (1,893) -- --
Non-Cash:
Value of warrants granted (Note 7) -- -- 212,000 -- 212,000
Net loss -- -- -- (1,361,093) (1,361,093)
--------- ------- ---------- ------------ -----------
Balance at August 31, 2000 2,088,000 $2,088 $ 210,107 $(1,361,093) $(1,148,898)
--------- ------- ---------- ------------ -----------
The accompanying notes are an integral part of these financial statements.
F - 45
cDEMO INC.
(a Development Stage Company)
STATEMENT OF CASH FLOWS
FOR THE PERIOD FROM JANUARY 14, 2000 (INCEPTION) TO AUGUST 31, 2000
(Expressed in Canadian Dollars)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (1,361,093)
Adjustments to reconcile net loss to net cash used in
operating activities:
Amortization 24,543
Consulting fees 64,000
Changes in operating assets and liabilities:
(Increase) in prepaid expenses and other current assets (739,339)
Increase in accounts payable and accrued expenses 90,300
------------
Net cash (used in) operating activities (1,921,589)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of fixed assets $ (118,831)
-----------
Net cash (used in) investing activities (118,831)
CASH FLOWS FROM FINANCING ACTIVITIES:
Deferred financing costs (456,549)
Non-competition costs (149,000)
Issue of convertible debentures 4,425,000
Sale of common stock 195
-----------
Net cash provided by financing activities 3,819,646
------------
NET INCREASE IN CASH 1,779,226
Cash and cash equivalents, at inception
------------
CASH AND CASH EQUIVALENTS, AT END OF PERIOD $ 1,779,226
============
The accompanying notes are an integral part of these financial statements.
F - 46
cDEMO INC.
(a Development Stage Company)
NOTES TO FINANCIAL STATEMENTS
AUGUST 31, 2000
NOTE 1 - ORGANIZATION AND NATURE OF OPERATIONS:
cDemo Inc. (the "Company"), was incorporated under the laws of the
State of Delaware by Articles of Incorporation dated January 14,
2000. The Company filed to have its name changed from the original
name of buyersangel.com inc. to consumersangel.com inc. A subsequent
filing was done to change the Company's name to C Me Buy Inc. A
final name change was filed for and received on May 4, 2000 changing
the Company's name to cDemo Inc.
The Company has designed a new business model that will establish a
nationwide electronic vehicle demonstration and Internet listing
service of used cars. The Company's service will enhance the
experience of both buyers and sellers of cars by providing an
independent, third party listing of the features and condition of
used vehicles for sale, including a series of interior and exterior
photos.
Since the most significant portion of the Company's operations are
located in Canada and its normal transaction currency is Canadian
dollars, these financial statements are stated in Canadian dollars.
The Company has been in the development stage in accordance with
Statement of Financial Accounting Standards No. 7, since its
inception. Principal operations of the Company have not yet
commenced.
NOTE 2 - BASIS OF PRESENTATION - GOING CONCERN:
The accompanying financial statements have been prepared in
conformity with accounting principles generally accepted in the
United States of America, which contemplate continuation of the
Company as a going concern. However, the Company as of August 31,
2000 has had significant operating losses, has a deficit in
shareholder's equity of $1,148,898 and has not yet generated
revenues. These factors create an uncertainty about the Company's
ability to continue as a going concern. The financial statements do
not include any adjustments relating to the recoverability and
classification of recorded asset amounts and classification of
liabilities that might be necessary should the Company be unable to
continue as a going concern.
As the Company is in its development state, it needs to continue to
conduct significant development and testing, and will incur
additional general and administrative expenses. It expects these
activities will result in substantial operating losses at least
through to August 31, 2002. Accordingly, the company will no be
generating its own capital and will remain dependent on outside
sources of financing during that time
The Company expects that its existing capital resources will enable
it to maintain its current and planned operations through August 31
2001. The Company expects that it will need to raise additional
funds to continue the development programs. The Company may further
need to raise additional capital or private equity financing,
partnerships, debt financings, bank borrowings, or other sources.
Capital requirements depend upon numerous factors including the
development of competing technologies on products, changing market
conditions, the cost of protecting intellectual property rights,
progress of research and development, and licensing.
Ultimate recovery of the Company's assets is dependent on the
Company, after an expected period of initial losses, achieving and
maintaining profitability which is dependant on market conditions,
successful rollout of the Company's business plan and the ability to
obtain adequate financing to meet capital and operational
requirements. It is management's opinion that the Company will be
able to obtain the necessary financing to continue development
activities over the next fiscal year.
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
The Company's accounting policies are in accordance with accounting
principles generally accepted in the United States of America
(GAAP). Outlined below are those policies considered particularly
significant.
F - 47
cDEMO INC.
(a Development Stage Company)
NOTES TO FINANCIAL STATEMENTS
AUGUST 31, 2000
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued):
(a) Deferred financing
Deferred financing charges represent costs paid by the Company
relating to the convertible debenture financing. Financing fees and
expenses relating to this debt financing will be amortized over the
term of the related debt which is 3 years. During the period,
$12,682 of these costs have been amortized.
(b) Fixed assets
Fixed assets are recorded at cost. Depreciation of fixed assets is
provided on a straight-line basis as follows:
Furniture and fixtures - 5 years
Computer hardware - 3 years
Computer software - 3 years
Leasehold improvements are amortized over the term of the lease.
Maintenance and repairs are charged to operations and major
improvements are capitalized.
(c) Foreign currency
Assets and liabilities transacted in a foreign currency are
translated at the period end exchange rate while revenues and
expenses are translated at average exchange rates for the period.
Any gains or losses resulting from the translation of these assets
and liabilities are recorded on the statement of operations.
(d) Financial instruments
The Company's assets and liabilities include various financial
instruments. Unless otherwise indicated, it is management's opinion
that the Company is not exposed to significant interest, currency or
credit risks arising from these financial instruments. The fair
market values of these financial instruments approximate their
carrying values, unless otherwise noted.
(e) Use of estimates
The preparation of financial statements in conformity with
accounting principles generally accepted in the United States
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 revenues and expenses during
the period. Actual results could differ from those estimates.
(f) Statement of Comprehensive Income
SFAS 130, "Reporting Comprehensive Income" is effective for years
beginning after December 15, 1997. This statement prescribes
standards for reporting other comprehensive income and its
components. Since the Company currently does not have material items
of other comprehensive income, a statement of comprehensive income
is not required.
F - 48
cDEMO INC.
(a Development Stage Company)
NOTES TO FINANCIAL STATEMENTS
AUGUST 31, 2000
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued):
(g) Advertising Expenses
To date the Company has incurred no expenses for advertising and
promoting its services. Such costs will be expensed as incurred.
