SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
AMENDMENT NUMBER 4 TO
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.
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 6,200,385 $ 1.15(2) $7,130,442.75 $656.00
$0.0467 (1)
Common
Stock, par value 200,000 $ 4.375 $ 875,000 $ 80.50
$0.0467 (3)
Common 1,000,000 $ 1.15(2) $ 1,150,000 $105.80
Stock, par value
$0.467 (4)
Total
Total 7,400,385 Registration $842.30
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 average of the high and low sale price as
reported by Nasdaq for our common stock on June 6, 2002.
(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.
ii
SUBJECT TO COMPLETION, DATED JUNE__, 2002
PROSPECTUS
7,400,385 Shares Common Stock
Chell Group Corporation
This Prospectus relates to 7,400,385 shares of our common stock, of which
6,400,385 shares are being offered by certain selling shareholders and 1,000,000
shares are being offered by us. We will not receive any of the proceeds from the
sale of common stock by the selling shareholders.
Our stock is traded in the over-the-counter market and is quoted on the
NASDAQ Small-Cap Market under the symbol CHEL. On June 6, 2002, the average of
the high and low sale price of the common stock as reported by NASDAQ was $1.32.
6,400,385 shares may be offered from time to time by the selling
shareholders 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. Up to 1,000,000 shares
are being sold by us through our officers and directors, on a self-underwritten,
best efforts basis, with no minimum number of shares being required to be sold
to accept the shares sold for a closing. It is possible that no shares will be
sold by us and accordingly, we may raise no proceeds pursuant to this offering.
Our offering will commence on the date of this prospectus and will continue
until the earlier of March 31, 2003, all of the shares offered are sold or we
otherwise terminate the 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 prospesctus. Any representation to
the contrary is a criminal offense.
The date of this Prospectus is _____, 2002
iii
TABLE OF CONTENTS
Prospectus Summary ........................................................ 1
Risk Factors .............................................................. 6
Special Note Concerning Forward Looking Statements ........................ 15
Use of Proceeds ........................................................... 15
Selling Shareholder ....................................................... 15
Plan of Distribution ...................................................... 17
Description of Securities to be Registered ................................ 19
Legal Matters ............................................................. 21
Experts ................................................................... 21
Description of Business ................................................... 22
Management's Discussion and Analysis of Financial Condition
and Results of Operations ................................................. 44
Certain Relationships and Related Transactions ............................ 66
iv
Prospectus summary
The following summary is qualified in its entirety by reference to the
more detailed information and financial statements, including the notes thereto,
appearing elsewhere in this Prospectus or incorporated by reference herein. This
Prospectus contains certain forward looking statements concerning our
operations, economic performance and financial condition. Such statements are
subject to a number of risks and uncertainties. Our actual results could differ
materially from those currently anticipated due to a number of factors including
those identified under "Risk Factors" and elsewhere in this Prospectus.
Our business
We are engaged in the business of providing interactive entertainment
services, electronic/on-line products and services, systems integration
services, corporate services and merchant capital services. Our corporate and
merchant capital businesses involve 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. The 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. Our
newly acquired systems integration business provides server based computing,
network design and delivery, network administration and support, procurement
services, hardware support services, and storage area network services. Our
revenue is primarily generated through our systems integration business through
our subsidiary, Logicorp Data Systems Ltd., and our interactive entertainment
services operations within two of our operating subsidiaries, being NTN
Interactive Network Inc. and GalaVu Entertainment Network Inc., as well as a NTN
Interactive Network subsidiary.
Abbreviated references to dollar amounts contained in this Registration
Statement, are denoted as "Cdn$" or "US$". "Cdn$" refers to Canadian dollars.
"US$" refers to United States dollars.
During the two most recent fiscal years, those ending August 31, 2000 and
August 31, 2001, we sustained operating losses in the respective approximate
amounts of Cdn$2,000,000 and Cdn$11,000,000. For the six-month period ending
February 28, 2002, we sustained a loss from continuing operations in the amount
of Cdn$2,865,603. We anticipate that we will incur additional operating losses
in the immediate future as well. As a result, we expect to continue to incur
operating losses and may not have enough money to satisfy our existing
obligations and expand our business operations in the future.
1
We currently conduct our business through nine directly or indirectly
wholly-owned subsidiaries and two partially owned subsidiaries. The following is
a list of such subsidiaries, and which of our business segments each operates
in:
Wholly-owned subsidiaries Business Segment
- ------------------------- ----------------
o Chell Merchant Capital Group - Merchant Services
o Chell.com USA Inc. - Merchant Services
o NTN Interactive Network Inc. - Entertainment
o GalaVu Entertainment Network Inc. - Entertainment
o 348751 Canada Inc. - Corporate
o Logicorp Data Systems Ltd. - Systems Integration
o Logicorp Service Group - Corporate
o 123557 ALBERTA LTD. - Corporate
o 591360 ALBERTA LTD. - Corporate
Partially Owned Subsidiaries
- ----------------------------
o Engyro, Inc. (approx. 8%) - Merchant Services
o cDemo Inc. (14.3%) - Merchant Services
According to our most recent quarter-end financial reports, our revenues
by industry segment, with their percentage of our total revenue, are set forth
in the table below:
6-month period ended
February 28, 2002
Cdn$ amount and percentage
REVENUE
Entertainment 6,023,574 38.5 (%)
Systems Integration 9,620,372 61.51(%)
Corporate (3,057) --
Merchant Services -- --
- --------------------------------------------------------------------------------
Cdn$15,640,889
No minimum amount of securities must be sold pursuant to this offering and
accordingly, no minimum amount of proceeds will be raised. Therefore, investors
may ultimately hold securities in a company that has failed to raise sufficient
capital to continue operations and/or may have an illiquid market for its
shares.
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.
The consolidated financial statements of Chell Group Corporation for the
fiscal years ending August 31, 2001 and 2000 appearing in this Prospectus and
Registration Statement have been audited by Lazar, Levine & Felix, LLP.
3
The offering
Securities Offered 7,400,385 shares of common stock. This amount
includes 1,000,000 shares offered by us
through our directors and officers, which in
the aggregate constitutes 31.3% of our total
issued and outstanding shares after
completion of this offering.
Common Stock Outstanding
Before the Offering
(As of May 28, 2002) 22,477,698 shares, assuming the approval at
the annual stockholders' meeting scheduled
for June 28, 2002 of the issuance of shares
of our common stock pursuant to the Logicorp
transaction, the issuance of shares of our
common stock pursuant to the conversion of
the 8% convertible promissory notes and the
issuance of shares of our common stock
pursuant to the conversion of two promissory
notes issued by us.
Common Stock Outstanding
After Maximum Offering 23,477,698 Shares
Use of Proceeds We will not receive any proceeds from sales
of our common stock by the selling
shareholders. We will divide the net proceeds
of our offering of 1,000,000 shares of our
common stock between utilizing approximately
one-half for repaying portions of certain of
our loans and utilizing approximately
one-half 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
making an investment in us.
NASDAQ Symbol CHEL
4
Statement of Operations Data (expressed in Canadian Dollars):
- ------------------------------------------------------------------------------------------------------------
Year Ended August 31,
2001 2000 1999 1998* 1997*
Cdn$ Cdn$ Cdn$ Cdn$ Cdn$
============================================================================================================
Operating revenues 18,222,374 19,107,290 12,823,691 13,404,542 10,351,689
Cost of sales 6,818,111 7,204,919 4,874,768 5,030,602 3,395,898
Gross profit 11,404,263 11,902,371 7,948,923 8,373,940 6,955,791
Income (loss) from continuing
operations (9,622,841) (1,466,205) (744,240) 358,492 609,387
Income (loss) from continuing
operations per share (1.15) (.51) (.28) .14 0.25
Weighted average number of
Shares outstanding 8,393,589 2,873,042 2,635,050 2,550,805 2,441,992
============================================================================================================
* The 1998 and 1997 comparative consolidated financial statements have been
reclassified from statements previously presented to conform to the
presentation of the 2001 consolidated financial statements.
Six-month period ending Six-month period ending
February 28, 2002 February 28, 2001
- ----------------------------------------------------------------------------------------
Operating Revenue Cdn$15,640,889 Cdn$6,915,927
- ----------------------------------------------------------------------------------------
Cost of Sales 11,312,447 2,599,049
- ----------------------------------------------------------------------------------------
Gross Profit 4,328,442 4,316,878
- ----------------------------------------------------------------------------------------
Income (loss) from continuing
operations (2,865,603) (6,193,521)
- ----------------------------------------------------------------------------------------
Income (loss) from continuing
operations per share (.26) (.74)
- ----------------------------------------------------------------------------------------
Weighted average number of shares
outstanding 10,976,487 8,356,045
- ----------------------------------------------------------------------------------------
As at August 31:
2001 2000 1999 1998 1997
- --------------------------------------------------------------------------------------
Total assets 16,225,003 17,220,211 14,546,003 15,802,359 14,287,602
- --------------------------------------------------------------------------------------
Long-term obligations 5,943,512 4,436,213 2,216,675 2,840,218 2,185,249
- --------------------------------------------------------------------------------------
Shareholders' equity 2,248,128 9,383,419 10,792,767 11,033,178 9,488,648
- --------------------------------------------------------------------------------------
As at February 28, 2002
- ----------------------------------------------------------
Total assets 38,870,764
- ----------------------------------------------------------
Long-term obligations 28,813,124
- ----------------------------------------------------------
Shareholders' equity 10,057,640
- ----------------------------------------------------------
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, 2000 and August 31, 2001, we
sustained an operating loss in the respective approximate amounts of
Cdn$2,000,000 and Cdn$11,000,000. For the six-month period ending February 28,
2002, we sustained a loss from continuing operations in the amount of
Cdn$2,865,603. We anticipate continuing to incur additional 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 continue our current business operations or 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 can be no assurance that we will be able to raise the
funds needed for our business. Failure to raise the necessary funds at terms
acceptable to management or raise them in a timely fashion may seriously inhibit
our growth.
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 of US$3,656,000 for the year ended December 31, 2001 and a net loss of
US$166,000 for the three months ended March 31, 2002.
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.
6
The resignation of independent auditors creates a perceived damage to our image
and reputation.
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 any representations made by Cameron Chell.
Although E&Y's resignation creates 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.
In addition, Lazar, Levine & Felix acted as our auditors for the fiscal year
ended August 31, 2001. We have authorized E&Y to fully respond to any and all
inquiries of Lazar, Levine & Felix, LLP concerning E&Y's resignation.
7
We rely upon satellite communications systems which are controlled by third
parties.
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.
With a lack of operating history, the business and development plans of cDemo
and Engyro may prove to be unsuccessful.
One of our partially owned subsidiaries, cDemo, has not yet commenced
operations and the other, Engyro, began its operations in the third quarter of
its last fiscal year and recently began to generate revenues. Both of these
partially owned subsidiaries either have or 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
cDemo has 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-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
8
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.
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 systems integration 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
9
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 have managerial control over Engyro and
cDemo.
As a result of our minority position in each of Engyro, a Delaware
corporation and cDemo, a Delaware corporation, we do not have the right to
control the management and business activities of Engyro or cDemo. As of
September 19, 2000, pursuant to an Agreement of Purchase and Sale, we acquired
22.1% of Engyro's shares (reduced to approximately 8% by subsequent financing)
and 14.3% of cDemo's shares. While cDemo has not commenced operations, Engyro
began its operations in the third quarter of its current fiscal year and
recently began to generate revenues. We may lose some or all of our investment
in these companies.
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 Cdn$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 affect 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 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 principal shareholder has effective control over our business matters.
Cameron Chell, the President and Chief Executive Officer, beneficially
owns approximately 15.3 % of our outstanding Common Shares. As a result, Mr.
Chell possesses significant influence over us on matters, including the election
of directors. Mr. Chell has agreed to vote in favor of all of the proposals
which will be brought before the shareholders at our annual meeting, scheduled
for June 28, 2002. The concentration of our share ownership may:
o delay or prevent a change in our control;
10
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.
Not all of our Officers and Directors nor those of Engyro and cDemo 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 and cDemo 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 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.
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 are
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. Our outside
directors are involved in other business enterprises which require their time
and attention. Accordingly, they will be engaging in other businesses similar or
dissimilar to ours and allocating their time and services between us and any
such other entities. The conflicts of interest will be dealt with in the manner
required by the laws applicable to us.
11
Risks Related to our Industry
We are subject to intense competition in our existing and intended business
areas and those of Engyro and cDemo.
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 our subsidiaries, Engyro and
cDemo, thereby gaining a competitive edge. We 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 systems integration
services, 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
12
delays, expenses, technical problems or difficulties, as well as the possible
insufficiency of funds 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.
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.
The shares in this offering represent a high percentage of what will be our
total issued and outstanding shares after this offering.
The shares to be registered in this offering (7,400,385) represent
approximately 31.3% of our total issued and outstanding shares after this
offering.
93% 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 Securities and Exchange Commission pursuant to ss.4(1) of the
Securities Act of 1933. Such percentage includes 12,307,418 shares of our common
stock which are being registered in a form S-3 Registration Statement which has
been filed with the SEC and has not been declared effective. If the investors
who
13
purchase shares pursuant to this offering sell such shares in the near future,
in view of the past limited trading market, share value may drop substantially.
This offering is not being conducted by an underwriter and we may not sell any
or all of the shares which we are offering.
The shares of our common stock that are being sold pursuant to this
offering are not subject to any agreements with an underwriter for the sale of
any of the common stock being offered by us. No minimum number of shares is
required to be sold, and there can be no assurance that any minimum number of
shares will be sold in this offering. If all shares of common stock that are
being sold by us in this offering are not sold, then the proceeds available to
us will be reduced, and our expansion efforts will be more limited.
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. Reports,
registration statements, proxy statements and other information filed by us with
the Securities and Exchange Commission can be inspected and copied at the public
reference facilities maintained by the the Securities and Exchange Commission at
Room 1024, 450 Fifth Street, NW, Washington, D.C. 20549, and at the the
Securities and Exchange Commission's Regional Offices located at Citicorp
Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661 and 233
Broadway, New York, NY 10279. Copies of such material can be obtained from the
Securities and Exchange Commission's Public Reference Section, 450 Fifth Street,
NW, Washington, D.C. 20549, at prescribed rates. The the Securities and Exchange
Commission maintains a World Wide Web site that contains reports, proxy and
information statements and other information regarding registrants that file
electronically with the the Securities and Exchange Commission. The address of
the World Wide Web site is http://www.sec.gov.
We have filed with the the Securities and Exchange Commission 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 Securities and Exchange Commission'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 the Securities
and Exchange Commission's public reference facilities at the addresses set forth
above or through the the Securities and Exchange Commission's World Wide Web
site.
Statements contained in this Prospectus 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
14
Statement which prospective investors should review. Investors may rely upon the
statements and representations contained in this prospectus.
Special note concerning forward-looking statements
Prospective investors should carefully consider the aforementioned 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 aforementioned
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 6,400,385 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
US$950,000 (based upon an assumed public offering price of US$1.15 per share)
after deducting offering expenses of US$200,000. We will divide the net proceeds
of our offering of shares of our common stock between utilizing approximately
one-half for repaying portions of certain of our loans and approximately
one-half 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 7,400,385 shares may be sold pursuant to this
Prospectus of which 6,400,385 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 6,400,385 shares of common stock by the selling shareholders.