(h) Income Taxes
Deferred income taxes are recognized for tax consequences of
temporary differences, principally depreciation, by applying enacted
statutory tax rates applicable for years in which taxes are expected
to be paid or recovered to differences between the financial
reporting and the tax bases of existing assets and liabilities.
(i) Cash Equivalents
The Company defines cash equivalents as all short-term, highly
liquid investments with original maturity dates of less than 90
days.
(j) New accounting pronouncements
(i) In June 1998, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 133 ("SFAS No.
133"), Accounting for Derivative Instruments and Hedging
Activities. SFAS No. 133 requires companies to recognize all
derivative contracts as either assets or liabilities in the
balance sheet and to measure them at fair value. Based on its
current and planned future activities, the Company believes
that the adoption of SFAS No. 133 will not have any current
effect or expected future effect on its financial statements.
(ii) On December 3, 1999, the United States Securities and Exchange
Commission (SEC) issued Staff Accounting Bulletin 101 ("SAB
101"), Revenue Recognition in Financial Statements. SAB 101
summarizes some of the SEC's interpretations of the
application of generally accepted accounting principles to
revenue recognition. Revenue recognition under SAB 101 was
initially effective for the Company's first quarter 2000
financial statements. However, SAB 101B, which was released on
June 26, 2000, delayed adoption of SAB 101 until no later than
the fourth fiscal quarter 2000. Changes resulting from SAB 101
require that a cumulative effect of such changes for 1999 and
prior years be recorded as an adjustment to net income on
January 1, 2000.
The Company believes that its revenue recognition practices
are in substantial compliance with SAB 101 and that adoption
of its provisions will not be material to its results of
operations.
F - 49
cDEMO INC.
(a Development Stage Company)
NOTES TO FINANCIAL STATEMENTS
AUGUST 31, 2000
NOTE 4 - FIXED ASSETS:
The major classes of fixed assets are as follows:
Furniture and fixtures $ 7,876
Computer hardware 59,327
Computer software 10,570
Leasehold improvements 41,058
-----------
118,831
Less: accumulated depreciation 11,862
-----------
Net book value $ 106,969
===========
NOTE 5 - CONVERTIBLE DEBENTURES:
During the period, the Company issued $4,425,000 (US$3,000,000) in
convertible debentures bearing interest at 8% per annum, due on July
31, 2003 and secured by a general security agreement on all of the
assets of the Company. These debentures are convertible into 1
common share of the Company's common stock for every US$5 of debt.
When the Company is publicly traded, the debentures are convertible
into 1 common share at the lower of US$5 or 80% of the average
closing price for 15 consecutive trading days prior to the
conversion, subject to a floor price of US$2.50. The convertible
debenture was subscribed for by two related parties, VC Advantage
Limited Partnership and the VC Advantage (Bermuda) Fund Ltd., of
which a director of the Company is an investor and beneficiary,
respectively.
Costs aggregating $456,550, required to obtain this financing are
reflected in deferred financing costs on the balance sheet.
NOTE 6 - NONCOMPETITION AGREEMENT:
On August 22, 2000, the Company entered into a noncompetition
agreement with Frank Killoran, a former officer of the Company, for
a period of three years. The cost of this arrangement of $149,000
(US$100,000) will be amortized on a straight-line method over the
term of the agreement. No amortization expense was charged to
operations for the period ended August 31, 2000.
NOTE 7 - SHAREHOLDERS EQUITY (DEFICIENCY):
During the period ended August 31, 2000, the Company changed its
authorized shares from 200,000 common shares with no par value to
20,000,000 common shares with $.001 par value.
On August 21, 2000, the Board of Directors authorized a 12 for 1
stock split of the Company's common stock. As a result of the split,
1,914,000 additional shares were issued, and additional paid-in
capital was reduced by $1,893.
F - 50
cDEMO INC.
(a Development Stage Company)
NOTES TO FINANCIAL STATEMENTS
AUGUST 31, 2000
NOTE 7 - SHAREHOLDERS EQUITY (DEFICIENCY) (Continued):
During the period ended August 31, 2000, the Company issued 660,000
warrants, allowing the holder to purchase 1 common share for every
warrant at prices varying between US$2.083 and US$5 per share, until
dates varying from March 1, 2003 to August 21, 2003.
No expense has been recorded for 480,000 of these warrants issued to
a trust fund on behalf of a director. The value attributable to
these warrants, based on the Black-Scholes pricing model, with an
expected volatility of 0% and risk free rate of return of 6% would
approximate $593,000. Accordingly, the value attributable to the
warrants is approximately $1.24 each. The expected life of the
warrants is the date of expiration. It is expected that no dividends
will be paid on the common shares after conversion of any warrants.
Had cost for these 480,000 warrants issued to the fund been
recorded, the pro-forma income statement would have been as follows:
Reported net loss $ (1,361,093)
Cost of warrants (593,000)
-------------
Pro forma net loss $ (1,954,093)
=============
As to the remaining warrants, the Company issued 60,000 of these
warrants to a consultant for services provided (see Note 9) and
120,000 warrants were issued in conjunction with the convertible
debenture financing (see Note 5). An expense of $64,000 has been
recorded for the warrants issued to the consultant. The $148,000 of
value attributed to the convertible debentures financing has been
netted against the debentures on the balance sheet and will be
amortized over the life of the convertible debt. The value of the
warrants granted was estimated using the Black-Scholes pricing
model.
Pursuant to an escrow agreement dated August 21, 2000 with the
shareholders of the Company, all 2,088,000 common shares of the
Company may not be traded, released, transferred or dealt with in
any manner. The shares will be released from escrow 1/3 each on the
dates of July 31, 2001, July 31, 2002 and July 31, 2003.
NOTE 8 - INCOME TAXES:
The Company has adopted SFAS 109, "Accounting for Income Taxes"
which requires use of the asset and liability approach of providing
for income taxes. SFAS 109 requires recognition of deferred tax
liabilities and assets for the expected future tax consequences of
events that have been included in the financial statements or tax
returns. Under this method deferred tax liabilities and assets are
determined based on the difference between the financial statement
and the tax basis of assets and liabilities using enacted tax rates
in effect for the year in which the differences are expected to
reverse. 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.
F - 51
cDEMO INC.
(a Development Stage Company)
NOTES TO FINANCIAL STATEMENTS
AUGUST 31, 2000
NOTE 8 - INCOME TAXES (Continued):
The Company has available for income tax purposes a net operating
loss carry forward of approximately $1,300,000 which can be carried
forward over the next 7 years as per Canadian tax law. Since there
is no assurance that the Company will generate future taxable income
to utilize the deferred tax asset generated by the net operating
loss carry forward, the Company has taken a full valuation allowance
against the asset.
NOTE 9 - RELATED PARTY TRANSACTIONS:
(a) The Company has paid consulting fees to Al Chell, Bernie
Knaus, Richard Curtis, Stuart Dalgleish and Wade Schultz,
parties related by virtue of being shareholders or on the
management team in an amount aggregating $318,927.
(b) The Company has committed to paying $2,900 per month for rent
to Chell.com Ltd., a related party by virtue of being a common
shareholder and director.
(c) The Company has entered into an agreement with Chell.com Ltd.,
a party related by virtue of being a common shareholder and
director for provision of supplying certain strategic services
and advice. The contract called for a lump sum payment of
$1,065,600 (US$720,000). As at August 31, 2000, four months of
services have been performed therefore, $710,400 (US$480,000)
has been recorded as prepaid expenses and $355,200 ($240,000)
has been expensed. 60,000 warrants have also been issued
pursuant to this contract (Note 7).
(d) The Company issued US$3,000,000 in convertible debentures to
two related parties (Note 5).
(e) The Company entered into a noncompetition agreement at a cost
of $149,000 with a former officer of the Company (Note 6).
NOTE 10 - FINANCIAL INSTRUMENTS:
As disclosed in Note 3 (d), the Company holds various forms of
financial instruments. The nature of these instruments and the
Company's operations expose the Company to foreign currency risk and
industry credit risk. The Company manages its exposure to these
risks by operating in a manner that minimizes its exposure to the
extent practical.
(a) Foreign currency rate risk management
The Company manages its exposure to foreign currency
fluctuations by maintaining foreign currency bank accounts and
receivables to offset foreign currency payables and planned
expenditures. At August 31, 2000, approximately US$1.1 million
was being held at one institution.
(b) Credit risk
Substantially all of the Company's cash is being held at one
financial institution.
F - 52
cDEMO INC.
(a Development Stage Company)
NOTES TO FINANCIAL STATEMENTS
AUGUST 31, 2000
NOTE 11 - COMMITMENTS AND CONTINGENCIES:
(a) As per the convertible debt agreement, prior to May 31, 2001,
the Company is required to file a registration statement with
the SEC to register common stock to be issued by the Company
as well as 200% of the shares that would be issued upon debt
conversions and 100% of the shares to be issued upon exercise
of the lender and agent warrants. Any delay in obtaining such
registration will result in the Company paying the lender an
amount equal to 1% per month of the original advance. The
lender has the option of converting this penalty into common
shares at the same conversion price as the original principal
loan.
(b) The Company has entered into consulting agreements with
various individuals which require monthly payments of
approximately $46,000. These agreements can be terminated at
any time by either party without any additional liability.
F - 53
eSUPPLIES (ALBERTA) LTD.
FINANCIAL STATEMENTS
FOR THE PERIOD FROM OCTOBER 29, 1999 (INCEPTION) TO AUGUST 31, 2000
F - 54
eSUPPLIES (ALBERTA) LTD.
FOR THE PERIOD FROM OCTOBER 29, 1999 (INCEPTION) TO AUGUST 31, 2000
- INDEX -
Page(s)
-------
Independent Auditors' Report 1.
Financial Statements:
Balance Sheet - August 31, 2000 2.
Statement of Operations - For the Period from
October 29, 1999 (Inception) to August 31, 2000 3.
Statement of Shareholders' Equity (Deficiency) -
For the Period from October 29, 1999 (Inception) to August 31, 2000 4.
Statement of Cash Flows - For the Period from
October 29, 1999 (Inception) to August 31, 2000 5.
Notes to Financial Statements 6. - 14.
F - 55
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders
eSupplies (Alberta) Ltd.
Calgary, Alberta
We have audited the accompanying balance sheet of eSupplies (Alberta) Ltd. as of
August 31, 2000 and the related statements of operations, shareholders' equity
(deficiency) and cash flows for the period from October 29, 1999 (Inception) to
August 31, 2000. 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 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 audit provides a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of eSupplies (Alberta) Ltd. and
the results of its operations and cash flows for the period from October 29,
1999 (Inception) to August 31, 2000 in conformity with accounting principles
generally accepted in the United States of America.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 2 to the
financial statements, operations have generated losses from inception and, as of
August 31, 2000, the Company has an accumulated deficit and negative working
capital. Such matters raise substantial doubt about the Company's ability to
continue as a going concern. Management's plans concerning these matters are
also described in Note 2. The financial statements do not include any
adjustments that might result from the outcome of these uncertainties.
/s/ Lazar Levine & Felix LLP
-----------------------------------
LAZAR LEVINE & FELIX LLP
New York, New York
January 25, 2001
F - 56
eSUPPLIES (ALBERTA) LTD.
BALANCE SHEET
AS OF AUGUST 31, 2000
(Expressed in Canadian Dollars)
- ASSETS (Note 6) -
CURRENT ASSETS:
Cash and cash equivalents $ 782,672
Restricted cash (Note 10) 940,407
Accounts receivable - net of allowance for doubtful accounts of $309,544 565,528
Accounts receivable - affiliates (Note 8i) 58,668
Inventory 11,941
Prepaid expenses (Note 8b) 530,489
---------------
TOTAL CURRENT ASSETS 2,889,705
FIXED ASSETS - net of accumulated depreciation and amortization (Note 4) 784,882
OTHER ASSETS:
Deferred financing costs (Note 6) $ 415,773
Non-competition costs (Note 9) 120,961 536,734
---------------- ---------------
$ 4,211,321
---------------
- LIABILITIES AND SHAREHOLDERS' (DEFICIENCY) -
CURRENT LIABILITIES:
Accounts payable and accrued liabilities (Note 11) $ 659,709
Convertible debt (Note 6) 3,623,801
---------------
TOTAL CURRENT LIABILITIES 4,283,510
COMMITMENTS AND CONTINGENCIES (Notes 8, 10, 11, 12, 13 and 14)
SHAREHOLDERS' EQUITY (DEFICIENCY) (Note 7)
Class A voting common shares - unlimited number of shares
authorized, no par value; 3,550,000 shares issued and outstanding $ 4,879,222
Class B voting common shares, unlimited number of shares
authorized, no par value; no shares issued and outstanding --
Class C and D non-voting common shares, unlimited number of
shares authorized, no par value; no shares issued and outstanding --
Additional paid-in capital 675,580
Accumulated deficit (5,626,991) (72,189)
---------------- ---------------
$ 4,211,321
---------------
The accompanying notes are an integral part of these financial statements.
F - 57
eSUPPLIES (ALBERTA) LTD.