15
The following table sets forth certain information with respect to the
selling shareholders:
- --------------------------------------------------------------------------------------------------------
Selling Shares Percentage Shares Shares Owned Percentage of
Shareholder Owned of Registered After Shares after
Prior to Shares Offering(2) Offering
Offering Prior to
Offering(1)
- --------------------------------------------------------------------------------------------------------
Chell.com Ltd. (3)(7)(8) 3,147,271 14.9% 3,147,271 0 0%
- --------------------------------------------------------------------------------------------------------
Michael Rice (4) 1,700,000 7.6% 1,700,000 0 0%
- --------------------------------------------------------------------------------------------------------
Peter Rona (5) 386,500 1.7% 107,143 279,357 1.2%
- --------------------------------------------------------------------------------------------------------
iCapital 22,500 0% 22,500 0 0%
Corporation (9)
- --------------------------------------------------------------------------------------------------------
Naveen Chanana 22,500 0% 22,500 0 0%
- --------------------------------------------------------------------------------------------------------
Bruce Elliot 21,974 0% 21,974 0 0%
- --------------------------------------------------------------------------------------------------------
WYWITB PTY (10) 112,750 0% 112,750 0 0%
Limited
- --------------------------------------------------------------------------------------------------------
HDL Capital 100,000 0% 100,000 0 0%
Corporation (6)(12)
- --------------------------------------------------------------------------------------------------------
Canadian Advantage
Limited Partnership (11) 2,086,009 9.3% 451,868 1,634,141 7.0%
- --------------------------------------------------------------------------------------------------------
Vanguard Market 100,000 0% 100,000 0 0%
Management (7)(13)
- --------------------------------------------------------------------------------------------------------
Kevin Daly 277,777 2.3% 277,777 0 0%
- --------------------------------------------------------------------------------------------------------
Neil Anderson (14) 200,000 0% 200,000 0 0%
- --------------------------------------------------------------------------------------------------------
Canadian Imperial
Bank of Commerce 637,546 2.8% 136,602 500,944 2.1%
- --------------------------------------------------------------------------------------------------------
Total 8,814,827 6,400,385 2,414,442
- --------------------------------------------------------------------------------------------------------
16
(1) Less than 1%, shown as 0%.
(2) Assumes all of the shares offered hereby are sold by the selling
shareholders.
(3) 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 Cdn$1.00 from each
recipient.
(4) Michael Rice is a director on our board of directors. He acquired such
shares from Chell.com Ltd.
(5) 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 been vested.
(6) Includes shares issuable upon the exercise of Warrants held by the Selling
Stockholder.
(7) Includes shares issuable upon the exercise of Warrants held by the Selling
Stockholder.
(8) Chell.com Ltd. is 100% owned by Cameron Chell.
(9) 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.
(10) WYWITB is controlled by Craig Hawkins, a resident of Australia. Neither
WYWITB nor its principal/director is in any way related to us.
(11) Excludes options to purchase 33,500 shares of our common stock. Includes
442,145 shares of our common stock to be issued upon shareholder approval
scheduled for June 28, 2002.
(12) HDL Capital Corporation is controlled by its principal, Bernard Grybowski.
Neither HDL nor its principal/director is in any way related to us.
(13) Vanguard Market Management, Inc. is controlled by its principal, Jeffrey
Kirsch. Neither Vanguard nor its principal/director is in any way related
to us.
(14) Mr. Anderson acquired such shares from Chell.com.
Plan of distribution
A total of up to 6,400,385 shares may be sold pursuant to this prospectus.
This includes 1,000,000 shares of our common stock which as of the date 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' commissions will be paid as may be
17
negotiated in accordance with applicable laws and regulations. The remaining
6,500,385 shares may be sold pursuant to this prospectus by the stockholders
listed above. We will not receive any of the proceeds from the sale of our
common stock by the selling shareholders.
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-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 in accordance with applicable laws and regulations. Such brokers and
dealers and any other participating brokers or dealers may be deemed to be
"underwriters" within 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, 2001, 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,
- -------------------------------------------------------------------------------------------
2001 2000 1999 1998 1997
- -------------------------------------------------------------------------------------------
At end of period Cdn$1.5478 Cdn$1.4715 Cdn$1.4965 Cdn$1.5722 Cdn$1.3885
- -------------------------------------------------------------------------------------------
Average for period 1.5298 1.4714 1.4949 1.4390 1.3676
- -------------------------------------------------------------------------------------------
High for period 1.5784 1.4955 1.5135 1.5770 1.3942
- -------------------------------------------------------------------------------------------
Low for Period 1.4995 1.4489 1.4760 1.4100 1.3381
- -------------------------------------------------------------------------------------------
The Noon Buying Rate as of June 3, 2002 was 1.5282.
18
Description of Securities to be Registered
We are authorized to issue 50,000,000 Common Shares of which 22,477,698
Common Shares were outstanding as at the date hereof (assuming the approval at
the annual stockholders' meeting scheduled for June 28, 2002 of the issuance of
shares of our common stock pursuant to the Logicorp transaction, the issuance of
shares of our common stock pursuant to the conversion of the 8% convertible
promissory notes and the issuance of shares of our common stock pursuant to the
conversion of two promissory notes issued by us). We have proposed to increase
the number of authorized of our common stock to 75,000,000, which is subject to
shareholder approval at the annual shareholders' meeting.
As at the date hereof, we had also issued warrants which enable holders
thereof to acquire up to 555,571 Common Shares and had also issued stock options
which entitle holders thereof to acquire up to 1,324,625 Common Shares.
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
bore interest at 10% per annum, payable upon conversion, redemption or maturity.
The unpaid principal of the debenture bore interest from the date that it was
actually advanced until paid. Interest was payable in cash or stock at our
option. The convertible debenture was 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. On September 1, 2001, we exchanged the convertible debenture in
the face amount of U.S.$3,000,000, of which an aggregate principal amount of
U.S.$1,700,000 was outstanding, which, with interest at 10%, resulted in a total
amount outstanding of US$1,870,000, which was held by Canadian Advantage Limited
Partnership II on behalf of Canadian Advantage Limited Partnership and Advantage
(Bermuda) Fund Ltd. for Promissory Notes in the aggregate amount of
U.S.$1,870,000, secured by a General Security Agreement against our assets, in
priority to all other claims, subject to the existing security of the Bank of
Montreal in connection with loans in the total amount of CDN$1,250,000. On
December 11, 2001, Canadian Advantage Limited Partnership II and Advantage
(Bermuda) Fund Ltd. offered to convert their promissory notes to equity at
US$0.80 per share. The original note dated Sept 1, 2001 between us and Advantage
(Bermuda) Fund Ltd. in the amount of US$504,900 was converted into 649,533
shares of our common stock. The original note dated Sept 1, 2001 between us and
Canadian Advantage Limited Partnership in the amount of US$1,365,100 was
converted into 1,756,145 shares of our common stock.
We also issued 50,000 warrants to VC Advantage Limited Partnership. Each
Warrant
19
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
We are authorized to issue up to one million five hundred thousand
(1,500,000) shares of Preferred Stock. Shares of Preferred Stock may be issued
in one or more series as determined by the Board of Directors. The Board will
determine by resolution the powers, designations, preferences and relative
participating, optional or other rights, if any, and the qualifications,
limitations or restrictions of any series of Preferred Stock, including, the
number of shares, dividend rights, redemption rights, liquidation preferences,
voting rights and conversion rights.
Pursuant to a Securities Exchange Agreement dated February 6, 2002 by and
between us and Triton Private Equities Fund, L.P. we issued 64,935 shares of our
Series B Convertible Preferred Stock, par value $.01 per share to Triton Private
Equities in exchange for 64,935 shares of Series "A" 6% Convertible Preferred
Stock of Wareforce.com, Inc. Pursuant to a Securities Exchange Agreement dated
February 6, 2002 by and between us and Shaar Fund Ltd. we issued 389,610 shares
of our Series B Convertible Preferred Stock, par value $.01 per share to Shaar
Fund Ltd. in exchange for 389,610 shares of Series "A" 6% Convertible Preferred
Stock of Wareforce.com, Inc.
Shares eligible for future sale
The 7,500,385 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
20
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 years ending August 31, 2001 and 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 2001 and 2000 and for the years 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 three-month and six month periods ending February 28, 2002
have been reviewed by Lazar, Levine & Felix, LLP, and the information under the
caption "Selected Financial Data" at February 28, 2002 and for the three-month
and six-month periods then ended appearing in this Prospectus and Registration
Statement have been derived from consolidated financial statements 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 fiscal year then ended appearing in this Prospectus and
Registration Statement have been audited by Ernst & Young LLP, independent
auditors, as set forth in their report thereon appearing elsewhere herein and
are included in reliance upon such report given on the authority of such firm as
experts in accounting and auditing.
21
OUR BUSINESS
We are engaged in the business of providing interactive entertainment
services, electronic/on-line products and services, systems integration
services, corporate services and merchant capital services. Our core businesses
are interactive entertainment services provided by our NTN Interactive Network
subsidiary and the systems integration services provided by our Logicorp Data
Systems Ltd. subsidiary.
Our corporate and merchant capital businesses involve 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. The 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. Our newly acquired systems integration business provides
server based computing, network design and delivery, network administration and
support, procurement services, hardware support services, and storage area
network services.
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.
The following is an organizational chart of the Corporation: (1)
-----------
CHELL GROUP
CORPORATION
-----------
|
|
---------------------------------------------------------------------
| | | | | | | |
| | | | | | | |
- --------------- | | -------------- | | --------- |
NTN Interactive | | Chell Merchant | | Chell.com |
Network, Inc. | | Capital Group | | USA Inc. |
- --------------- | | -------------- | | --------- |
| | | | |
- --------------------- | ------------------ | ------------- ----------------
Gala Vu Entertainment | 348751 Canada Inc. | Logicorp Data Logicorp Service
Network, Inc. | | Systems, Ltd. Group
- --------------------- | ------------------ | ------------- ----------------
| | | |
| | | |
| | ----------- -----------
| | 123557 591360
| | ALBERTA LTD ALBERTA LTD
| | ----------- -----------
| |
----------- ----------
Engyro Inc. eDemo Inc.
approx. 8% 14.3%
----------- ----------
(1) All subsidiaries are 100% owned unless otherwise stated.
22
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 with Subsidiary's
Ownership Equity Shares and Revenues as a
Percentages Percentage of
our Total
Revenues
- -------------------------------------------------------------------------------------------
Chell Merchant Capital 100% N.A. 0%
Group, Inc.
- -------------------------------------------------------------------------------------------
NTN Interactive Network 100% N.A. 9.9%
Inc.
- -------------------------------------------------------------------------------------------
GalaVu Entertainment 100% (through NTN N.A. 9.4%
Network Inc. Interactive Network,
Inc.)
- -------------------------------------------------------------------------------------------
348751 Canada Inc. 100% N.A. 0%
- -------------------------------------------------------------------------------------------
Chell.com USA Inc. 100% N.A. 0%
- ------------------------------------------------------------------------------------------
Logicorp Data Systems, 100% N.A. 78.1%
Ltd.
- -------------------------------------------------------------------------------------------
Logicorp Service Group 100% N.A. 2.6%
- -------------------------------------------------------------------------------------------
123557 ALBERTA LTD. 100% N.A. 0%
- -------------------------------------------------------------------------------------------
591360 ALBERTA LTD. 100% N.A. 0%
- -------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Investment Our Percentage Other Entities with Subsidiary's
Companies: Ownership Equity Shareholding Revenues as a
and Percentages Percentage of
our Total
Revenues
- --------------------------------------------------------------------------------
Engyro, Inc. Approx. 8% Private Venture *
Capitalists (60%,);
Engyro's
Management (17.9%)
- --------------------------------------------------------------------------------
cDemo Inc. ** 14.3% Private Venture *
Capitalists (22.32%);
cDemo's
Management and
Employees (59.82%)
- --------------------------------------------------------------------------------
* Due to our current minority investment in such entities, future revenues,
when and if realized, will not be included in our total revenues.
** All entities so indicated are not yet fully operational.
23
Financial Information about Industry Segments: (In Canadian $'s)
Reference is hereby made to the Business Sector data for the years ended
August 31, 2001, 2000, and 1999 in Exhibit 99.1 below.
=========================================================================
2001 2000 1999
$ $ $
=========================================================================
External revenue
Entertainment 13,588,788 14,121,764 7,569,929
Education 4,616,991 4,971,823 5,192,378
Merchant Services -- -- --
Corporate 16,595 13,703 61,384
=========================================================================
18,222,374 19,107,290 12,823,691
=========================================================================
Inter-segment revenue
Education 183,329 275,941 --
Corporate -- 128,283 223,435
=========================================================================
183,329 404,224 223,435
=========================================================================
Operating profit (loss)
Entertainment (208,371) 515,167 446,681
Education (1,084,531) (792,665) (623,400)
Merchant Services (5,887,912) -- --
Corporate (2,113,866) (1,218,183) (319,634)
=========================================================================
(9,294,680) (1,495,681) (496,353)
=========================================================================
Identifiable assets
Entertainment 5,459,008 7,009,552 4,725,971
Education 3,793,863 3,526,317 4,290,025
Merchant Services 1,489,711 -- --
Corporate 654,823 895,894 837,653
=========================================================================
11,397,405 11,431,763 9,853,649
=========================================================================
Corporate assets
Entertainment 3,170,363 4,352,448 3,699,785
Education (666,589) 844,142 (22,367)
Merchant Services 99,754 -- --
Corporate 2,141,512 355,590 1,063,713
=========================================================================
4,745,040 5,552,180 4,741,131
=========================================================================
Capital expenditures
Entertainment 729,486 842,955 350,836
Education 673,976 319,191 250,797
Merchant Services 50,900 -- --
=========================================================================
1,430,962 1,162,146 601,633
=========================================================================
Depreciation & Amortization
Entertainment 1,960,652 1,808,715 967,188
Education 507,218 408,856 428,377
Merchant Services 431,967 -- --
Corporate 140,570 31,750 33,654
=========================================================================
3,040,407 2,249,321 1,429,219
=========================================================================
** As a result of the sale of our Magic Lantern subsidiary, the Education
financial information is for historical purposes only.
24
Description of Business and Corporate History
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.
In October 1996, we acquired all of the outstanding stock of Magic Lantern
Communications Ltd., an Ontario corporation, and its subsidiaries. Effective
March 20, 2002, we sold all of the outstanding stock of Magic Lantern
Communications Ltd. for Cdn$1.85 million in cash.
In August 1997, we acquired certain business assets of Image Media Ltd.
and 802117 Ontario Inc., operating as Pilot Software. As of June 1999, we
acquired all of the outstanding stock of Interlynx Multimedia Inc., an Ontario
corporation. Effective June 2001, we sold our interest in Interlynx.
In September 1999, we acquired substantially all of the property and
assets (excluding accounts receivable) of GalaVu Entertainment Inc., an Ontario
corporation.
In September 2000, we and our Merchant Capital Group subsidiary acquired
the following assets from Chell.com and shares for an aggregate purchase price
of US$27,002,086: (a) 480,000 shares of cDemo which represented approximately
14.3% of cDemo's issued and outstanding stock; (b) 875,000 shares of Engyro Inc.
which represented approximately 22.1% of Engyro's issued and outstanding stock;
and (c) 100% of the issued and outstanding stock of Chell.com (USA) Inc., a
Nevada corporation. The sole director and shareholder of Chell.com is Cameron
Chell.
As of January 1, 2002, pursuant to a Share Purchase Agreement with
Logicorp Data
25
Systems Ltd. Logicorp Service Group and the individuals and entities which own
all of the issued and outstanding shares of Logicorp Data and Logicorp Group ,
together with 123557 ALBERTA LTD. and 591360 ALBERTA LTD., which own 1/3 of the
shares of Logicorp Data and Logicorp Group, respectively, we acquired all of the
issued and outstanding shares of Logicorp Data and Logicorp Group from the
individuals and entities which own said shares.
Discontinued Operations
On March 18, 2002, pursuant to a Share Purchase Agreement, we completed
the sale of our educational video and media resources business which was
conducted through our Magic Lantern subsidiary and its subsidiaries.
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 3,575 restaurants, lounges, hotels,
and other hospitality sites across North America have subscribed to these
services and installed systems capable of receiving Network broadcasts. These
subscriber systems receive satellite broadcasts containing the Network
interactive programs, such that thousands of patrons at subscriber locations can
interact with the same programs simultaneously. Our NTN Interactive Network
subsidiary markets the Network throughout Canada to the hospitality industry,
installs the systems, and provides technical and marketing support to Network
sites. Over 500 Group Subscribers are located in Canada. Designed to be hardware
independent, the Network may be transmitted through a variety of techniques
including, direct satellite, cable, gateway service, FM sideband, Internet, TV
vertical blanking interval, and telephone. We currently use direct satellite as
the method of transmission.
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Network Programming
The two-way interactive programming currently featured over the Network
includes a variety of interactive sports and trivia games permitting viewer
interaction and participation for 16 hours each day. All present Network
programming is structured to provide time for national, regional and local
advertisements, as well as for local inserts, which permit each subscriber to
display announcements of promotional prices or other events at its business
location.
NTN Play-Along Games
NTN Play-Along Games are played in conjunction with live, televised
events. The prime NTN Play-Along Game is QB1, a game of football strategy.
NTN Premium Trivia Games
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
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
27
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 hotel guests while generating revenue for our
GalaVu subsidiary and its hotel partners.
Merchant Capital Group
Business Strategy
Our Merchant Capital Group subsidiary is in the business of defining,
building and re-engineering businesses using new economy technologies to
maximize market value. The Merchant Capital Group's continual focus is to
identify upcoming technology trends and create the effective infrastructure
required to build out and support these trends.
Our Merchant Capital Group subsidiary is helping to define and grow a new
business and computing model known as the Application Service Provider, which we
refer to as the Application Service Provider industry.
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 were approximately Cdn$409,000.
Application Service Provider - Software as a Service
Application Service Provider is changing the way application software is
distributed. The Application Service Provider concept is based on centrally
hosted computing. Instead of purchasing software applications for installation
on personal computers, companies and individuals subscribe to (i.e. rent) the
applications and then securely access them from any web connection. Application
Service Providers are transforming software from a product to a service that
provides specific functionality for end-users without the problems of
installation, servicing, and upgrading. Most major software corporations have
announced new initiatives in the Application Service Provider market.
Merchant Capital Group Services:
1. Fee Based Consulting Services: Our Merchant Capital Group subsidiary
serves clients
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by advising them on e-commerce strategy, with particular focus on the
Application Service Provider industry. Consulting services include, but
are not limited to, business development activities, strategic alliances,
and marketing and promotional activities.
2. Creation of Businesses: Our Merchant Capital Group subsidiary intends to
create companies to become leaders in areas that we believe will define
new technological trends. 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 Application
Service Provider Industry Consortium, the Personalization Consortium, and
the Rich Media Consortium. These memberships and established relationships
allow Our Merchant Capital Group subsidiary to assist client
29
activities in the sourcing and formulation of strategic alliances,
business arrangements, joint development programs, and general business
development.
3. Additional Financings: Our Merchant Capital Group subsidiary maintains an
up-to-date database on venture capital activity. This allows Our Merchant
Capital Group subsidiary to identify appropriate venture capitalists that
would be interested in pursuing financing relationships with client
companies.
LOGICORP
LOGICORP is a Western Canadian Network Infrastructure provider, specializing in
Server-Based Computing solutions, Managed Services - using Computer Associates'
Unicentre, Network design, delivery, administration, and support Procurement
services, Warranty/Off-Warranty [W/OW] hardware support services, and
Information Storage technologies.
LOGICORP's primary focus is high-performance computer systems for the corporate
market. The firm provides solutions to mid-range and large corporations, as well
as the government, education and medical markets.
LOGICORP is committed to delivering high-quality products from key technology
manufacturers such as: 3Com, Cisco, Citrix, Compaq, Hewlett Packard, IBM,
Lexmark, Microsoft, NEC, Novell and Toshiba.
Founded in 1988 by three Edmonton-based entrepreneurs, the company currently
operates 6 offices; branch office in each of Edmonton, Calgary, Vancouver,
Regina and Saskatoon, and a corporate head office in Edmonton. The branch
offices provide essential customer sales and support functions, while the head
office houses the accounting, marketing and internal IT departments. The
management team and board of directors also reside in the corporate office.
As part of its commitment to customers, LOGICORP three years ago launched
LOGICORP Central, a call center dedicated to optimizing customer support. It
houses a separate IP-based phone system and integrated call center software.
This dedicated telephone help center is available to attend to customers'
technical needs 24 hours a day, 7 days per week. By calling a single toll-free
line for assistance, the call center can dispatch the appropriate technical
resource for efficient problem resolution. LOGICORP Central is part of
LOGICORP's program to ensure customers' needs are fulfilled quickly, efficiently
and accurately.
Additionally, LOGICORP has established a leasing arm: LOGICORP Financial.
LOGICORP Financial offers an alternate form of financing technology equipment to
those clients who require such a service.
Recent Developments
LOGICORP Transaction. Chell Merchant Capital Group, Inc., our wholly owned
subsidiary, has entered into a Share Purchase Agreement with Logicorp Data
Systems Ltd., Logicorp Service Group and the individuals and entities which own
all of the issued and
30
outstanding shares of Logicorp Data Systems and Logicorp Service Group, together
with 123557 ALBERTA LTD. and 591360 ALBERTA LTD., which own one-third of the
shares of Logicorp Data Systems and Logicorp Service Group. Pursuant to said
agreement, we have purchased all of the issued and outstanding shares of
Logicorp Data Systems and Logicorp Service Group from the individuals and
entities which own said shares.
Logicorp Data Systems is a corporation incorporated under the laws of the
province of Alberta, Canada and is a Western Canadian Network Infrastructure
Provider which specializes in server based computing, network design and
delivery, network administration and support, procurement services, Hardware
Support Services, and Storage Area Network Solutions. Logicorp Data Systems's
primary focus is high-performance computer systems for the corporate market.
Logicorp currently has 113 employees. We entered into the agreement pursuant to
our strategy to acquire and grow undervalued technology companies. The address
of Logicorp Data Systems and Logicorp Service Group is 8215 112 St., S.W., Suite
1500, Edmonton, Alberta, Canada.
Pursuant to the Logicorp agreement, the total purchase price payable by
Chell Merchant Capital Group to the sellers shall be a maximum of
Cdn$8,199,668.00, subject to adjustments which are set forth in the agreement.
Pursuant to the Logicorp transaction, our wholly-owned subsidiary, Chell
Merchant Capital Group, acquired all of the issued and outstanding securities of
Logicorp Data Systems, 123557 ALBERTA LTD., Logicorp Service Group and 591360
ALBERTA LTD. In consideration for such acquisition, in addition to cash payments
in the amount of US$1,500,000 and the issuance of promissory notes in the amount
of US$2,540,000, we issued to the former shareholders of the Logicorp securities
5,355,000 exchangeable shares of our wholly-owned subsidiary Chell Merchant
Capital Group. Chell Merchant Capital Group paid a non-refundable deposit of
$100,000.00 to the sellers' counsel from the proceeds of the 8% convertible
promissory notes offering. We financed the acquisition of Logicorp substantially
by using the proceeds which were obtained from such offering.
The purchase price shall be adjusted downward by 3 times the amount, if
any, that the earnings before taxes, depreciation for the first full 12 months
after the effective date is less than Cdn$1,000,000 to a maximum downward
adjustment of Cdn$3,000,000. The adjustment will be made, at the option of the
sellers, by reduction of any consideration remaining unpaid, by reducing the
balance owing in respect of any promissory note payable by Chell Merchant
Capital Group and us to the sellers and canceling such promissory note if fully
paid, by payment of cash to Chell Merchant Capital Group, or by returning to
Chell Merchant Capital Group any share consideration equivalent in dollar terms
calculated by using the share price of US$1.00 per share with a currency
exchange rate of Cdn$1.58 per US dollar.
The exchangeable shares are exchangeable into shares of our common stock
on a one for one basis upon the occurrence of certain events and have the same
voting rights in us as if the exchangeable shares were exchanged for our common
stock. In addition, the exchangeable shares were deposited in escrow in
connection with the closing of the transaction and will not be released until
our shareholders ratify the Logicorp transaction and approve the issuance of the
shares of our common stock issuable upon the exchange of the exchangeable
shares. While the
31
exchangeable shares are in escrow, the holders of the exhangeable shares are not
entitled to vote, transfer, exchange or encumber such shares, nor are they
entitled to dividends.
The exchangeable shares are exchangeable on a one-for-one basis for shares
of our common stock at any time after the filing of a registration statement
with the Securities and Exchange Commission pursuant to a Registration Rights
Agreement. The Registration Rights Agreement by and between us and the holders
of all of the issued and outstanding shares of Logicorp Data Systems and
Logicorp Service Group requiring us to file a registration statement for
2,677,500 shares of our common stock within 6 months after the effective date
and for a further 2,677,500 shares of its common stock within 1 year after the
effective date.
The issuance of shares of our common stock issuable upon the conversion of
the 5,355,000 exchangeable shares of our wholly-owned subsidiary Chell Merchant
Capital Group pursuant to the Logicorp transaction is subject to the approval by
a majority of votes cast at our shareholders' annual meeting.
Private Placement.
a) Pursuant to a Private Placement Memorandum, dated December 1, 2001, we
conducted an offering to raise a maximum of US$8,000,000, consisting of 8%
promissory notes which were convertible into shares of common stock. The 8%
convertible promissory notes offering has closed. Pursuant to such offering, we
raised $4,154,880 in convertible debt. All of the investors in the 8% promissory
notes offering have voluntarily converted their promissory notes, including
accrued interest, into shares of our common stock, to be issued upon shareholder
approval. Such conversion will result in the issuance of 4,373,558 shares of our
common stock, which represents approximately 19.46% of our issued and
outstanding shares of common stock as of May 31, 2002. Such percentage assumes
the approval by the shareholders of the issuance of shares of our common stock
pursuant to the Logicorp transaction, the issuance of shares of our common stock
pursuant to the conversion of the 8% convertible promissory notes and the
issuance of shares of our common stock pursuant to the conversion of two
promissory notes issued by us.
We financed the acquisition of Logicorp in part by using the proceeds
which were obtained from the 8% convertible promissory notes offering. The net
proceeds from such offering were also used for debt repayment, a merger fee to
the placement agent of such offering, and will be used for working capital and
expenses.
b) Pursuant to a Private Placement Memorandum, dated April 15, 2002, we
conducted a private offering of shares of our common stock at a price of $1 per
share. As of the date of this Prospectus, we have received and accepted $890,000
pursuant to such offering.
Shaar Fund Transaction. We entered into a Securities Exchange Agreement
with The Shaar Fund Ltd. Pursuant to the Securities Exchange Agreement, we and
Shaar have exchanged 389,610 shares of Series A 6% Convertible Preferred Stock
of Wareforce.com, Inc., par value $0.01 per share for 389,610 shares of our
Series B Convertible Preferred Stock, par value $.01 per share having the
designations, preferences and rights set forth in our Certificate of Designation
of Series B Convertible Preferred Stock in a transaction exempt from the
registration and
32
prospectus delivery requirements of the Securities Act of 1933, as amended. We
entered into the Shaar Fund Securities Exchange Agreement partly for the purpose
to induce The Shaar Fund to invest in the 8% convertible promissory notes
offering. In addition, the Securities Exchange Agreement furthers our potential
interest and further involvement in an equity interest in Wareforce.com, Inc.
The Shaar Fund has invested an aggregate of $660,000 in the 8% convertible
promissory notes offering.
The shares of the Wareforce.com, Inc. Series A 6% Convertible Preferred
Stock are convertible at the option of the holder into shares of Wareforce
common stock. Pursuant to the Series A 6% Convertible Preferred Stock
Certificate of Designation, the convertible shares are convertible into
3,896,100 shares of common stock of Wareforce.com, Inc.
In consideration for the Wareforce.com, Inc. Preferred Stock, we have
issued 389,610 shares of the our Series B Convertible Preferred Stock, which is
convertible into shares of our common stock at the option of the holders at any
time at a conversion price per share of US$1.00 and provides for mandatory
conversion of the preferred stock into shares of our common stock on January 22,
2005. Pursuant to the certificate of designation, the convertible shares are
convertible into 3,896,100 shares of our common stock.
Wareforce.com, Inc. provides computer-related technical services, support,
hardware and software that clients need to design, develop, manage and maintain
their data processing and information systems. The company believes that its
approach to the market for information technology is to be a diversified
information technology organization and to develop a complete single-source
solution for all information technology requirements. Wareforce.com, Inc.'s
address is 2361 Rosecrans Ave., Suite 155, El Segundo, CA 90245.
We entered into a non-binding expression of interest, dated October 25,
2001, concerning this proposed merger. We are in the process of negotiating a
definitive agreement with Wareforce.com, Inc. but the terms of the transaction
have yet to be finalized. The terms of the definitive agreement to purchase the
business and assets of Wareforce.com, Inc. are currently being negotiated with a
purchase price in the range of $1.5 million to $3 million, consisting of cash
and stock. There can be no assurance when or if we will consummate such a
transaction, what the terms of such transaction will be or if any such
transaction is consummated, that it will be successful.
Triton Private Equities Fund Transaction. Triton Private Equities Fund,
L.P. was the beneficial owner of 64,395 shares of Series "A" 6% Convertible
Preferred Stock of Wareforce.com, Inc., a Nevada corporation, par value $0.001
per share. Pursuant to a Securities Exchange Agreement, Triton Private Equities
Fund exchanged the Wareforce.com, Inc. Preferred Stock for shares of our Series
B Preferred Stock upon the terms and conditions set forth in the Triton
Securities Exchange Agreement. We entered into the Triton Securities Exchange
Agreement partly for the purpose to induce Triton Private Equities Fund to
invest in the 8% convertible promissory notes offering. In addition, the
Securities Exchange Agreement furthers our potential interest and further
involvement in an equity interest in Wareforce.com, Inc. Triton Private Equities
Fund has invested an aggregate of $140,000 in the 8% convertible promissory
notes offering.
Pursuant to the Securities Exchange Agreement, we and Triton Private
Equities Fund
33
have agreed to exchange all of the Wareforce.com, Inc. Preferred Stock owned by
Triton Private Equities Fund for 64,395 shares of our Series B Convertible
Preferred Stock, par value $.01 per share having the designations, preferences
and rights set forth in our Certificate of Designation of Series B Convertible
Preferred Stock, in a transaction exempt from the registration and prospectus
delivery requirements of the Securities Act of 1933, as amended. We and Triton
Private Equities Fund have agreed to this share exchange upon substantially the
same terms and conditions as set forth in the above discussion of the share
exchange between us and The Shaar Fund.
The shares of the Wareforce.com, Inc. Series A 6% Convertible Preferred
Stock which we acquired from Triton Private Equities Fund are convertible at the
option of the holder into shares of Wareforce.com, Inc. common stock. Pursuant
to the Series A 6% Convertible Preferred Stock Certificate of Designation, the
convertible shares are convertible into 643,950 shares of common stock of
Wareforce.com, Inc. The Wareforce.com, Inc. Certificate of Designation has a
conversion limitation with respect to the Wareforce.com, Inc. Preferred Stock
such that the holder does not have the right to convert all or any portion of
the Series A Preferred Stock if such conversion would result in the holder being
deemed a "beneficial owner" of more than 5% of the then outstanding common
shares of Wareforce.com, Inc.
In consideration for the Wareforce.com, Inc. Preferred Stock which we
acquired from Triton Private Equities Fund, we have issued 64,395 shares of our
Series B Convertible Preferred Stock, which is convertible into shares of our
common stock at the option of the holders at any time at a conversion price per
share of US$1.00 and provides for mandatory conversion of the preferred stock
into shares of our common stock on January 22, 2005. Pursuant to the certificate
of designation, the convertible shares are convertible into 643,950 shares of
our common stock.
Pursuant to the Shaar Securities Exchange Agreement and the Triton
Securities Exchange Agreement, we have acquired all of the issued and
outstanding shares of Wareforce.com, Inc. preferred stock. In consideration for
all of the issued and outstanding shares of the Wareforce.com, Inc. Preferred
Stock, we issued a total of 454,005 shares of our Series B Preferred Stock. The
value of the consideration of such stock is approximately $109,000.
Such shares are convertible into an aggregate of 4,540,050 shares of
Wareforce.com, Inc. common stock. However, the Wareforce.com, Inc. Certificate
of Designation has a conversion limitation with respect to the Wareforce.com,
Inc. Preferred Stock such that the holder does not have the right to convert all
or any portion of the Series A Preferred Stock if such conversion would result
in the holder being deemed a "beneficial owner" of more than 5% of the then
outstanding common shares of Wareforce.com, Inc. Accordingly, based upon the
conversion of such number of shares that would result in us being a 4.99% owner
of the issued and outstanding common stock of Wareforce.com, Inc., we may
convert such number of shares of Preferred Stock which will result in the
ownership of 672,483 shares of common stock of Wareforce.com, Inc. Such
ownership represents 26.2% beneficial ownership of the Wareforce issued and
outstanding common stock.