STATEMENT OF OPERATIONS
FOR THE PERIOD FROM OCTOBER 29, 1999 (INCEPTION) TO AUGUST 31, 2000
(Expressed in Canadian Dollars)
SALES $ 1,076,123
COST OF SALES 1,043,222
------------
GROSS PROFIT 32,901
EXPENSES:
Depreciation and amortization $ 287,402
Impairment charge (Note 4) 746,499
Website development costs 757,302
General and administrative costs 3,576,038
Financing costs 75,809
Interest expense 216,842 5,659,892
----------- ------------
NET LOSS $ (5,626,991)
------------
The accompanying notes are an integral part of these financial statements.
F - 58
eSUPPLIES (ALBERTA) LTD.
STATEMENT OF SHAREHOLDERS' EQUITY (DEFICIENCY)
FOR THE PERIOD FROM OCTOBER 29, 1999 (INCEPTION) TO AUGUST 31, 2000
(Expressed in Canadian Dollars)
Deficit
accumulated
Class A Class B, C and D Additional during the
Common Common paid-in development Total
Shares Amount Shares Amount capital stage (Deficit)
--------- ----------- ------ -------- --------- ------------ -----------
Subscription of common
shares
Cash:
Common stock issued
(Note 7a) 2,500,000 $ 1 -- $ -- $ -- $ -- $ 1
Issued upon conversion of
VCALP debt - net (Note 7b) 416,667 3,492,504 -- -- -- -- 3,492,504
Non-Cash:
Issued upon conversion of
Willsons debt (Note 7c) 633,333 1,386,717 -- -- -- -- 1,386,717
Value of warrants granted
(Note 7d) -- -- -- -- 675,580 -- 675,580
Net loss -- -- -- -- -- (5,626,991) (5,626,991)
--------- ----------- ------ -------- --------- ------------ -----------
Balance at August 31, 2000 3,550,000 $ 4,879,222 -- $ -- $ 675,580 $ (5,626,991) $ (72,189)
--------- ----------- ------ -------- --------- ------------ -----------
The accompanying notes are an integral part of these financial statements.
F - 59
eSUPPLIES (ALBERTA) LTD.
STATEMENT OF CASH FLOWS
FOR THE PERIOD FROM OCTOBER 29, 1999 (INCEPTION) TO AUGUST 31, 2000
(Expressed in Canadian Dollars)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (5,626,991)
Adjustments to reconcile net loss to net cash used in
operating activities:
Amortization and write-down of capital assets 1,049,058
Interest 157,634
Amortization of deferred finance cost and noncompetition costs 102,901
Changes in operating assets and liabilities:
Decrease in accounts receivable 255,867
Decrease in inventory 275,654
(Increase) in prepaid expenses (530,489)
Increase in accounts payable and accrued liabilities 659,709
------------
Net cash (used in) operating activities (3,656,657)
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of assets $ 369,966
Purchase of capital assets (1,733,940)
Noncompetition costs (148,110)
Restricted cash (940,407)
------------
Net cash (used in) investing activities (2,452,491)
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of convertible debenture 3,680,500
Deferred financing (378,130)
Issuance of common stock 3,589,450
------------
Net cash provided by financing activities 6,891,820
------------
NET INCREASE IN CASH 782,672
Cash and cash equivalents, at beginning of period --
------------
CASH AND CASH EQUIVALENTS, AT END OF PERIOD $ 782,672
============
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING
ACTIVITIES:
The Company purchased the assets of Willson Stationers Ltd. in the aggregate
amount of $1,637,624 and assumed debt in the aggregate amount of $5,455,660
The accompanying notes are an integral part of these financial statements.
F - 60
eSUPPLIES (ALBERTA) LTD.
NOTES TO FINANCIAL STATEMENTS
AUGUST 31, 2000
NOTE 1 - ORGANIZATION AND NATURE OF OPERATIONS:
eSupplies (Alberta) Ltd. (the "Company"), was incorporated under the
Canadian Alberta Business Corporations Act on October 29, 1999. The
Company filed to have its name changed from the original name of
851970 Alberta Ltd. to eSupplies (Alberta) Ltd. The Company is a
provider of business products and services.
Since the most significant portion of the Company's operations are
located in Canada and its normal transaction currency is Canadian
dollars, these financial statements are stated in Canadian dollars.
NOTE 2 - BASIS OF PRESENTATION - GOING CONCERN:
The accompanying financial statements have been prepared in
conformity with accounting principles generally accepted in the
United States of America, which contemplate continuation of the
Company as a going concern. However, the Company as of August 31,
2000 has negative working capital of $1,393,805, a deficit in
shareholder's equity of $72,189 and net loss for the period from
October 29, 1999 to August 31, 2000 of $5,626,991. Ultimate recovery
of the Company's assets is dependent on the Company, after an
expected period of initial losses, achieving and maintaining
profitability which is dependant on market conditions, successful
rollout of the Company's business plan and the ability to obtain
adequate financing to meet capital and operational requirements. It
is management's opinion that the Company will be able to obtain the
necessary financing to continue development activities over the next
fiscal year.
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
The Company's accounting policies are in accordance with accounting
principles generally accepted in the United States of America
(GAAP). Outlined below are those policies considered particularly
significant.
(a) Deferred financing
Deferred financing charges represent costs paid by the Company
relating to the convertible debenture financing. Financing fees and
expenses relating to the debt financing will be amortized over the
term of the related debt which is approximately one year. During the
period, $75,809 of these costs have been amortized.
(b) Revenue recognition
Revenue is generally recorded on shipment, with a provision for
estimated returns recorded at that time.
(c) Inventory
Inventory is recorded at the lower of actual cost (first-in,
first-out method) or market. Market is considered as net realizable
value.
(d) Fixed assets
Fixed assets are reflected at cost. Depreciation is provided on a
straight-line basis over the following useful lives:
F - 61
eSUPPLIES (ALBERTA) LTD.
NOTES TO FINANCIAL STATEMENTS
AUGUST 31, 2000
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued):
(d) Fixed assets and depreciation (Continued)
Computer hardware - 3 years
Software - 2 years
Furniture and equipment - 5 years
Vehicles - 5 years
Leasehold improvements are amortized over the life of the lease.
Maintenance and repairs are expensed as incurred while renewals and
betterments are capitalized.
(e) Foreign currency
Assets and liabilities transacted in a foreign currency are
translated at the period end exchange rate while revenues and
expenses are translated at average exchange rates for the period.
Any gains or losses resulting from the translation of these assets
and liabilities are recorded on the statement of operations.