VC Advantage Limited Transaction. On October 12, 2000, we issued a
convertible debenture in the amount of US$3,000,000 to VC Advantage Limited
Partnership. On November 30, 2000, VC Advantage Limited Partnership assigned the
convertible debenture to Canadian
34
Advantage Limited Partnership. A total of US$1,700,000 had been advanced to us
in 2000. Effective September 2001, the convertible debenture was converted into
the following:
(i) we issued a promissory note in the principal amount of $1,365,100 to
Canadian Advantage Limited Partnership; and
(ii) we issued a promissory note in the principal amount of $504,900 to
Advantage Bermuda Fund Ltd.
Conversion of the Canadian Advantage Limited Partnership Promissory Note
Pursuant to a conversion agreement, as of March 28, 2002, in full
satisfaction of the Canadian Advantage Limited Partnership promissory note, we
agreed to issue 1,314,000 shares of our common stock immediately and 442,145
shares of our common stock upon the approval of our shareholders at our annual
shareholders' meeting.
Conversion of the Advantage Bermuda Fund Ltd. Partnership Promissory Note
Pursuant to a conversion agreement, as of March 28, 2002, in full
satisfaction of the Advantage Bermuda Fund Ltd. promissory note, we agreed to
issue 486,000 shares of our common stock immediately and 163,533 shares of our
common stock upon the approval of our shareholders at our annual shareholders'
meeting.
Planned Future Activities
Going forward, we intend to focus upon continuing to grow our systems
integration business and our interactive entertainment operations.
Partially Owned 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
approximately 8% of the stock of Engyro and the remaining equity of the company
is owned by private venture capitalists and Engyro's management. Revenues began
in Engyro's third quarter of its last fiscal year.
Engyro is a financial transaction engine designed to support the high
demands created by rapid growth in the Application Service Provider industry.
Engyro is focusing on providing the critical back end administrative services
for the Application Service Provider industry. Our management believes that this
will allow integration of the billing, payment, disbursement, and settlement
functions for Application Service Provider companies. Engyro has custom designed
its system to enable simplification of the complex economic variables of
delivery, measurement and payment, with full reconciliation and posting directly
to the accounting systems of all parties
35
in the Application Service Provider transaction. Engyro intends to strategically
deploy its service offering to give efficient and flexible local service to the
Application Service Providers', Independent Software Vendors and Network Service
Providers. Engyro's platform is flexible enough to allow it to grow into other
market areas such as business-to-business and e-commerce.
Engyro's primary market is the Application Service Provider marketplace.
Most Application Service Providers have yet to develop sophisticated and
integrated accounting systems and backroom capabilities, and typically outsource
non-core operations. Engyro proposes to approach potential customers and work
with them to design creative solutions for their billing and payment needs.
Engyro also intends to approach Independent Software Vendors to market Engyro's
ability to enable them to transition to an e-commerce platform to take advantage
of new distribution channels in the Application Service Providers. Engyro
intends to approach Independent Software Vendors and Network Service Providers
and seek to assist them in their provision of Application Service Provider
value-added services to their core offering. Engyro intends to reach its target
market in the following ways:
1. Indirectly by offering Independent Software Vendors a secure method
to enable Application Service Providers alternative subscription
software rental-models through the remote management of the payment
process; and
2. Through strategic partnerships/marketing relationships with software
metering/monitoring companies, billing companies, accounting
software providers, Data Centers, and other components of the
community of Application Service Provider elements.
cDemo
cDemo is a start up company that was incorporated in the State of Delaware
in February 2000. The head office is located at 236B Broadway, Chico,
California, 95926 and there is a satellite office located at 114, 1215 - 13th
Street SE, Calgary, Alberta. We own 14.3% of the stock of cDemo and the
remainder of the company's stock is distributed as follows: private venture
capitalists (22.32%); cDemo's management and employees (59.82%), none of whom
are affiliated with us. Allan Chell, Cameron Chell's brother, is a Director and
principal shareholder of cDemo and its Vice-President of Strategic Development.
cDemo has not commenced operations yet.
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.
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cDemo's first target industry is used vehicle sales. In order for the
automotive industry and Internet-based automotive companies to access the
multi-billion dollar used vehicle industry, cDemo intends to provide the
nationwide electronic assessment and listing infrastructure necessary for this
to occur and intends to generate revenue from service providers, trade-ins,
on-site volume assessments, lease returns, advertising, and data mining.
The cDemo electronic assessment service will include:
o An unbiased and detailed 100 plus point assessment.
o Multiple digital photographs of the vehicle.
o A computer generated assessment report, book value, and rating of the
vehicle.
o A one-stop upload listing service to automotive and classified
advertisement websites.
cDemo's third party information will enable consumers to buy, sell,
trade-in, and complete finance, insurance, and extended warranty contracts
online, not all of which is possible today.
In order to establish the nationwide assessment and listing
infrastructure, cDemo plans to foster business alliances with nationwide quick
lube chains and other service stations; newspapers, photo buy publications, and
Internet based classifieds; automobile finance, insurance and extended warranty
companies; and automotive dot-com businesses. cDemo has no current business
operations and as at the date hereof, cDemo has not entered into any agreement
with third parties and there can be no assurance that cDemo will be able to do
so in the future.
Competition
The market for merchant capital services, interactive entertainment
services and electronic/online products and services is rapidly evolving and
highly competitive. Although we believe that the diverse segments of the
interactive entertainment and venture capital services 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
37
ICG, is an Internet holding company actively engaged in
business-to-business e-commerce through a network of partner companies.
ICG has a network of over 60 companies. The strategy of the company is to
integrate its holdings and interests into a collaborative network that
leverages knowledge and resources; and
3. Softbank: Based in Tokyo and California, Softbank is perhaps the largest
Internet market force in the world. Softbank has a global presence and
powerful global strategic partnerships. The company has established a
worldwide presence by leveraging strategic alliances with subsidiaries
such as Softbank Capital Partners (US$1.35 billion), and Softbank
Technology Group. Softbank has ownership positions in over 120 Internet
companies.
Our NTN Interactive Network subsidiary operates in the interactive
entertainment services industry. In 1996, we became aware of a new entertainment
system, Sports Active, attempting to enter the hospitality market. Sports Active
offers only two programs, a football game and a trivia game. While it is
visually entertaining, it requires audio and we believe this is a significant
drawback in the restaurant environment in which it is being marketed. We have
not found this to be a significant competitive entry.
With the entrance of motion picture, cable and TV companies, competition
in the interactive entertainment and multimedia industries will likely intensify
in the future.
GalaVu's competition includes other interactive in-room entertainment
providers. With the development of new satellite technologies, and the
increasing speed of network connections, GaluVu expects the competition to
develop new services. These new services may include digital programming on
demand, enhanced hotel concierge services, billing presentment and settlement,
and others. GaluVu expects that new technologies will lead to intensifying
competition in the future.
Engyro's competition includes financial institutions that are pursuing
online settlement, disbursement, and clearing services. While there are numerous
online financial institutions, most are focused on the consumer end of the
market, offering products and services aimed at allowing consumers to complete
banking activities online. In addition, many competitors exist within the
Application Service Provider financial supply chain, each offering a different
set of services that in conjunction allow Application Service Provider services
to be offered. We believe that there is currently no direct competition to
Engyro as no other financial transaction company is focused exclusively on the
Application Service Provider market.
cDemo's competition includes assessment services, newspaper classified
advertisement and related services, photo buy and sell publications,
Internet-based automobile description and search organizations, and
Internet-based automobile sales organizations. We believe that these
organizations exist within a highly fragmented market each playing a role in the
overall assessment and vehicle transaction process. We believe that cDemo is
unique within the marketplace in that it acts as an independent and unbiased
collector of information that is presented for the benefit of all participants
in the used vehicle marketplace.
38
Employees
We have 182 employees in the nine operating subsidiaries, consisting of 8
executives, 3 general managers, 46 salespersons, 41 persons involved in
technical services, 5 involved in graphic development, 6 in marketing, 23
individuals involved in administration, 16 individuals involved in finance and
accounting, 2 individuals involved in research and development, 31 individuals
involved in information services and 1 individual involved in investor
relations. We believe that our staff is adequate for our anticipated needs.
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. Our NTN Interactive Network subsidiary presently utilizes 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.
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
August 31, 2001 was Cdn$1,206,478. Our former subsidiary, Magic Lantern, is
entitled to lease the space which it currently occupies at this property for
rent in the amount of $7,300 per month for a period of 6 months following the
March 18, 2002 closing of the sale of Magic Lantern.
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 ($77,729 annually). 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
($39,130 annually).
Our Merchant Capital Group subsidiary leases 12,043 square feet of office
space in Suites 301, 500 and 700 in a building located at 630 - 8th Avenue S.W.
Calgary, Alberta, T2P 1G6. The combined annual rent of the three suites is
Cdn$202,087.
We believe that our 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,
39
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.
We believe 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 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".
40
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.
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$) for
shares of common stock for each full quarterly period within our three most
recent fiscal years and our first and second quarters of the current year. The
information reflects inter-dealer prices, without retail mark-ups, markdowns or
commissions and may not necessarily represent actual transactions. We have never
declared dividends on our stock in our history.
- --------------------------------------------------------------------------------
High Low Trading Volume
-------------------------------------
(US$) (US$)
================================================================================
1999 Fiscal Year
First Quarter 4.750 1.125 1,385,390
Second Quarter 5.375 2.000 4,131,407
Third Quarter 3.500 1.375 1,000,982
Fourth Quarter 3.000 1.500 874,184
2000 Fiscal Year
First Quarter 2.500 1.500 585,270
Second Quarter 3.625 1.375 2,109,781
Third Quarter 7.875 2.250 3,825,607
Fourth Quarter 11.438 3.000 3,323,447
2001 Fiscal Year
First Quarter 7.219 3.000 581,689
Second Quarter 4.813 1.813 502,712
Third Quarter 2.313 0.938 1,811,151
Fourth Quarter 1.600 0.870 2,816,087
2002 Fiscal Year
First Quarter 1.240 0.550 26,684
Second Quarter 1.900 0.530 66,115
Third Quarter 2.160 1.320 64,369
41
On May 31, 2002, the closing price of the Common Shares on Nasdaq was
US$1.32.
As of the close of business on May 31, 2002, there were 214 holders of
record of our Common Stock. We believe that there are approximately 1,100
beneficial holders of Common Stock.
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 Logicorp Service Group, Ltd. ....... F - 44
Audited Financial Statements of Logicorp Data Systems, Ltd. ........ F - 62
Audited Financial Statements of 591360 Alberta Ltd. ................ F - 85
Audited Financial Statements of 123557 Alberta Ltd. ................ F - 94
Audited Financial Statements of Engyro ............................. F - 105
* Page F-1 follows page 76 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, 2001 and the six-months ended February 28, 2002 and 2001.
The earnings per share amounts, prior to 1998, have been restated as required to
comply with Statement of Financial Accounting Standards No. 128 Earnings Per
Share ("SFAS 128"). For further discussion of earnings per share and the impact
of SFAS 128, see Note 13 to the consolidated financial statements.
Statement of Operations Data (expressed in Canadian Dollars):
- -------------------------------------------------------------------------------------------------------
Year Ended August 31,
2001 2000 1999 1998* 1997*
Cdn$ Cdn$ Cdn$ Cdn$ Cdn$
=======================================================================================================
Operating revenues 18,222,374 19,107,290 12,823,691 13,404,542 10,351,689
Cost of sales 6,818,111 7,204,919 4,874,768 5,030,602 3,395,898
Gross profit 11,404,263 11,902,371 7,948,923 8,373,940 6,955,791
Income (loss) from continuing
operations (9,622,841) (1,466,205) (744,240) 358,492 609,387
Income (loss) from continuing
operations per share (1.15) (.51) (.28) .14 0.25
Weighted average number of
Shares outstanding 8,393,589 2,873,042 2,635,050 2,550,805 2,441,992
=======================================================================================================
* The 1998 and 1997 comparative consolidated financial statements have been
reclassified from statements previously presented to conform to the
presentation of the 2001 consolidated financial statements.
42
Six-month period ending Six-month period ending
February 28, 2002 February 28, 2001
- --------------------------------------------------------------------------------------
Operating Revenue $ 15,640,889 $ 6,915,927
- --------------------------------------------------------------------------------------
Cost of Sales 11,312,447 2,599,049
- --------------------------------------------------------------------------------------
Gross Profit 4,328,442 4,316,878
- --------------------------------------------------------------------------------------
Income (loss) from continuing
operations (2,865,603) (6,193,521)
- --------------------------------------------------------------------------------------
Income (loss) from continuing
operations per share (.26) (.74)
- --------------------------------------------------------------------------------------
Weighted average number of shares 10,976,487 8,356,045
outstanding
- --------------------------------------------------------------------------------------
Balance sheet data
As at August 31:
2001 2000 1999 1998 1997
- -------------------------------------------------------------------------------------------
Total assets 16,225,003 17,220,211 14,546,003 15,802,359 14,287,602
- -------------------------------------------------------------------------------------------
Long-term obligations 5,943,512 4,436,213 2,216,675 2,840,218 2,185,249
- -------------------------------------------------------------------------------------------
Shareholders' equity 2,248,128 9,383,419 10,792,767 11,033,178 9,488,648
- -------------------------------------------------------------------------------------------
As at February 28, 2002
- --------------------------------------------------------------------------------
Total assets 38,870,764
- --------------------------------------------------------------------------------
Long-term obligations 28,813,124
- --------------------------------------------------------------------------------
Shareholders' equity 10,057,640
- --------------------------------------------------------------------------------
43
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 Results of Operations is expressed in
Canadian dollars. The following discussion should be read in conjunction with
the consolidated financial statements, and notes thereto, included in this
document.
Results of Operations
Year Ended August 31, 2001 Compared to Year Ended August 31, 2000
Revenues. Revenues from network services for the 2001 Fiscal Year were
$6,300,891, compared to $6,345,552 for our fiscal year ended August 31, 2000
(the "2000 Fiscal Year"), a decrease of $44,661 or 0.7%. The number of
hospitality sites decreased slightly between the 2001 and 2000 fiscal years.
Revenues from Pay-tv for the 2001 Fiscal Year were $6,651,913, compared to
$6,517,940 for our 2000 Fiscal Year, an increase of $133,973 or 2.1%. The
increase is the result an increase in the buy-rate experienced in the rooms, due
to more "blockbuster" movie titles.
Revenues from event programming for the 2001 Fiscal Year were $403,993,
compared to $500,168 for the 2000 Fiscal Year, a decrease of $96,175 or 19.2%.
The decrease was due to a decreased number of corporate events hosted, both in
Canada and abroad, in 2001 when compared to the number of events hosted in 2000.
Revenues from ad sponsorship were $231,991 for the 2001 Fiscal Year,
compared to $675,532 for the 2000 Fiscal Year, a decrease of $443,541 or 65.7%.
The decrease was the result of a decrease in the number and size of corporate
sponsors over the level experienced in the previous period.
Revenues from video and software sales were $3,113,725 for the 2001 Fiscal
Year, compared to $3,702,801 for the 2000 Fiscal Year, a decrease of $589,076 or
15.9%. Decreased levels of funding by all levels of government have resulted in
tighter budget constraints placed upon educational bodies, and as a result,
sales of educational material have fallen. In addition, the demand for analog or
VHS formats is decreasing, yet the demand for the digital formats has not
increased at the same rate.
Revenues from video dubbing were $682,870 for the 2001 Fiscal Year
compared to $717,596 for the 2000 Fiscal Year, a decrease of $34,726 or 4.8%.
The decrease can be attributed to
44
stabilization in the local customer base after our former Magic Lantern
subsidiary and its subsidiaries' relocation in late fiscal 1998 and the focus
towards more internal production, thus resulting in a lesser push towards
external revenue sources.
Revenues from digital encoding were $820,396 for the 2001 Fiscal Year,
compared to $539,815 for the 2000 Fiscal Year, an increase of $280,581 or 52.0%.
The increase can be attributed to increased demand for digital services and the
increased capacity in the production lab.
Other revenues were $16,595, compared to $107,886 for the 2000 Fiscal
Year, a decrease of $91,291 or 84.6%.
As a result of the foregoing, our total revenues in the aggregate were
$18,222,374, compared to $19,107,290 for the 2000 Fiscal Year, a decrease of
$884,916 or 4.6%.