(f) Financial instruments
The Company's assets and liabilities include various financial
instruments. Unless otherwise indicated, it is management's opinion
that the Company is not exposed to significant interest, currency or
credit risks arising from these financial instruments. The fair
market values of these financial instruments approximate their
carrying values, unless otherwise noted.
(g) Use of estimates
The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of
America requires management to make estimates and assumptions in
determining the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
financial statements and reported amounts of revenues and expenses
during the period. While actual results could differ from those
estimates, management does not expect such variance, if any, to have
a material effect on financial statements.
(h) Stock-based compensation plan
The Company applies Accounting Principles Board ("APB") Opinion 25,
"Accounting for Stock Issued to Employees," and related
Interpretations in accounting for its stock option plan. Under APB
Opinion 25, compensation cost would be recognized for stock options
granted to employees and directors for their services as directors
only if the option price is less than the market price of the
underlying common stock on the date of the grant.
SFAS No. 123, "Accounting for Stock-Based Compensation," requires
the Company to provide pro-forma information regarding net income as
if the compensation costs for the Company's stock option plan had
been determined in accordance with the fair value based method
prescribed in SFAS No. 123. To provide the required pro-forma
information, the Company estimates the fair value of each stock
option at the grant date by using the Black-Scholes option-pricing
model (see Note 7e).
F - 62
eSUPPLIES (ALBERTA) LTD.
NOTES TO FINANCIAL STATEMENTS
AUGUST 31, 2000
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued):
(i) Cash equivalents
For purposes of the statement of cash flows the Company considers
all highly liquid investments purchased with an original maturity of
three months or less to be cash equivalents.
(j) Advertising expenses
To date the Company has incurred no expenses for advertising and
promoting its services. Such costs will be expensed as incurred.
(k) Statement of Comprehensive Income
SFAS 130, "Reporting Comprehensive Income" is effective for years
beginning after December 15, 1997. This statement prescribes
standards for reporting other comprehensive income and its
components. Since the Company currently does not have material items
of other comprehensive income, a statement of comprehensive income
is not yet required.
(l) Valuation of long-lived assets
The Company periodically evaluates the carrying value of its
long-lived assets. The carrying value of the long-lived assets is
considered impaired when the undiscounted net cash flow from such
assets is estimated to be less than its carrying value. Management
has recorded an impairment adjustment of $746,499 in the initial
period ended August 31, 2000 (see Note 4).
(m) New accounting pronouncements
(i) In June 1998, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 133 ("SFAS No.
133"), Accounting for Derivative Instruments and Hedging
Activities. SFAS No. 133 requires companies to recognize all
derivative contracts as either assets or liabilities in the
balance sheet and to measure them at fair value. Based on its
current and planned future activities relative to derivative
instruments, the Company believes that the adoption of SFAS
No. 133 will not have a significant effect on its financial
statements.
(ii) On December 3, 1999, the United States Securities and Exchange
Commission (SEC) issued Staff Accounting Bulletin 101 ("SAB
101"), Revenue Recognition in Financial Statements. SAB 101
summarizes some of the SEC's interpretations of the
application of generally accepted accounting principles to
revenue recognition. Revenue recognition under SAB 101 was
initially effective for the Company's first quarter 2000
financial statements. However, SAB 101B, which was released
June 26, 2000, delayed adoption of SAB 101 until no later than
the fourth fiscal quarter of 2000. Changes resulting from SAB
101 require that a cumulative effect of such changes for 1999
and prior years be recorded as an adjustment to net income on
January 1, 2000.
F - 63
eSUPPLIES (ALBERTA) LTD.
NOTES TO FINANCIAL STATEMENTS
AUGUST 31, 2000
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued):
(m) New accounting pronouncements (ii) (Continued):
The Company believes that its revenue recognition practices
are in substantial compliance with SAB 101 and that adoption
of its provisions would not be material to its results of
operations.
NOTE 4 - FIXED ASSETS:
The major classes of fixed assets are as follows:
Computer hardware and software $ 824,195
Furniture and equipment 480,892
Vehicles 129,920
Leasehold improvements 398,933
------------
1,833,940
Less: accumulated depreciation and write downs 1,049,058
------------
$ 784,882
============
During the period ended August 31, 2000, certain computer hardware
and software and furniture and equipment were deemed to be impaired
and written down to their fair value. Fair value, which was
determined by references to the present value of the estimated
future cash in flows of such assets, exceeded their carrying value
by $746,499. An impairment loss of that amount (included in
expenses) has been charged to operations in the period ended August
31, 2000.
NOTE 5 - BUSINESS COMBINATION:
Effective February 7, 2000, the Company purchased the assets of
Willson Stationers Ltd. ("Willsons"), an office stationary business
in Western Canada. This acquisition has been accounted for using the
purchase method of accounting with results from operations being
included since the acquisition date. The acquisition has been
accounted for as a non-monetary transaction and as such, the fair
value of assets acquired has been used to determine the value of the
debt assumed. Net assets acquired were as follows:
Cash $ 369,966
Accounts receivable 880,063
Inventory 287,595
Fixed assets 100,000
-----------
Net book value of assets purchased $ 1,637,624
-----------
Purchase price paid via the assumption of debt (i) $ 1,637,624
-----------
(i) This debt was converted to common shares on May 23, 2000
(Note 7c)
The transaction was negotiated with the court appointed
receiver/manager of Willsons as Willsons was in receivership at the
time of this transaction. Certain shareholders of the Company were
shareholders of Willsons as well.
F - 64
eSUPPLIES (ALBERTA) LTD.
NOTES TO FINANCIAL STATEMENTS
AUGUST 31, 2000
NOTE 6 - CONVERTIBLE DEBT:
Effective May 24, 2000, (and after conversion of prior debt, see
Note 7b) the Company entered into a US$6 million, non-revolving term
loan agreement with VC Advantage Limited Partnership ("VCALP").
Under the terms of this agreement, VCALP would have a general
security interest over the assets of the Company for any advances.
All advances carry an 8% fee on the date of each draw down of funds
and a 10% per annum interest on gross amounts advanced. The
principal amount including interest must be repaid by June 18, 2001
(the "Maturity Date") unless such a date is mutually extended. On
May 26, 2000, a gross amount of $3,680,500 (US$2,500,000) was
advanced to the Company under this agreement.
Advances are convertible prior to the Maturity Date or as extended,
at VCALP's option, to Class A common shares at the lower of (1) US$7
for conversions up to and including May 24, 2002, US$8 for
conversions between and including May 25, 2002 and May 24, 2004 and
US$9 after May 24, 2004; or (2) maximum of (a) 80% of the weighted
average of the closing bid price on a stock exchange or quotation
system during a period of 10 consecutive trading days ending not
more than 3 trading days before written notice from VCALP of such
intentions; (b) US$2 per share.