Cost of Sales. Cost of Sales for network services for the 2001 Fiscal Year
were $2,384,303, compared to $2,160,351 for the 2000 Fiscal Year, an increase of
$223,952 or 10.4%. The number of hospitality sites outstanding in 2001 compared
to the number outstanding in 2000 decreased, however we are billed by NTN
Communications, Inc. in United States dollars and the increase in cost of sales
resulted from a weaker Canadian dollar in the 2001 Fiscal year ($1.5284 for the
2001 Fiscal Year compared to $1.4714 for the 2000 Fiscal Year). As a percentage
of our total revenues, such costs increased to 13.1% for the 2001 Fiscal Year
from 11.3% for the 2000 Fiscal Year.
Pay-tv costs were $2,937,189 for the 2001 Fiscal Year, compared to
$2,919,417 for the 2000 Fiscal Year, an increase of $17,772 or 0.6%. Even though
revenue increased, we are receiving lower cable costs than experienced in the
2000 Fiscal Year, thus offsetting increased promotion and royalty costs. As a
percentage of our total revenues, such costs increased to 16.1% for the 2001
Fiscal Year from 15.3% for the 2000 Fiscal Year.
Event programming costs were $255, compared to $23,819 for the 2000 Fiscal
Year, a decrease of $23,564 or 98.9%. The decrease was commensurate with the
decrease in the number of events hosted in event programming revenues and
decreased costs resulting from the events being client run and not performed by
us.
Advertising sponsorship costs were nil, compared to $93,496 for the 2000
Fiscal Year. The decrease was the result of decreased costs associated with
restructuring of the department.
Video and software costs in aggregate were $1,249,851, compared to
$1,625,885 for the 2000 Fiscal Year, an decrease of $376,034 or 23.1%. The
decrease corresponds to the decrease in revenue as discussed above. As a
percentage of our total revenues, these costs have fallen to 6.9% in the 2001
Fiscal Year from 8.5% in the 2000 Fiscal Year.
Video dubbing costs were $244,670, compared to $157,289 for the 2000
Fiscal Year, an increase of $87,381 or 55.6%. The increase can be attributed to
a higher cost of tape and case. As
45
a percentage of our total revenues, these costs have risen to 1.3% in the 2001
Fiscal Year from 0.8% in the 2000 Fiscal Year.
Digital encoding costs were $1,843 for the 2001 Fiscal Year, compared to
$111,657 for the 2000 Fiscal Year, a decrease of $109,814 or 98.3%. The decrease
is the result of digital encoding materials being supplied by customers.
As a result of the foregoing, our total cost of sales was $6,818,111,
compared to $7,204,919 for the 2000 Fiscal Year, a decrease of $386,808 or 5.4%.
Total gross margins increased to 62.6% in the 2001 Fiscal Year from 62.3% in the
2000 Fiscal Year.
Expenses. Selling, general and administrative expenses for the 2001 Fiscal
Year were $16,250,171, compared to $10,726,556 for the 2000 Fiscal Year, an
increase of $5,523,615 or 51.5%. The increase was caused by the addition of the
Chell Merchant Capital Group and Chell.com (USA). Chell Merchant Capital Group's
and Chell.com (USA)'s selling, general and administration expenses for the 2001
Fiscal Year were $5,452,378 and $121,715 respectively (There are no comparative
figures for the 2000 Fiscal Year). There were increased consulting, legal and
accounting fees of $298,556, $819,215 and $302,739 respectively. These increased
due to the acquisition and the increased reporting requirements for the
Quarterly reviews. There were also increased operating costs due to the addition
of the two new companies, such as; communications ($202,531), rent and utilities
($117,649), travel ($992,595), office supplies ($100,023). Also there was
increased advertising and promotion ($418,557) and investor and public relations
($492,846) associated with the two new companies. In addition there was an
increase in salaries and benefits of $1,762,128. These staffing levels have been
reduced and these costs should not be incurred in the next fiscal year. As a
whole, Chell Merchant Capital Group and Chell.com (USA) attributed for the
increase in selling, general and administrative expenses, however these costs
have been dramatically decreased and should not occur with our current company
structure in the next fiscal year. As a percentage of our total revenues, total
selling, general and administrative expenses increased to 89.2% for the 2001
Fiscal Year from 56.1% for the 2000 Fiscal Year.
Write-off of leaseholds was $355,560 for the 2000 Fiscal Year. Chell
Merchant Capital Group experienced the one-time write-offs.
Bad debts expense was $171,407, compared to $140,090 for the 2000 Fiscal
Year, an increase of $31,317 or 22.4%. The increase resulted from an increase in
the allowance for doubtful accounts. As a percentage of our total revenues, such
costs increased to 0.9% for the 2001 Fiscal Year from 0.7% for the 2000 Fiscal
Year.
Interest and bank charges for the 2001 Fiscal Year were $881,398, compared
to $282,085 for the 2000 Fiscal Year, an increase of $599,313 or 212.5%. The
increase was the result of the increased debt levels associated with the
purchase of Richard Wolff Enterprises, and the increased debt for the promissory
note and convertible debenture. As a percentage of our total revenues, such
costs increased to 4.8% for the 2001 Fiscal Year from 1.5% for the 2000 Fiscal
Year.
46
Depreciation and amortization for the 2001 Fiscal Year were $3,040,407,
compared to $2,249,321 for the 2000 Fiscal Year, an increase of $791,086 or
35.2%. This increase is the result of depreciation on the capital asset
additions in 2001, and the addition of our Chell Merchant Capital Group
subsidiary ($431,697). As a percentage of our total revenues, such costs
increased to 16.7% for the 2001 Fiscal Year from 11.8% for the 2000 Fiscal Year.
Net Income/Loss. As a result of all of the above, our net loss for the
2001 Fiscal Year was $11,226,225 compared to net loss of $2,323,621 for the 2000
Fiscal Year, a change of $8,902,604. This represents a decrease in net income as
a percentage of total revenues to (61.6%) in the 2000 Fiscal Year from (12.2%)
in the 2000 Fiscal Year.
Year Ended August 31, 2000 Compared to Year Ended August 31, 1999
Revenues. Revenues from network services for the 2000 Fiscal Year were
$6,345,552, compared to $6,607,915 for our fiscal year ended August 31, 1999
(the "1999 Fiscal Year"), a decrease of $262,363 or 4.0%. The revenue earned
from playmaker repairs and maintenance performed by us for NTN Communications
during the 2000 Fiscal Year was $57,387 compared to $184,356 for the 1999 Fiscal
Year, a decrease of $126,969. In addition the 1999 Fiscal Year included a one
time sale that resulted in a variance of $134,630. The remaining revenues are
relatively constant between years due to the number of hospitality sites
remaining at the same level between the 2000 and 1999 fiscal years.
Revenues from Pay-tv for the 2000 Fiscal Year were $6,517,940. There is no
comparative revenue for the 1999 Fiscal Year as the revenue comes from our
GalaVu subsidiary, which was acquired in Fiscal 2000.
Revenues from event programming for the 2000 Fiscal Year were $500,168,
compared to $527,740 for the 1999 Fiscal Year, a decrease of $27,572 or 5.2%.
The decrease was due to a decreased number of corporate events hosted, both in
Canada and abroad, in 2000 when compared to the number of events hosted in 1999.
Revenues from ad sponsorship were $675,532 for the 2000 Fiscal Year,
compared to $308,602 for the 1999 Fiscal Year, an increase of $366,930 or
119.0%. The increase was the result of an increase in the number and size of
corporate sponsors over the level experienced in the previous period.
Revenues from video and software sales were $3,702,801 for the 2000 Fiscal
Year, compared to $4,033,980 for the 1999 Fiscal Year, a decrease of $331,179 or
8.2%. Decreased levels of funding by all levels of government have resulted in
tighter budget constraints placed upon educational bodies, and as a result,
sales of educational material have fallen. In addition, the demand for analog or
VHS formats is decreasing, yet the demand for the digital formats has not
increased at the same rate.
Revenues from video dubbing were $717,596 for the 2000 Fiscal Year
compared to $691,156 for the 1999 Fiscal Year, an increase of $26,440 or 3.8%.
The increase can be attributed to
47
stabilization in the local customer base after our former Magic Lantern
subsidiary and its subsidiaries' relocation in late fiscal 1998.
Revenues from digital encoding were $539,815 for the 2000 Fiscal Year,
compared to $462,742 for the 1999 Fiscal Year, an increase of $77,073 or 16.7%.
The increase can be attributed to increased demand for digital services and the
increased size in the production lab.
Other revenues, which consisted primarily of revenue from installation
services, Internet services and interest income, were $107,886, compared to
$191,556 for the 1999 Fiscal Year, a decrease of $83,670 or 43.7%. Installation
services revenue was constant due to a constant number of sites and interest
income was constant due to the short-term investments remaining at a consistent
level. The change in other revenues arose primarily from Internet services;
$2,301 for the 2000 Fiscal Year compared to $98,959 for the 1999 Fiscal Year, a
decrease of $96,658. Internet services are no longer being provided.
As a result of the foregoing, our total revenues in the aggregate were
$19,107,290, compared to $12,823,691 for the 1999 Fiscal Year, an increase of
$6,283,599 or 49.0%.
Cost of Sales. Cost of Sales for network services for the 2000 Fiscal Year
were $2,160,351, compared to $2,353,705 for the 1999 Fiscal Year, a decrease of
$193,354 or 8.2%. The number of hospitality sites outstanding in 2000 compared
to the number outstanding in 1999 was constant, however we are billed by NTN
Communications, Inc. in United States dollars and a $29,850 decrease in cost of
sales resulted from a stronger Canadian dollar in the 2000 Fiscal year ($1.4714
for the 2000 Fiscal Year compared to $1.4949 for the 1999 Fiscal Year). As a
result of the decreased revenue from playmaker repairs, the associated cost of
sales decreased by $82,654. As a percentage of our total revenues, such costs
decreased to 11.3% for the 2000 Fiscal Year from 18.4% for the 1999 Fiscal Year.
Pay-tv costs were $2,919,417 for the 2000 Fiscal Year. There are no
comparative figures for the 1999 Fiscal Year. The Pay-tv costs as a percentage
of our total revenues were 15.3%.
Event programming costs were $23,819, compared to $24,650 for the 1999
Fiscal Year, a decrease of $831 or 3.4%. The decrease was commensurate with the
decrease in the number of events hosted in event programming revenues. As a
percentage of our total revenues, such costs decreased to 0.1% for the 2000
Fiscal Year from 0.2% for the 1999 Fiscal Year.
Advertising sponsorship costs were $93,496, compared to $61,255 for the
1999 Fiscal Year, an increase of $32,241 or 52.6%. The increase was the result
of increased marketing campaigns and its associated costs. As a percentage of
our total revenue such costs remained constant at 0.5% for the 2000 Fiscal Year
compared to the 1999 Fiscal Year.
Video and software costs in aggregate were $1,625,885, compared to
$1,709,626 for the 1999 Fiscal Year, a decrease of $83,741 or 4.9%. The decrease
corresponds to the decrease in revenue as discussed above. As a percentage of
our total revenues, these costs have fallen to 8.5% in the 2000 Fiscal Year from
13.3% in the 1999 Fiscal Year.
48
Video dubbing costs were $157,289, compared to $353,983 for the 1999
Fiscal Year, a decrease of $196,694 or 55.6%. The decrease also can be
attributed to the decrease in customer base and more efficient operations since
the acquisition of Image Media Ltd. As a percentage of our total revenues, these
have fallen to 0.8% in the 2000 Fiscal Year from 2.7% in the 1999 Fiscal Year.
Digital encoding costs were $111,657 for the 2000 Fiscal Year, compared to
$11,738 for the 1999 Fiscal Year, an increase of $99,919 or 851.2%. The increase
is associated with the increased level of production and costs associated with
the additional production facilities.
Other costs, were $113,005, compared to $359,811 for the 1999 Fiscal Year,
a decrease of $246,806 or 68.6%. As a percentage of our total revenues, such
costs decreased to 0.6% for the 2000 Fiscal Year from 2.8% for the 1999 Fiscal
Year. The decrease relates primarily to Viewer Services ($222,751), which became
a wholly-owned subsidiary on June 16, 1999.
As a result of the foregoing, our total cost of sales was $7,204,919,
compared to $4,874,768 for the 1999 Fiscal Year, an increase of $2,330,151 or
47.8%. Total gross margins increased to 62.3% in the 2000 Fiscal Year from 61.9%
in the 1999 Fiscal Year.
Expenses. Selling, general and administrative expenses for the 2000 Fiscal
Year were $10,726,556, compared to $6,830,575 for the 1999 Fiscal Year, an
increase of $3,895,981 or 57.0%. The increase was caused by the following
factors; firstly, GalaVu's selling, general and administration expenses for the
2000 Fiscal Year were $2,761,254 or 70.9% of the total increase (There are no
comparative figures for the 1999 Fiscal Year); secondly, severance packages
associated with executive restructuring; thirdly, a provision for certain
investments; fourthly, there were increased legal and accounting fees associated
with operations and items pertaining towards our future; fifthly, there was a
one-time compensation charge of $337,779 resulting from the change in the
preferred share conversion rate and finally, costs associated with the purchase
of the remaining 49% of Interlynx. As a percentage of our total revenues, total
selling, general and administrative expenses increased to 56.1% for the 2000
Fiscal Year from 53.3% for the 1999 Fiscal Year.
Bad debts expense was $140,090, compared to $126,170 for the 1999 Fiscal
Year, an increase of $13,920 or 11.0%. The increase resulted from an increase in
the allowance for doubtful accounts. As a percentage of our total revenues, such
costs decreased to 0.7% for the 2000 Fiscal Year from 1.0% for the 1999 Fiscal
Year.
Interest and bank charges for the 2000 Fiscal Year were $282,085, compared
to $59,312 for the 1999 Fiscal Year, an increase of $222,773 or 375.6%. The
increase was the result of the increased debt levels associated with the
purchase of our GalaVu subsidiary. Our GalaVu subsidiary had interest charges of
$176,325 or 79.1% of the total increase. As a percentage of our total revenues,
such costs increased to 1.5% for the 2000 Fiscal Year from 0.5% for the 1999
Fiscal Year.
Depreciation and amortization for the 2000 Fiscal Year were $2,249,321,
compared to
49
$1,429,219 for the 1999 Fiscal Year, an increase of $820,102 or 57.4%. This
increase is the result of depreciation on the capital asset additions in 2000,
primarily the addition of our GalaVu subsidiary. Our GalaVu subsidiary had
depreciation and amortization for the 2000 Fiscal Year of $936,400. As a
percentage of our total revenues, such costs increased to 11.8% for the 2000
Fiscal Year from 11.1% for the 1999 Fiscal Year.
Income Taxes. There was no provision for income taxes for the 2000 Fiscal
Year, compared to $150,000 for the 1999 Fiscal Year, a decrease of $150,000 or
100%. The provision for taxes is lower in 2000 when compared to the 1999
provision due to no individual operating unit experiencing a taxable income.
Net Income/Loss. As a result of all of the above, our net loss for the
2000 Fiscal Year was $2,323,621 compared to net loss $971,497 for the 1999
Fiscal Year, a change of $1,352,124. This represents a decrease in net income as
a percentage of total revenues to (12.2%) in the 1999 Fiscal Year from (7.6%) in
the 1999 Fiscal Year.
Liquidity and Capital Resources
At August 31, 2001, we had a working capital deficit of $4,432,000 a
decrease of $6,849,551 from working capital of $2,417,551 at August 31, 2000.
Accounts receivable were $2,308,790 at August 31, 2001, compared to
$3,098,808 at August 31, 2000, a decrease of $790,018. The decrease can be
attributed to a decrease in the advertising and sponsorship sales, event
programming and software revenue and as well as a decrease in the average number
days outstanding in the receivables of Interactive. Property and equipment was
$8,260,282 at August 31, 2001 compared to $7,689,620 at August 31, 2000, an
increase of $570,662. This increase can be attributed to the following: the new
corporate wide financial and accounting package purchased and implemented in the
2001 Fiscal Year for which the approximate cost was $200,000. There was an
increase of approximately $150,000 of digital masters, that are required for the
production of digital media as well as the additional assets associated with the
acquisition of Richard Wolff Enterprises, Inc. Long-term debt was $9,658,997 in
the 2001 Fiscal Year compared to $4,774,672, an increase of $4,884,325. The
increase can be attributed to the $US1,700,000 convertible debenture associated
with the Chell acquisition and the US$1,500,000 promissory note. Accounts
payable were $2,469,663 in the 2001 Fiscal Year compared to $1,379,727 in the
2000 Fiscal Year, an increase of $1,089,936. The increase can be attributed the
increase in accounting and legal fees as a result of additional SEC reporting
and as well as the payables associated with the new entity, CMCG.