As additional consideration, the Company agreed to grant warrants
convertible to a maximum of 255,000 Class A common shares based on a
conversion rate of 14.1667 shares for each US$1,000 advanced. Theses
warrants are exercisable at US$7 per share up to May 24, 2003. The
Company has a right to cause mandatory conversion of these warrants
after May 24, 2001 if the average share price of each common share
exceeds US$9 on any public exchange for 30 consecutive trading days.
As at August 31, 2000, US$2,500,000 has been advanced therefore,
106,500 warrants have been issued at a value of $170,093 (see Note
7d).
Provided that the advances are not repaid by the Maturity Date, the
Company will issue, on the first date of each month after the
Maturity Date, warrants to VCALP to purchase 2,500 Class A common
shares for each US$500,000 of indebtedness outstanding. These
warrants expire 3 years from the Maturity Date and are exercisable
at US$7 per share up to and including the second anniversary of the
Maturity Date and at US$8 per share after the second anniversary up
to the expiry date. The Company has a right to cause mandatory
conversion of these warrants after June 18, 2002 if the average
share price of each common share exceeds US$9 on any public exchange
for 30 consecutive trading days.
NOTE 7 - SHAREHOLDERS' EQUITY (DEFICIENCY):
(a) In November 1999, the Company issued 10,000,000 shares of
Class A common stock to its initial founders. In May 2000, the
Company authorized a 1 for 4 reverse stock split and
accordingly these became 2,500,000 shares outstanding.
(b) In February 2000, the Company issued convertible debt in the
net amount of $3,589,450 (US$2,500,000) to VCALP. On May 23,
2000, the Company and VCALP agreed to convert debt in the
amount of US$2,500,000 into Class A common shares at a
conversion rate of one share for each US$6 of debt. The value
attributed to the common shares issued was $3,492,504
(original loan of $3,589,450, net of accrued interest of
$106,686 and discount of $203,632).
F - 65
eSUPPLIES (ALBERTA) LTD.
NOTES TO FINANCIAL STATEMENTS
AUGUST 31, 2000
NOTE 7 - SHAREHOLDERS' EQUITY (DEFICIENCY) (Continued):
(c) As part of the acquisition of Willsons (see Note 5), the
Company assumed its debt owing to secured creditors. On May
23, 2000, the Company and the secured creditors agreed to
convert debt in the amount of $5,451,860 (US$3,800,000) into
Class A common shares at a conversion rate of one share for
each US$6 of debt. As a result 633,333 Class A common shares
were issued to satisfy that debt. As the underlying
acquisition transaction is a non-monetary transaction, the
value of the debt assumed was valued at the fair value of the
assets acquired. The value attributed to the common shares
issued was $1,386,717 (fair value of the assets of $1,637,624
(see Note 5), net of accrued interest of $50,948 and discount
of $301,855).
(d) During the period, the Company issued 316,500 and 106,500
warrants, valued at $505,487 and $170,093, respectively,
allowing the holders to purchase 1 common share for every
warrant at US$7 per share until May 23, 2003 and May 24, 2003,
respectively. The Company has a right to cause a mandatory
call on the 316,500 and 106,500 warrants on May 23, 2001 and
May 24, 2001, respectively, if the Company is listed on an
exchange and their average stock price exceeds US$9 per share
for 30 consecutive trading days.
Of these amounts, $56,699, which represents the value of the
warrants issued to the lender, was attributed to the
convertible debenture financing (discount) and has been netted
against the debentures in the financial statements. The
balance has been reflected as deferred financing costs and
will be amortized over the life of the debt.
The value attributable to these warrants was calculated based
on the Black-Scholes pricing model, with an expected
volatility of 0% and risk free rate of return of 6%. The
expected life of the warrants is the date of expiration. It is
expected that no dividends will be paid on any shares,
resulting from the exercise of warrants.
(e) In May 2000, the Company adopted a stock option plan, through
which options may be granted to directors, officers,
employees, consultants and affiliates for the purchase of
1,970,000 Class A common shares. As at August 31, 2000 there
were 380,000 stock options outstanding. These options are
exercisable at US$7 per share and expire in April 2010.
Pro-forma information has not been provided for these options
as these options have yet to vest. 1/3 of the options vest on
each of November 1, 2000, November 1, 2001 and November 1,
2002.
The Company has granted stock options to the officers and
employees of the Company as follows:
Weighted
Average
Number Option Price Exercise
of Shares per Share Price
---------- ------------ ---------
Options-granted 380,000 US$7 US$7
Options outstanding, 380,000 US$7 US$7
August 31, 2000
F - 66
eSUPPLIES (ALBERTA) LTD.
NOTES TO FINANCIAL STATEMENTS
AUGUST 31, 2000
NOTE 7 - SHAREHOLDERS' EQUITY (DEFICIENCY) (Continued):
The following table summarizes information about the stock
options outstanding at August 31, 2000:
Weighted Weighted Number of Weighted Average
Average Average Options Exercise Price of
Options Exercise Remaining Currently Options Currently
outstanding Option price Price Contractual Life Exercisable Exercisable
----------- ------------ ---------- ---------------- ----------- -----------------
380,000 US$7 US$7 10 -- --
NOTE 8 - RELATED PARTY TRANSACTIONS:
(a) The Company has issued 423,000 warrants to a parties related
by virtue of them being common shareholders of the Company
(see Note 7d).
(b) The Company has entered into an agreement with a party related
by virtue of them being common shareholders of the Company for
provision of supplying certain strategic services and advice.
The contract called for a lump sum payment of $1,034,856
(US$720,000). As at August 31, 2000, $455,829 remains in
prepaid expenses and $579,027 has been amortized and included
in general and administrative expense.
(c) The Company issued US$2,500,000 in convertible debt to a party
related by virtue of being a shareholder in the Company (see
Note 6).
(d) The Company paid $413,227 (US$279,000) to an affiliated
consultant for financing costs related to the convertible
debenture which will be deferred and amortized over the life
of the debenture.
(e) The Company entered into an agreement to lease premises from
Bankton Development Corp., a party related by virtue of being
a common shareholder, commencing on February 7, 2000 to
January 31, 2005. Under the terms of this agreement, the
Company is committed to paying basic rent and condo fees of
$96,000 and $30,636 per annum, respectively. For the period
ended August 31, 2000, $69,027 has been included in general
and administrative expenses.
(f) General and administrative expenses also includes $533,682 in
fees associated with computer services provided by Futurelink
Corp., a party related by virtue of being a common shareholder
of the Company.
(g) On March 15, 2000, the Company entered into an agreement with
a party related by virtue of being a shareholder and officer
of an entity which is a shareholder of the Company. Under the
terms of this agreement, the individual is not to carry on
business in competition with the Company for a period of 3
years. As consideration, the Company has paid US$100,000. For
the period ended August 31, 2000, $27,149 has been included in
general and administrative expenses (see Note 9).
(h) In the normal course of business, the Company had purchases
from parties related by virtue of being common shareholders
and directors in the amount of $110,526.
(i) Included in accounts receivable are amounts owed from parties
related by virtue of being common shareholders and officers of
$56,866.
F - 67
NOTE 9 - NONCOMPETITION AGREEMENT:
On August 22, 2000, the Company entered into a noncompetition
agreement with a former officer of the Company for a period of three
years. The cost of this arrangement of $148,110 (US$100,000) will be
amortized on a straight-line basis over the term of the agreement.
At August 31, 2000, $27,149 was amortized and charged to operations.
NOTE 10 - RESTRICTED CASH:
Restricted cash includes $382,772 that is held in trust for any
remaining liabilities that may arise from the convertible debt
financing raised during the period, $300,000 for costs relating to
the negotiation of a contract for development of their e-commerce
business, and cash to support a pledge to secure accounts payable
relating to the purchase of certain inventory, which at period end,
including interest earned, amounted to $257,635. Subsequent to the
period end, all restricted cash has been released and related
liabilities paid, except for the cash to support the pledge of
accounts payable (see Notes 11b and 12c).
NOTE 11 - ECONOMIC DEPENDENCY:
During the period ended August 31, 2000, purchases from one supplier
were in excess of 10% of the Company's total purchases and amounted
to approximately, $620,000. At August 31, 2000, accounts payable to
this supplier was $76,757.
NOTE 12 - COMMITMENTS AND CONTINGENCIES:
(a) The Company leases business premises under a five-year lease,
which expires on January 31, 2005, from a related party (see
Note 8e). The Company, in addition to the base rent under this
lease, is also responsible for condo fees. Rental expense for
the period ended August 31, 2000 was $51,816. Future minimum
rental payments under operating leases are as follows:
Twelve Months Ended August 31,
------------------------------
2001 $126,636
2002 126,636
2003 126,636
2004 126,636
2005 52,765
(b) During June 2000, the Company issued a letter of credit for
US$170,000 to secure accounts payables relating to the
purchase of inventory.
(c) In May 2000, the Company entered into an employment contract
with its Vice-President of marketing which requires an annual
salary of $190,000 and severance payment of nine months
salary. This employee was terminated as part of the
reorganization (see Note 14e).
F - 68
eSUPPLIES (ALBERTA) LTD.
NOTES TO FINANCIAL STATEMENTS
AUGUST 31, 2000
NOTE 13 - LITIGATION:
A vendor of the Company has filed a lawsuit against the Company for
outstanding amounts owing on software licenses and support services
in the amount of $133,250. Outside counsel for the Company is of the
opinion that it is too early to assess whether the supplier will
succeed in its claim against the Company. Also, another vendor has
filed a lawsuit against the Company for $15,000 with respect to
software supplied to the Company. Outside counsel for the Company
and management are of the opinion that an adverse outcome is
unlikely. The Company had previously recorded the full amount of
these liabilities as payables as of August 31, 2000.
NOTE 14 - SUBSEQUENT EVENTS:
(a) In September 2000, the Company's management decided to
re-focus the Company's business so as to realign itself and to
reduce costs. As a part of this reorganization, the Company is
currently in negotiations to dispose of certain assets to a
party related by virtue of having common shareholders and
directors. These assets will be sold at their approximate net
book value of $360,000. As a part of this plan, the Company
has reduced its workforce by about 30 employees, which
represented approximately 70% of the Company's employee base.
The Company incurred $200,000 in severance costs and
approximately $30,000 in moving and relocation expenses in
relation to this reorganization. As a result of the reduced
employee base, the Company has written off $100,000 of
leasehold improvements and capitalized software expenditures
in September 2000.
These costs have not been accrued on the Company's August 31,
2000 financial statements since the plan of reorganization was
not formerly approved by management at that date.
(b) During October 2000, the Company entered into an agreement
with a company related by virtue of them being common
shareholders of the Company. Under the terms of the agreement,
the Company has loaned US$450,000 to this company. The loan is
non-interest bearing, due on demand and is secured by various
assets of the Company.
(c) During October 2000, the letter of credit (see Note 12b) was
reduced from US$170,000 to US$70,000.
(d) In November 2000, the Company moved its offices to other
facilities where it would serve a dual purpose of being more
visible and more accessible to its main customer base. The
Company is presently in negotiations with its prior landlord
to be released from future rental commitments.
(e) In January 2001, the Company's management was changed to
better reflect the operational requirements of the Company.
This action resulted in the cash outlay of $150,000 and
payments of $30,000 per month through April 2001 and $15,000
per month through October 2001.
(f) In January 2001, the Company disposed of fixed assets no
longer required for operations. The net proceeds from the sale
of these assets were approximately $100,000.
F - 69
CHELL GROUP CORPORATION
(Formerly Networks North Inc.)
INTRODUCTION TO CONDENSED CONSOLIDATED PROFORMA FINANCIAL STATEMENTS
(Unaudited)
The following unaudited proforma financial statements have been prepared based
upon certain proforma adjustments to the historical financial statements of
Chell Group Corporation (the Company). These proforma statements should be read
in conjunction with the notes thereto and with the Company's historical
financial statements included with its annual report on Form 10-K.
The accompanying financial statements have been prepared as if the transactions
below had been consummated as of the beginning of the earliest period presented
(September 1, 1999). Unless stated differently, all amounts are reflected in
Canadian dollars.
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, effective August 31, 2000, certain shares and net assets from Cameron
Chell and Chell.com Ltd. ("Chell.com") a Company owned 100% by Cameron Chell.
Pursuant to the Agreement, the Company acquired (a) 480,000 common shares of
cDemo, Inc. (23%); (b) 875,000 common shares of Engyro, Inc. (34%); (c) 150,000
common shares of C Me Run Corp. (1%) and (d) 60,000 common shares of Chell.com
USA (100%). In addition, Chell Merchant Capital Group acquired 962,500 common
shares of eSupplies (Alberta) Ltd. (27%) as well as certain net assets from
Chell.com.
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.
In consideration for this acquisition, the Company issued 5,396,733 shares of
its common stock and Chell Merchant Capital Group issued 1,928,267 special
convertible shares to Cameron Chell, Chell.com and others. Each share issued by
Chell Merchant Capital Group is convertible into one share of common stock of
the Company. Pursuant to a Voting and Exchange Trust Agreement entered into with
a trustee, whereby voting privileges have been granted, such shares issued by
Chell Merchant Capital Group can be voted by the trustee immediately. The amount
of shares issued was determined based upon an appraisal valuation of the
investments and assets acquired which aggregated US $28,652,086.