For the 2001 Fiscal Year, we had a net cash outflow of $999,192, versus a
cash outflow of $662,509 for the 2000 Fiscal Year. The net cash inflow for the
1999 Fiscal Year was $1,017,007. The decrease in net cash flow for the 2001
Fiscal Year was primarily due to cash used in investing activities and cash used
in operating activities.
Cash used in operating activities for the 2001 Fiscal Year was $2,858,451.
The major factors contributing to the cash used in operations for the 2001
Fiscal Year include: net loss with non-cash expenses added back of $5,506,554;
increases in accounts payable and accrued liabilities of
50
$1,072,245, a decrease in accounts receivable, short-term investments and other
assets of $790,018, $250,051 and $111,072 respectively. The major factors
contributing to the cash provided from operations for the 2000 Fiscal Year
include: net loss with non-cash expenses added back of $436,555, an increase in
accounts payable and accrued liabilities of $919,707 and a decrease in inventory
of $119,616; cash used in operations were: increases in accounts receivable,
income taxes receivable and an increase in the net assets from discontinued
operations of $614,830, $143,227, $202,799 and $267,046 respectively. Cash
provided by operating activities for the 1999 Fiscal Year was $1,640,659. The
major factor contributing to the cash provided by operations during the 1999
Fiscal Year was net loss with non-cash expenses added back of $460,230 and a
decrease in short-term investments of $1,780,407 reduced by the use of cash
resulting from the increase in prepaid expenses, other receivables and decrease
in accounts payable of $103,356, $153,020 and $304,370 respectively.
Cash used in investing activities in the 2001 Fiscal Year was $3,070,672.
This amount resulted from the purchase of property and equipment of
$1,537,749,and the deposit on purchase of $1,430,962 Cash used in investing
activities in the 2000 Fiscal Year was $1,162,146. This amount resulted from the
purchase of capital assets totaling $1,162,146. Cash used in investing
activities in the 1999 Fiscal Year was $614,130. This amount was primarily made
up of purchases of capital assets totaling $601,633
Cash provided by financing in the 2001 Fiscal Year was $4,929,930. The
increase is primarily due to the sale of the convertible debenture and the
bridge financing. Cash provided by financing in the 2000 Fiscal Year was
$235,606 resulting primarily from the $281,134 proceeds of exercised employee
stock options. Cash used in financing activities in the 1999 Fiscal Year totaled
$9,521. This mainly resulted from $48,007 repayment of debt offset by a $38,486
increase in loans payable.
We purchased a minority interest in Engyro and cDemo, both of which are in
the Application Service Provider segment. We have no obligation to fund these
investments and we do not manage these businesses. Each of these companies is
attempting to raise capital. On June 4, 2001, Engyro announced that it signed a
Letter of Intent for significant interim funding and that funds have been
advanced based on this Letter of Intent. Revenues began in Engyro's third
quarter of its last fiscal year. As of the date hereof, cDemo has not begun
operations.
At the 2001 Fiscal Year end, we did have the requisite working capital to
fund our ongoing business operations based upon the losses that had been
incurred during the previous two fiscal years. Pursuant to two Private Placement
Memorandums, dated December 1, 2001 and April 15, 2002, we conducted two private
offerings for purposes of generating requisite working capital. We were
successful in generating sufficient working capital to continue our ongoing
business operations. In addition, our business plan for 2002 contemplates
obtaining additional working capital through refinancings or restructurings of
our existing loan agreements, reducing operating overhead (which has already
begun through workforce consolidation), and the possible sale of some of our
existing subsidiaries. Our management is of the opinion that they will be able
to obtain enough working capital and that together with funds provided by
operations, there will be sufficient working capital for our requirements.
Our NTN Interactive Network subsidiary is dependent upon NTN
Communications as its sole supplier for the transmission of program content to
our suppliers. Although NTN Communications reported a net loss for its quarters
ended September, June and March, 2001 and its year ended December 31, 2001, the
Company believes that as of the date hereof, the financial performance of NTN
Communications, Inc. has improved and therefore is in a more stable financial
condition. In addition, the Company intends to diversify its business and
ultimately will be less dependent upon NTN Communications, Inc.
51
Inflation
The rate of inflation has had little impact on our operations or financial
position during the year ended August 31, 2001 and August 31, 2000 and inflation
is not expected to have a significant impact on our operations or financial
position during the 2002 Fiscal Year.
We pay a number of our suppliers, including our licensor and principal
supplier, NTN Communications, Inc., in US dollars. Therefore, fluctuations in
the value of the Canadian dollar against the US dollar will have an impact on
our gross profit as well as our net income. If the value of the Canadian dollar
falls against the US dollar, our cost of sales will increase thereby reducing
our gross profit and net income. Conversely, if the value of the Canadian dollar
rises against the US dollar, our gross profit and net income will increase.
Results of Operations for the Three Months ended February 28, 2002
Revenues. Our total revenues for the 2002 Second Fiscal Quarter were
$12,386,011, compared to $3,359,465 for the 2001 Second Fiscal Quarter, an
increase of $9,026,546 or 268.7%.
Revenues from product sales for the 2002 Second Fiscal Quarter were
$9,062,129. There are no comparative figures for the 2001 Second Fiscal Quarter
as the revenues arose from the purchase of Logicorp as of January 2002.
Revenues from service sales for the 2002 Second Fiscal Quarter were
$558,243. There are no comparative figures for the 2001 Second Fiscal Quarter as
the revenues arose from the purchase of Logicorp as of January 2002.
Revenues from network services for the 2002 Second Fiscal Quarter were
$1,564,091, compared to $1,798,207 for the 2001 Second Fiscal Quarter, a
decrease of $234,116 or 13.0%. The decrease can be attributed to a decrease in
event programming of $90,855 offset by an increase of $30,553 in advertising
sponsorship. The revenues are decreasing due to a slight decrease in the number
of Hospitality sites between the 2002 and 2001 Second Fiscal Quarters.
Revenues from Pay-tv for the 2002 Second Fiscal Quarter were $1,204,140
compared to $1,511,369 for the 2001 Second Fiscal Quarter, a decrease of
$307,229 or 20.3%. This decrease can be attributed to travel levels still being
depressed as a result of September 11th.
Cost of Sales. Total cost of sales for the 2002 Second Fiscal Quarter were
$10,058,507, compared to $1,290,969 for the 2001 Second Fiscal Quarter, an
increase of $8,767,538 or 679.1%. The increase is primarily the result of the
addition of Logicorp's product and service cost of sales to the company. Product
($8,290,472) and service ($497,354) resulted in a total addition of $8,787,826
or almost 100% of the increase. Since Logicorp was added in January 2002, there
are no comparative figures for the 2001 Second Fiscal Quarter. Network services
cost of sales were $633,988 in the 2002 Second Fiscal Quarter, compared to
$625,717 in the 2001 Second Fiscal Quarter, an increase of $8,271 or 1.3%.
52
Pay-TV cost of sales were $636,693 in the 2002 Second Fiscal Quarter,
compared to $665,252 in the 2001 Second Fiscal Quarter, a decrease of $28,559 or
4.3%. As a percentage of revenues, cost of sales increased in the 2002 Second
Fiscal Quarter to 81.2% from 38.4% in the 2001 Second Fiscal Quarter.
Expenses. Total selling, general and administrative expenses for the 2002
Second Fiscal Quarter were $3,232,791, compared to $4,471,381 for the 2001
Second Fiscal Quarter, a decrease of $1,238,590 or 27.7%. The decrease can be
attributed to a couple of items: there was a decrease in the merchant services
segment of $2,000,999 resulting from decreased staffing costs and associated
cost reductions; offset by an increase resulting from the addition of Logicorp
$823,331 which purchased during January 2002, thus resulting in no comparative
figures.
Total selling, general and administrative expenses for the 2002 Second
Fiscal Quarter for Logicorp comprised the following major items salaries of
$521,847 and supplies and materials of $197,697.
As a percentage of the Company's total revenues, selling, general and
administration expenses decreased to 26.1% for the 2002 Second Fiscal Quarter
from 133.1% for the 2001 Second Fiscal Quarter.
Interest and bank charges for the 2002 Second Fiscal Quarter were
$918,818, compared to $198,812 for the 2001 Second Fiscal Quarter, an increase
of $720,006 or 362.2%. The increase results from an increase in debt related to
the sale of the convertible debenture and bridge financing. We are now
experiencing a full quarter of the expense for Second Fiscal 2002 as compared to
partial months in 2001 Second Fiscal Quarter. In addition, a $542,567 deemed
interest expense was incurred on the financing raised. As a percentage of the
Company's total revenues, interest and bank charges increased to 7.4% for the
2002 Second Fiscal Quarter from 5.9% for the 2001 Second Fiscal Quarter.
Total depreciation and amortization expense for the 2002 Second Fiscal
Quarter was $530,571, compared to $631,948 for the 2001 Second Fiscal Quarter, a
decrease of $101,377 or 16.0%. This decrease is primarily the result of some
assets becoming fully depreciated.
The net loss from continuing operations for the 2002 Second Fiscal Quarter
was $2,354,676, compared to net loss of $3,233,645 for the 2001 Second Fiscal
Quarter, a decrease of $878,969. The decrease primarily resulted from the cost
savings in the Merchant Services sector, offset by the increased cost from the
addition of Logicorp and increased costs associated with the raising of
financing.
As a result of all of the above, the net loss for the 2002 Second Fiscal
Quarter was $2,740,556, compared to net loss of $3,421,973 for the 2001 Second
Fiscal Quarter, a decrease of $681,417. The decrease primarily resulted from the
cost savings in the Merchant Services sector, offset by the increased cost from
the addition of Logicorp. The 2002 Second Fiscal Quarter loss resulted primarily
from the corporate costs associated with running and growing the
53
organization and the decrease in profits from the operating companies due the
economic downturn experienced since September 11th.
Results of Operations for the Six Months ended February 28, 2002
Revenues. Our total revenues for the 2002 First Fiscal Half were
$15,640,889, compared to $6,915,927 for the 2001 First Fiscal Half, an increase
of $8,724,962 or 126.2%.
Revenues from product sales for the 2002 First Fiscal Half were
$9,062,129. There are no comparative figures for the 2001 First Fiscal Half as
the revenues arose from the purchase of Logicorp in January 2002.
Revenues from service sales for the 2002 First Fiscal Half were $558,243.
There are no comparative figures for the 2001 First Fiscal Half as the revenues
arose from the purchase of Logicorp in January 2002.
Revenues from network services for the 2002 First Fiscal Half were
$3,274,309, compared to $3,544,330 for the 2001 First Fiscal Half, a decrease of
$270,021 or 7.6%. The decrease can be attributed to a decrease in event
programming of $81,075 offset by an increase of $63,064 in advertising
sponsorship. The revenues are decreasing due to a slight decrease in the number
of Hospitality sites between the 2002 and 2001 First Fiscal Half.
Revenues from Pay-tv for the 2002 First Fiscal Half were $2,736,561
compared to $3,296,475 for the 2001 First Fiscal Half, a decrease of $559,914 or
17.0%. This decrease can be attributed to travel levels still being depressed as
a result of September 11th.
Cost of Sales. Total cost of sales for the 2002 First Fiscal Half were
$11,312,447, compared to $2,599,049 for the 2001 First Fiscal Half, an increase
of $8,713,398 or 335.3%. The increase is primarily the result of the addition of
Logicorp's product and service cost of sales to the company. Product
($8,290,472) and service ($497,354) resulted in a total addition of $8,787,826
or almost 100% of the increase. Since Logicorp was added in January 2002, there
are no comparative figures for the 2001 First Fiscal Half. Network services cost
of sales were $1,223,105 in the 2002 First Fiscal Half, compared to $1,205,529
in the 2001 First Fiscal Half, an increase of $17,576 or 1.5%. Pay-TV cost of
sales were $1,301,516 in the 2002 First Fiscal Half, compared to $1,393,520 in
the 2001 First Fiscal Half, a decrease of $92,004 or 6.6%. As a percentage of
revenues, cost of sales increased in the 2002 First Fiscal Half to 72.3% from
37.6% in the 2001 First Fiscal Half.
Expenses. Total selling, general and administrative expenses for the 2002
First Fiscal Half were $4,819,575, compared to $8,578,934 for the 2001 First
Fiscal Half, a decrease of $3,759,359 or 43.8%. The decrease can be attributed
to a couple of items: there was a decrease in the merchant services segment of
$4,025,433 resulting from decreased staffing costs and associated cost
reductions; offset by an increase resulting from the addition of Logicorp
$823,331 which purchased during January 2002, thus resulting in no comparative
figures.
Total selling, general and administrative expenses for the 2002 First
Fiscal Half for
54
Logicorp comprised the following major items; salaries of $521,847 and supplies
and materials of $197,697.
As a percentage of our total revenues, selling, general and administration
expenses decreased to 30.8% for the 2002 First Fiscal Half from 124.0% for the
2001 First Fiscal Half.
During the 2001 First Fiscal Half, Chell Merchant Capital Group Inc.
vacated certain leased space and as a result the Company wrote off the net book
value of the related leasehold improvements in the amount of $355,560. There
were no similar transactions in the 2002 First Fiscal Half.
Interest and bank charges for the 2002 First Fiscal Half were $1,236,522,
compared to $280,115 for the 2001 First Fiscal Half, an increase of $956,407 or
341.4%. The increase results from an increase in debt related to the sale of the
convertible debenture and the bridge financing and the deemed interest expense
of $542,567 incurred on the funds raised. These items were not present for the
entire 2001 First Fiscal Half. As a percentage of the Company's total revenues,
interest and bank charges increased to 7.9% for the 2002 First Fiscal Half from
4.1% for the 2001 First Fiscal Half.
Total depreciation and amortization expense for the 2002 First Fiscal Half
was $1,137,948, compared to $1,295,790 for the 2001 First Fiscal Half, a
decrease of $157,842 or 12.2%. This decrease is primarily the result of some
assets becoming fully depreciated.
Net Income/Loss. The net loss from continuing operations for the 2002
First Fiscal Half was $2,865,603, compared to net loss of $6,193,521 for the
2001 First Fiscal Half, a decrease of $3,327,918. The decrease primarily
resulted from the cost savings in the Merchant Services sector, offset by the
increased cost from the addition of Logicorp.
As a result of all of the above, the net loss for the 2002 First Fiscal
Half was $3,720,347, compared to net loss of $6,712,542 for the 2001 First
Fiscal Half, a decrease of $2,992,195. The decrease primarily resulted from the
cost savings in the Merchant Services sector, offset by the increased cost from
the addition of Logicorp. The 2002 First Fiscal Half loss resulted primarily
from the corporate costs associated with running and growing the organization
and the decrease in profits from the operating companies due the economic
downturn experienced since September 11th.
Liquidity and Capital Resources
At February 28, 2002, we had a working capital deficit of $11,460,063, a
decrease of $6,431,638 from working deficit of $5,028,425 at August 31, 2001.
For the 2002 First Fiscal Half, we had a net decrease in cash of $259,040
compared to a net decrease of $1,133,938 in the 2001 First Fiscal Half.
Cash used in operating activities for the 2002 First Fiscal Half was
$19,078, compared to $3,649,405 used in operating activities in the 2001 First
Fiscal Half. In 2002, the major items
55
that contributed to cash being used in operating activities were as follows: the
net loss with non-cash expenses added back of $1,788,650, the increase in
accounts receivable of $627,929, the increase in income taxes receivable of
$22,962, the increase in inventory of $281,717, the increase in other accounts
receivable of $375,154, the increase in other assets of $317,190 and the
increase in net assets from discontinued operations of $222,103. The major item
that contributed to cash being provided by operating activities was the increase
in accounts payable and accrued liabilities of $3,553,740. In 2001, the major
items that contributed to cash being used in operating activities were as
follows: net loss with non-cash expenses added back of $4,024,951, increases in
income taxes receivable and prepaids of $98,475 and $94,275 respectively, and a
decrease in accounts payable and accrued liabilities of $75,301. The major
sources of operating funds included decreases in short-term investments of
$250,195 and accounts receivable of $101,969, a decrease in other accounts
receivable of $122,035 and a decrease in net assets from discontinued operations
of $188,265.