The shares of the Company that were issued in exchange for the shares of cMeRun
Corp. (421,829) and eSupplies (Alberta) Inc. (1,476,398) had been placed in
escrow and the investments in such companies were not to be recorded until such
time as certain contingent conditions were met. Subsequently, these acquisitions
were terminated and the shares in escrow are to be returned to the Company.
As a result of the above, Cameron Chell and Chell.com now own in excess of 70%
of the Company's outstanding common stock, that is, the Company has in effect
been acquired in a reverse acquisition.
This acquisition and the acquisition (except for the 100% acquisition of
Chell.com USA) by the Company of the minority equity interests, as described in
the first paragraph, are reflected at historical cost in the Company's separate
financial statements.
The Company will reflect the minority equity investments using the equity method
of accounting.
The purchase price of the investments and net assets acquired from the Chell
shareholders has been reflected at historical cost as follows:
Investment in unconsolidated subsidiaries $ 920
Fixed assets 2,079,339
Other net assets 521,541
---------------
$ 2,601,800
===============
F - 70
CHELL GROUP CORPORATION
(Formerly Networks North Inc.)
CONDENSED CONSOLIDATED PROFORMA BALANCE SHEET
AS OF AUGUST 31, 2000
(Unaudited)
(EXPRESSED IN CANADIAN DOLLARS)
Historical Transactions and adjustments Proforma
------------ ---------------- --------------- ----------------
Debit Credit
---------------- ---------------
$ $ $ $
- ASSETS -
CURRENT:
Cash and cash equivalents 1,355,613 1,355,613
Short-term investments 269,727 269,727
Accounts receivable, trade -net 3,154,134 3,154,134
Inventory 206,216 206,216
Prepaids and other current assets 996,943 100,000 (a) 1,096,943
----------- --------- ----------
TOTAL CURRENT ASSETS 5,982,633 100,000 6,082,633
----------- --------- ----------
Investments in affiliated companies 31 (b) 920
875 (c)
-- 14 (d)
Property and equipment, net 7,721,769 2,079,339 (a) 9,801,108
Goodwill, net of accumulated amortization 2,863,146 2,863,146
Other assets, net of amortization 813,047 312,278 (a) 1,125,325
----------- --------- ----------
11,397,962 2,392,537 13,790,499
----------- --------- ----------
17,380,595 2,492,537 19,873,132
----------- --------- ----------
- LIABILITIES AND SHAREHOLDERS' EQUITY -
CURRENT:
Account payable - trade 1,375,414 1,375,414
Accrued liabilities 1,654,917 1,654,917
Other current liabilities 530,632 109,263 (a) 421,369
----------- --------- ----------
TOTAL CURRENT LIABILITIES 3,560,963 109,263 3,451,700
----------- --------- ----------
Long-term debt 4,377,040 4,377,040
Deferred income taxes payable 59,173 59,173
----------- ----------
TOTAL LIABILITIES 7,997,176 109,263 7,887,913
----------- --------- ----------
SHAREHOLDERS EQUITY:
Preferred shares 10,917 10,917
Common sShares 183,235 2,600,880 (a) 2,785,035
31 (b)
875 (c)
14 (d)
Capital in excess of par value 10,124,777 10,124,777
Deficit (935,510) (935,510)
----------- --------- ---------- ----------
TOTAL SHAREHOLDERS' EQUITY 9,383,419 2,601,800 11,985,219
----------- --------- ---------- ----------
17,380,595 109,263 2,601,800 19,873,132
----------- --------- ---------- ----------
F - 71
CHELL GROUP CORPORATION
(Formerly Networks North Inc.)
CONDENSED CONSOLIDATED PROFORMA STATEMENT OF OPERATIONS
FOR THE YEAR ENDED AUGUST 31, 2000
(Unaudited)
(EXPRESSED IN CANADIAN DOLLARS)
Historical Transactions and adjustments Proforma
---------- ---------------------------- --------
Debit Credit
----------- --------
$ $ $ $
REVENUES 19,694,046 19,694,046
------------ -----------
COSTS AND EXPENSES:
Costs of sales 7,657,960 7,657,960
Selling, general and administrative 11,266,339 11,266,339
Bad debts 140,090 140,090
Interest and bank charges 297,654 297,654
Depreciation and amortization 2,347,321 481,800 (h) 2,829,121
Loss from equity investments -- 31 (e) 920
875 (f)
14 (g)
------------ -----------
21,709,364 22,192,084
------------ -----------
LOSS BEFORE PROVISION FOR INCOME TAXES (2,015,318) (2,498,038)
Provision for income taxes -- --
------------ -----------
LOSS BEFORE MINORITY INTEREST (2,015,318) (2,498,038)
Minority interest in net loss of subsidiary 29,476 29,476
------------ -----------
NET LOSS (1,985,842) (2,468,562)
------------ -----------
LOSS PER COMMON SHARE $ (.69) $ (.25)
------------ -----------
WEIGHTED AVERAGE SHARES OUTSTANDING 2,873,042 9,776,213
============ ===========
F - 72
CHELL GROUP CORPORATION
(Formerly Networks North Inc.)
NOTES TO CONDENSED CONSOLIDATED PROFORMA FINANCIAL STATEMENTS
(Unaudited)
a) The Company has recorded the purchase price of the investment in the net
assets acquired from Chell.com.
b) The Company has recorded the purchase price of the investment in the stock
of Cdemo, Inc.
c) The Company has recorded the purchase price of the investment in the stock
of Engyro Inc.
d) The Company has recorded the purchase price of the investment in the stock
of Chell.com (USA).
e) Reflects the Company's share of the losses (not to exceed the carrying
amounts of its investment) of Cdemo, Inc. using the equity method of
accounting.
f) Reflects the Company's share of the losses (not to exceed the carrying
amounts of its investment) of Engyro, Inc. using the equity method of
accounting.
g) Reflects the Company's share of the losses (not to exceed the carrying
amounts of its investment) of Chell.com (USA) using the equity method of
accounting.
The Company's equity in losses of above entities is limited to the amount
of its investment aggregating $920. If the entities subsequently report
net income, the Company will record its equity in those earnings only
after its share of that net income equals the share of net losses not
recognized.
h) The Company has recorded depreciation expense on the assets acquired from
Chell.com. Fixed assets acquired include computer and other equipment and
leasehold improvements which are being depreciated on a straight line
basis over 3-7 years.
F - 73