Cash used in investing activities in the 2002 First Fiscal Half was
$1,812,750 compared to the $2,644,750 used in investing activities in the 2001
First Fiscal Half, a decrease of $832,000. In the 2002 First Fiscal Half,
$312,750 of property and equipment was purchased compared to $653,940 in the
2001 First Fiscal Half, a decrease of $341,190. In the 2002 First Fiscal Half,
$1,500,000 was used in the purchase of Logicorp (note 5), where in the 2001
First Fiscal Half; a $1,689,710 deposit on purchase occurred, a decrease of
$189,710. In addition, a $301,000 increase in notes receivable occurred in the
2001 First Fiscal Half. There was no similar change in the 2002 First Fiscal
Half.
Cash provided by financing activities in the 2002 First Fiscal Half was
$1,572,788, compared to the $5,160,217 provided in the 2001 First Fiscal Half.
This decrease is primarily due to increases in debt repaid and a lower level of
new debt incurred in the 2002 First Fiscal Half.
During the 2002 Second Fiscal Quarter we issued promissory notes in the
amount of $3,191,568 under a private placement memorandum. The net proceeds of
approximately $2,900,000 were used as follows: to repay debt of approximately
$790,000; $1,400,000 was used in the acquisition of Logicorp; and approximately
$710,000 was used for working capital and expenses. We are in the process of
raising additional capital under our private placement memorandum. It is
anticipated that such funds raised will be converted to equity. These funds will
allow us to realize our acquisition strategy and to repay our loan obligations.
In addition, in the 2002 Third Fiscal Quarter we have negotiated the conversion
of approximately $2,954,600 owing to CALP and ABFL to equity. Our subsidiaries
operating in the entertainment and systems integration segments create liquidity
sufficient to fund our operations. Our management believes that the current
negotiations for terms and financing will be successful and that we will have
the required liquidity for its planned operating activities in the current year.
Inflation
The rate of inflation has had little impact on our operations or financial
position during the six months ended February 28, 2002 and February 28, 2001 and
inflation is not expected to have a significant impact on our operations or
financial position during the 2002 Fiscal Year.
56
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 our gross
profit as well as our net income. If the value of the Canadian dollar falls
against the US dollar, our cost of sales will increase thereby reducing its
gross profit and net income. Conversely, if the value of the Canadian dollar
rises against the US dollar, our gross profit and net income will increase.
Quantitative and Qualitative Disclosures About Market Risk
We are exposed to market risks from changes in foreign currency exchange rates
and interest rates. We and our wholly-owned subsidiaries are located in Canada
and its functional currency is the Canadian dollar.
Interest rate risks.
We also had various loans outstanding at August 31, 2001 (approximately
$9,659,000), which bear interest at a fixed rate. A hypothetical 10% adverse
change in the interest rate on this debt would negatively affect net income and
cash flow by approximately $40,000.
We did not use any derivative financial investments to manage this exposure.
Exchange rate risks.
We are subject to foreign currency exchange rate fluctuations in the Canadian
dollar value of foreign currency-denominated transactions. Based on our average
annual net currency positions in fiscal 2001 and 2000, a 10% adverse change in
average annual foreign currency exchange rates would not have been material to
our consolidated financial statements for the years ended August 31, 2001 or
2000.
Changes in and Disagreements with Accountants on Accounting and Financial
Disclosures
On October 12, 2000, Ernst & Young LLP ("E&Y"), the independent
accountants who were engaged as the principal accountants to audit our financial
statements resigned as our certifying accountants. E&Y's report on our financial
statements as at August 31, 1999 and for the two years then ended contained no
adverse opinion or disclaimer of opinion, and were not qualified or modified as
to uncertainty, audit scope or accounting principles. During the fiscal year
ended August 31, 1999 and during the subsequent interim period preceding E&Y's
resignation we had no disagreement with E&Y on any matter of accounting
principles or practices, financial statement disclosure, or auditing scope or
procedure. The facts and circumstances that relate to E&Y's resignation, as far
as they are known to us, are as follows:
E&Y served as our certifying accountants since 1995. E&Y orally informed
us that pursuant to E&Y's internal rules, E&Y would resign as our certifying
accountants since it was
57
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.
In addition, Lazar, Levine acted as our auditors for the year ending August 31,
2001. We have authorized E&Y to fully respond to any and all inquiries of Lazar,
Levine & Felix, LLP concerning E&Y's resignation.
Directors and Executive Officers
Director
Name Age Principal Positions with the Company Since
- ---- --- ------------------------------------ -----
Cameron Chell 33 President and Chief Executive Officer N/A
Don Pagnutti 51 Director, Vice President-Finance, and
Chief Financial Officer 2000
David Bolink 33 Director 2000
Gordon Herman 43 Director 2000
Adrian P. Towning 57 Director 1994
Robert Stone 58 Director 2000
Shelley Singhal 34 Director 2001
Michael J. Rice 35 Director 2002
Mark Truman 47 Secretary N/A
We anticipate that all our Directors will be re-elected at our annual
shareholders' meeting which is scheduled for June 28, 2002 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 President and Chief Executive Officer and is the
Chairman and Chief Executive Officer of Chell.com Ltd. Mr. Chell was a director
on our board from October
58
2000 until April 2002. 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. In April 2001, FutureLink filed for the protections of Chapter 11
bankruptcy reorganization. Mr. Chell is also a former Director and Shareholder
of VC Advantage Limited, the general partner of VC Advantage Fund Limited
Partnership. Mr. Chell is a Director and founder of C MeRun Corp. and is a
cofounder of JAWS Technologies Inc., a company which is quoted on the "Pink
Sheets" and a provider of information security consulting services and software
solutions. Mr. Chell is also the Chairman of the Board of Directors of 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
Cdn$25,000 fine and a three year period of enhanced supervision.
Gordon Herman was a Senior Managing Director of Chell Merchant Capital
Group from September 2000 to January 19, 2001 and currently has oversight of our
acquisition team operations. He is also 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 various
publicly held Canadian insurance companies. From 1988 to 1992, Mr. Herman was
the President of General Electric Capital Canada Leasing Inc., Canadian
Operations (Canadian Subsidiary of General Electric).
Don Pagnutti was appointed our Vice President of Finance on September 19,
2000. Mr. Pagnutti has been our Chief Financial Officer since September 1998,
and has been our Executive Vice President and Chief Operations Officer since
September 1997. 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.
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 is currently
Vice-President of Business Development at Engyro, Inc. 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.
Adrian Towning is a private, independent investor in several companies
involved in the
59
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,
which we refer to as TSE, and the American Stock Exchange, which we refer to as
AMEX, 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, a company listed on the TSE ;
Golden Star Resources Ltd., a company listed on the TSE and listed on AMEX;
Mainsborne Communications International Inc.; Manhatten Minerals Corp., a
company listed on the TSE; Mr. Stone is also a former director of Agrium Inc., a
company listed on the New York Stock Exchange and the TSE ; Cominco Ltd.; Global
Stone Corporation; Pine Point Mines Ltd.; TVI Pacific Inc., a company listed on
the TSE and Canadian Venture Exchange Inc.; and United Bolero Development Corp.,
a company listed on the Canadian Venture Exchange Inc.; Union Bank of
Switzerland and West Kootenay Power & Light Company.
Shelly Singhal has been a director on our board of directors since 2001.
Since December 2001, Mr. Singhal has been the President of vFinance Capital, a
private merchant banking concern providing investment opportunities to
corporations and high net worth individuals through equity investments in
emerging companies. From June 2001 until November of 2001, Mr. Singhal was
Managing Director of Technology Investment Banking for SBI E2-Capital (USA) Inc.
From November 2000 until May 2001 he was Managing Director of Technology
Investment Banking for BlueStone Capital Securities, Inc. From July of 1995
until August 2000, Mr. Singhal was Managing Director of Corporate Finance at
Roth Capital Partners where he was head of the E-Commerce Group and Manager of
the Roth Capital Partners Bridge Fund.
Michael J. Rice has been a Director since March 2002. Mr. Rice is the
Executive Director of the Retail Branch System within Prudential Securities'
Private Client Group, serving in this position since November 2000. In his
current role, Mr. Rice also sits on several of Prudential Securities' Leadership
and Business Review Committees that include the New Product Group, Investments,
Investment Management, and Public Finance. Mr. Rice joined Prudential Securities
in October 1997 as Senior Vice President and Director of Strategic Business
Initiatives. Prior to joining Prudential Securities, Mr. Rice was a Vice
President and Branch Manager for Smith Barney in New York City. He is an
Advisory Board member of NYC2012, the nonprofit group leading the initiative to
bring the 2012 Olympic Games to New York City. He is also a member of the
Financial Management Division of the Securities Industry Association. Mr. Rice
holds an undergraduate degree from Georgetown University and an
60
M.B.A. from The Wharton School at The University of Pennsylvania.
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 two years ended August 31, 2001 to those
individuals who served as our Chief Executive Officer during the 2001 Fiscal
Year and all our other executive officers or any of our subsidiaries at August
31, 2001 who received total annual salary and bonuses in excess of US$100,000
(Cdn$147,140) during the 2001 Fiscal Year.
Long-term
Annual Compensation Compensation
=====================================================================
Other Annual Securities Under All Other
Name and Principal Salary(1) Bonus Compensation(1) Options/Granted
Compensation
Position Year (Cdn$) (Cdn$) ($) (#) ($)
- ------------------ ---- ------ ------ --- --- ---
Cameron Chell (2) 2001 0 -- -- -- --
President and
Chief Executive Officer
Donald Pagnutti (3) 2001 160,000 -- -- -- --
Vice-President, Finance 2000 156,249 -- -- 22,500 --
and Chief Financial Officer
Notes:
(1) Perquisites and other personal benefits received in 2000 and 2001 did not
exceed the lesser of US$50,000 or 10% of the total annual salary and
bonuses for any of the executive officers set forth above.
(2) Mr. Chell did not receive monetary compensation in fiscal years 2000 or
2001. He did receive health benefits pursuant to our employee benefit plan
and was reimbursed for certain expenses he incurred in connection with his
position as our President and Chief Executive Officer.
(3) Mr. Pagnutti's title was changed to Vice President of Finance and Chief
Financial Officer on September 19, 2000.
During the three year period ended August 31, 2001, we did not grant any
restricted stock awards or stock appreciation rights. Additionally, all of our
group life, health, hospitalization, medical reimbursement or relocation plans,
if any, do not discriminate in scope, terms or operation, in favor of the named
executive officers and are generally available to all salaried
61
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 US$50,000 or 10% of the total salary and bonus reported for the named
executive officer in the fiscal years in which such benefits were received, and
no single type of perquisite or other personal benefits exceeded 25% of the
total perquisites and other benefits reported for the named executive officer in
the applicable fiscal year.
Option Grants Table
The following table sets forth (a) the number of shares underlying options
granted to each named executive officer during the 2001 Fiscal Year, (b) the
percentage the grant represents of the total number of options granted to all of
our employees during the 2001 Fiscal Year, (c) the per share exercise price of
each option, (d) the expiration date of each option, and (e) the potential
realized value of each option based on: (i) the assumption of a five (5%)
percent annualized compounded appreciation of the market price of the common
stock from the date of the grant of the subject option to the end of the option
term, and (ii) the assumption of a ten (10%) percent annualized compounded
appreciation of the market price of the common stock from the date of the grant
of the subject option to the end of the option term.
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%
- ---- ------- ----------- ----- ---- -- ---
Donald Pagnutti (1) Nil Nil Nil Nil Nil Nil
Vice-President,
Finance and Chief
Financial Officer
Notes:
(1) Mr. Pagnutti's title was changed to Vice President of Finance and
Chief Financial Officer on September 19, 2000.
Options Exercised and Remaining Outstanding
Set forth in the table below is information, with respect to each of the
named executive officers, as to the (a) number of shares acquired during the
2001 Fiscal Year upon each exercise of options granted to such individuals, (b)
the aggregate value realized upon each such exercise (i.e., the difference
between the market value of the shares at exercise and their exercise price),
(iii) the total number of unexercised options held on August 31, 2001,
separately identified between those exercisable and those not exercisable, and
(iv) the aggregate value of in-the-money, unexercised options held on August 31,
2001, separately identified between those exercisable and those not exercisable.
62
Securities Aggregate Value of Unexercised in the
Acquired on Value Unexercised Options at Money Options at August 31,
Exercise Realized August 31, 2000 2001
(#) ($) (#) 1 ($)
------------ ------------ --------------------------- ----------------------------------
Exercisable Unexercisable Exercisable(1) Unexercisable(1)
----------- ------------- -------------- ----------------
Donald Pagnutti Nil Nil 31,875 20,625 Nil Nil
Note:
(1) The value of the unexercised "in-the-money" options has been determined by
subtracting the exercise price of the options from the closing Common
Share price of US$1.33 on August 31, 2001, and multiplying by the number
of Common Shares that may be acquired upon the exercise of the options.
The current exercise price of the options was higher than the closing
Common Share price of US$1.430, therefore the Value of the options is nil.
(2) As of October 31, 2001, the options were repriced at $1.00 per share. The
vesting for these options are one-third per year on each anniversary of
the grant date.
Compensation of Directors
Prior to September 8, 2000, each director, not otherwise our full-time
employee, was eligible to receive $500 for each meeting of the Board of
Directors or committee thereof which they attended, along with the reimbursement
of their reasonable expenses incurred on our behalf. In addition, each director,
not otherwise our full-time employee, was eligible to receive 1,500 stock
options annually.
As of December 11, 2000, the Board of Directors formally adopted a
standard arrangement pursuant to which only our outside directors are
compensated by us for their services in their capacity as directors. This
compensation arrangement is retroactive to September 19, 2000 (the date of the
closing of the Agreement of Purchase and Sale between Networks North Inc.,
Networks North Acquisition Corp., Chell.com Ltd. and Cameron Chell).
Outside Director's Compensation Schedule Cash Options
(US$)
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
In November 2001, we renewed Donald Pagnutti's employment agreement
originally dated November 1, 1999, 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
of Finance and Chief Financial Officer. The agreement provides for an initial
base compensation of Cdn$160,000 with annual reviews,
63
together with automobile expenses of Cdn $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
Cdn$360,000, together with automobile expenses of Cdn$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.
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.
Although we have had transactions with companies and firms with which
certain members of our compensation committee are, or at some point during
fiscal year 2001 were, affiliated as an officer and/or director, there are no
such relationships in which members of our compensation committee have a direct
or indirect material interest. In addition, there are no interlocking
relationships of the nature described above involving members of our
compensation committee.
Security Ownership of Certain Beneficial Owners and Management [need to update]
Set forth in the table below is information concerning the ownership, as
of the close of business on May 31, 2002, 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.
64
Amount and Nature of Percent of
Name and Address (1) Beneficial Ownership Class (2)
- -------------------- -------------------- ---------
Chell.com Ltd. (3) ...................................... 3,147,271 14.0%
Cameron Chell (President & Chief Executive Officer) (4) . 3,230,971 14.4%
Canadian Advantage Limited Partnership .................. 2,086,009 9.3%
Gordon Herman (Director) (5) ............................ 332,236 1.5%
David Bolink (Director) (6) ............................. 311,411 1.4%
Don Pagnutti (Director, Vice-President-Finance,
and Chief Financial Officer) (7) ....................... 187,500 0.8%
Michael J. Rice (Director) .............................. 1,700,000 7.6%
Adrian Towning (Director) (8) ........................... 150,000 0.7%
Robert Stone (Director) (9) ............................. 150,000 0.7%
Shelley Singhal (Director) .............................. 0 0%
All directors and executive officers as a group
(8 persons) (10) ...................................... 6,062,118 27%
(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.
(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. The percentages reflected in this
table assume the approval of the issuance of shares of our common stock
pursuant to the Logicorp transaction, the issuance of shares of our common
stock pursuant to the conversion of the 8% convertible promissory notes
and the issuance of shares of our common stock pursuant to the conversion
of two promissory notes issued by us.
(3) Cameron Chell is the sole director and shareholder of Chell.com Ltd.
(4) Includes 3,147,271 shares of our common stock held by Chell.com Ltd. Does
not include 5,000,000 options to purchase shares of our common stock, the
granting of which is subject to conditions which have not yet been met as
of the date hereof.
(5) 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.
(6) 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.
(7) Represents options, which have vested and are available for exercise.
(8) Represents options, which have vested and are available for exercise.
(9) Includes 100,000 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
was 22,477,698 on May 31, 2002 and the applicable outstanding options held
by certain Officers and Directors in the aggregate of 487,500, which for
purposes of this footnote does not include options held by Messrs. Bolink
and Herman which are described in footnotes 5 and 6 above. Our total
outstanding common stock includes 5,355,000 shares of our wholly-owned
subsidiary, Chell Merchant Capital Group, which are exchangeable into
shares of our common stock which will be held in escrow until shareholder
approval of the issuance of such shares with respect to the Logicorp
transaction. Such shares do not have voting power while held in escrow.
65
Certain Relationships and Related Transactions
Set forth below is a description of certain transactions between us and
our directors, executive officers, beneficial owners of five percent or more of
the outstanding common stock, or 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 2001 Fiscal Year and subsequent
thereto. Our management believes that the transactions described in this section
were made on terms no less favorable than those which could have been obtained
from third parties.
A) Cameron Chell is Chairman of the Board and a director of cDemo.
Chell.com., which is owned by Mr. Chell. Mr. Chell holds 120,000 warrants to
purchase common shares of cDemo at $5.00 per share and 85,000 warrants to
purchase Class A Voting Shares of eSupplies at $7.00 per share and 500,000
options at $7.00 per share. Chell.com holds 200,000 options to purchase 200,000
shares of common stock of Engyro for $5.00 per share and warrants to purchase
97,500 shares of common stock of Engyro at $5.00 per share.
B) Gordon Herman holds an option from Chell.com to acquire 332,236 shares
of our common stock, which are held by Chell.com, at a price of $1.00 (which may
be adjusted up or downward based upon certain contingencies).
C) David Bolink holds an option from Chell.com to acquire 311,411 shares
of our common stock, which are held by Chell.com, at a price of $1.00 (which may
be adjusted up or downward based upon certain contingencies).
D) License Agreement between us, Cameron Chell, and Chell Merchant Capital
Group dated August 31, 2000 whereby Mr. Chell grants us and Chell Merchant
Capital Group the right to use the trademarks "Chell.com", "Chell Merchant
Capital Group" and "Chell Corporation" in exchange for the fee of $1.00 per
year.
E) Securities Purchase Agreement with VC Advantage Fund on October 3,
2000, for up to US$3,000,000 loan to us. VC Advantage Fund received a
Convertible Debenture, which was convertible into our common stock, based upon
an agreed conversion price of $3.00 per share. As of November 30, 2000, VC
Advantage Fund had assigned its rights in this Agreement to Canadian Advantage
Limited Partnership and a total of US$1,700,000 has been advanced to us. The
US$1,700,000 advance is convertible into 566,667 Common shares. Cameron Chell is
a Director and shareholder of VC Advantage Limited, the general partner of VC.
Pursuant to the assignment of this agreement to Canadian Advantage Limited
Partnership, our loan is no longer a related transaction because Mr. Chell has
no interests in Canadian Advantage Limited Partnership. The Securities Purchase
Agreements entered into with The Shaar Fund and Triton include a provision
stating that on or before March 31, 2002, we would convert our outstanding debt
to VC Advantage Limited Partnership in the amount of $1,500,000 into long term
debt with a maturity date for all of the principal after the third anniversary
of the date hereof. On November 30, 2000, VC Advantage Limited Partnership
assigned the convertible debenture to Canadian Advantage Limited Partnership. A
total of US$1,700,000 had been advanced to us in 2000. Effective September 2001,
the convertible debenture was converted into the following: (i) we
66
issued a Promissory Note in the principal amount of $1,365,100 to CALP (the
"CALP Promissory Note") and (ii) we issued a Promissory Note in the principal
amount of $504,900 to ABFL (the "ABFL Promissory Note"). Pursuant to a
Conversion Agreement, as of March 28, 2002, in full satisfaction of the CALP
Promissory Note, we agreed to issue 1,314,000 shares of our common stock
immediately and 442,145 shares of our common stock upon the approval of our
Shareholders at our shareholders' annual meeting. In addition, pursuant to a
Conversion Agreement, as of March 28, 2002, in full satisfaction of the ABFL
Promissory Note, we agreed to issue 486,000 shares of our Common Stock
immediately and 163,533 shares of our common stock upon the approval of our
shareholders at the shareholders' annual meeting.
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
7,400,385 Shares of
Common Stock
CHELL GROUP CORPORATION
PROSPECTUS
___________, 2002
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 US$ 967.06
Legal and Accounting
Fees and Expenses 90,000.00*
Offering commissions
and fees 100,000.00*
Miscellaneous 9,032.94*
Total US$ 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
The following sets forth certain information regarding sales of, and other
transactions with respect to, securities of our company issued within the past
three years, which sales and other transactions were not registered pursuant to
the Securities Act of 1933, as amended (the "Securities Act"). All of such sales
and transactions were exempt from the registration requirements of the
Securities Act pursuant to Section 4(2) thereof or as otherwise indicated
herein. The basis for such exemption was belief that the investors were either
accredited or sophisticated. For those investors deemed sophisticated, they had
access to information on the Registrant necessary to make an informed decision.
1. The convertible preferred shares were converted, resulting in the
issuance of 300,000 shares of our common stock.
2. 5,426,772 common shares were issued for the asset purchase from Cameron
Chell and Chell.com Ltd.
3. 145,000 common shares were issued as payment for consulting fees
rendered.
4. We issued 131,974 common shares in lieu of salary.
5. We also issued 36,602 common shares for the settlement of debt.
6. We issued approximately 1,249,396 shares of our common stock as
repayment of several promissory notes.
7. We issued 40,000 shares of our common stock for services rendered.
70
Exhibits and Financial Statement Schedules
(a) Financial Statements of the Registrant
Balance sheet and statements of income and cash flows of the Registrant
for the fiscal year ended August 31, 2001 and for the fiscal quarter ended
February 28, 2002.
(b) Financial Statements of the businesses in which the Registrant acquired
securities.
Balance sheet and statements of income and cash flows of Logicorp Data
Systems, Ltd., Logicorp Service Group, Ltd. and 591360 Alberta Ltd. for
the fiscal years ended June 30, 2001 and 2000 and 123557 Alberta Ltd for
the fiscal years ended October 31, 2001 and 2000.
(c) Financial Statements of the businesses in which the Registrant acquired
securities.
Balance sheet and statements of income and cash flows of Engyro Period
from Inception (November 4, 1999) through August 31, 2000
(d) 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.*
5.1 Opinion of Mintz & Fraade, P.C.
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.*
71
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 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 Stock Purchase Agreement, dated January 17, 2001, by and among
Chell Group Corporation and ApplicationStation.com Inc.
10.29 Securities Purchase Agreement dated October 3, 2000 by and
between Chell Group Corporation and VC Advantage Limited
Partnership.**
10.30 License Agreement dated August 31, 200 by and among Cameron
Chell and Networks North Acquisition Corp. **
10.31 Consulting Agreement dated November 26, 1999 by and between
Chell.com Inc. and R Home Funding Co. Ltd.**
10.32 Consulting Agreement dated January 15, 2000 by and between
Chell.com Ltd. and Buyersangel.com, Inc.**
10.33 Share Purchase Agreement dated as of December 13, 2001 by and
among Chell Group Corporation, Chell Merchant Capital Group,
Inc., a wholly-owned subsidiary of the
72
Company, Melanie Johannesen, Randy Baxandall, Morris
Chynoweth, Elaine Chynoweth, the Johannesen Family Trust, the
Baxandall Family Trust, the Merc Family Trust, Logicorp Data
Systems Ltd., 123557 Alberta Ltd., Logicorp Service Group Ltd.
and 591360 Alberta Ltd.***
10.34 Securities Exchange Agreement dated February 6, 2002 by and
between the Company and The Shaar Fund Ltd***
10.35 Securities Exchange Agreement dated February 6, 2002 by and
between the Company and Triton Private Equities Fund, L.P.***
10.36 Share Purchase Agreement as of March 18, 2002 by and among
Magicvision Media inc., NTN Interactive Network inc., and
Magic Lantern Communications Ltd ****
22 List of Subsidiaries*
23.3 Consent of Lazar, Levine & Felix, LLP
23.4 Consent of Ernst & Young LLP
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)
** All exhibits so indicated are incorporated herein by reference to the
exhibit listed above in the Company's Second Amendment to Form S1 (Date of
Report: May 16, 2001)(File No. 333-55844).
*** All exhibits so indicated are incorporated herein by reference to the
exhibit listed above in the Company's Preliminary Proxy on Schedule 14A
(Date of Report: February 26,2001) (File No. 000-18066)
**** All exhibits so indicated are incorporated herein by reference to the
exhibit listed above in the Company's Third Amendment to Form S1 (Date of
Report: July 12, 2001)(File No. 333-55844).
***** All exhibits so indicated are incorporated herein by reference to the
exhibit listed above in the Company's Current Report on Form 8-K (Date of
Report: April 3, 2002) (File No. 000-18066)
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)
73
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, 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 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 the Securities and
Exchange Commission 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 10th day of June 2002.
Chell Group Corporation
By: /s/ Don Pagnutti*
------------------------------
Don Pagnutti, Director, Vice
President-Finance, Chief Financial
Officer
POWER OF ATTORNEY
I, the undersigned director of Chell Group Corporation, hereby constitute
and appoint Don Pagnutti, my true and lawful attorney-in-fact and agent, with
full power of substitution, for me and in my stead, in any and all capacities,
to sign any and all amendments (including pre-effective and post-effective
amendments) to this Registration Statement and all documents in connection
thereto, and to file the same, with all exhibits thereto, and other documents in
connection therewith, with the Securities and Exchange Commission, granting to
said attorneys-in-fact and agents, and each of them, full power and authority to
do and perform each and every act and thing necessary or advisable to be done in
and about the premises, as full to all intents and purposes as he or she might
or could do in person, hereby ratifying and confirming all the said
attorneys-in-fact and agents, or any of them, or their substitute or substitutes
may lawfully do or cause to be done by virtue hereof.
In accordance with the requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following person in the capacities
and on the dates stated.
Signature Title(s) Date
- --------- -------- ----
/s/ Michael J. Rice Director June 10, 2002
- ------------------------
Michael J. Rice
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/ Don Pagnutti* Director June 10, 2002
- ------------------------
David Bolink
/s/ Don Pagnutti* President & Chief
- ------------------------ Executive Officer June 10, 2002
Cameron Chell
/s/ Don Pagnutti* Director June 10, 2002
- ------------------------
Gordon Herman
/s/ Don Pagnutti* Director, Vice President-Finance, June 10, 2002
- ------------------------ Chief Financial Officer
Don Pagnutti
/s/ Don Pagnutti* Director June 10, 2002
- ------------------------
Shelly Singhal
/s/ Don Pagnutti* Director June 10, 2002
- ------------------------
Robert Stone
/s/ Don Pagnutti* Director June 10, 2002
- ------------------------
Adrian P. Towning
* Signed by Don Pagnutti, attorney-in-fact pursuant to power of attorney.
76
INDEPENDENT AUDITORS REPORT
The Board of Directors
Chell Group Corporation
Toronto, Ontario
We have audited the accompanying consolidated balance sheets of Chell Group
Corporation and subsidiaries as of August 31, 2001 and 2000 and the related
consolidated statements of operations and shareholders' equity and cash flows
for each of the two years in the period ended August 31, 2001. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Chell Group
Corporation and subsidiaries as of August 31, 2001 and 2000, and the results of
their operations and their cash flows for the years then ended in conformity
with accounting principles generally accepted in the United States of America.
/S/ LAZAR LEVINE & FELIX LLP
----------------------------------------
New York, New York
November 16, 2001
F-1
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Shareholders of
Chell Group Corporation
We have audited the accompanying consolidated statements of operations,
shareholders' equity and cash flows of Chell Group Corporation and subsidiaries
for the year ended August 31, 1999. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated results of operations and cash flows
of Chell Group Corporation and subsidiaries for the year ended August 31, 1999
in conformity with accounting principles generally accepted in the United
States.
/S/ Ernst & Young LLP
----------------------------------------
Toronto, Canada Chartered Accountants
November 12, 1999
F-2
CHELL GROUP CORPORATION
CONSOLIDATED BALANCE SHEETS
AS AT AUGUST 31
(Expressed in Canadian dollars)
================================================================================================
2001 2000
(Restated - note 17)
$ $
================================================================================================
ASSETS
Current
Cash and cash equivalents 356,421 1,355,613
Short-term investments (note 4) 19,676 269,727
Accounts receivable, trade - net of allowance for doubtful
accounts of $227,000; [2000 - $178,000] 2,308,790 3,098,808
Other receivables (note 16) 84,814 216,990
Income taxes receivable 155,204 143,227
Inventory 105,590 206,216
Prepaid expenses 570,868 527,549
- ------------------------------------------------------------------------------------------------
Total current assets 3,601,363 5,818,130
- ------------------------------------------------------------------------------------------------
Property and equipment, net (notes 6 & 8) 8,260,282 7,689,620
Licenses, net of accumulated amortization 247,321 250,248
Goodwill, net of accumulated amortization 1,795,737 1,938,480
Notes receivable (note 5) 160,000 160,000
Deposit on purchase (note 14) 1,689,710 --
Other assets, net of amortization 388,032 202,799
Net assets from discontinued operations (note 13 [a]) 82,558 1,160,934
- ------------------------------------------------------------------------------------------------
16,225,003 17,220,211
================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current
Accounts payable - trade (note 16) 2,469,663 1,379,727
Accrued liabilities 1,789,042 1,623,220
Current portion of long-term debt (note 8) 3,774,658 397,632
- ------------------------------------------------------------------------------------------------
Total current liabilities 8,033,363 3,400,579
- ------------------------------------------------------------------------------------------------
Long-term debt, net of current portion(note 8) 5,884,339 4,377,040
Deferred income taxes payable (note 7) 59,173 59,173
- ------------------------------------------------------------------------------------------------
Total liabilities 13,976,875 7,836,792
- ------------------------------------------------------------------------------------------------
Commitments and Contingent liabilities (notes 9 & 12)
Shareholders' equity
Share capital (note 10)
0 Preferred shares [2000 - 900,000] -- 10,917
9,028,239 common shares [2000 - 2,925,141] 604,109 191,122
Capital in excess of par value 14,143,533 10,454,669
Deficit (12,499,514) (1,273,289)
- ------------------------------------------------------------------------------------------------
Total shareholders' equity 2,248,128 9,383,419
- ------------------------------------------------------------------------------------------------
16,225,003 17,220,211
================================================================================================
The accompanying notes are an integral part of these statements
F-3
CHELL GROUP CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED AUGUST 31
[Expressed in Canadian dollars]
2001 2000 1999
(Restated -
Note 17)
- --------------------------------------------------------------------------------------------------------------------
$ $ $
- --------------------------------------------------------------------------------------------------------------------
REVENUE
Network services 6,300,891 6,345,552 6,607,915
Pay-tv 6,651,913 6,517,940 --
Event programming 403,993 500,168 527,740
Advertising sponsorship 231,991 675,532 308,602
Video and software sales 3,113,725 3,702,801 4,033,980
Video dubbing 682,870 717,596 691,156
Digital encoding 820,396 539,815 462,742
Other 16,595 107,886 191,556
- --------------------------------------------------------------------------------------------------------------------
18,222,374 19,107,290 12,823,691
- --------------------------------------------------------------------------------------------------------------------
COST OF SALES
Network services [note 9] 2,384,303 2,160,351 2,353,705
Pay-tv 2,937,189 2,919,417 --
Event programming 255 23,819 24,650
Advertising sponsorship -- 93,496 61,255
Video and software sales 1,249,851 1,625,885 1,709,626
Video dubbing 244,670 157,289 353,983
Digital encoding 1,843 111,657 11,738
Other -- 113,005 359,811
- --------------------------------------------------------------------------------------------------------------------
6,818,111 7,204,919 4,874,768
- --------------------------------------------------------------------------------------------------------------------
EXPENSES
Selling, general and administrative 16,250,171 10,726,556 6,830,575
Write-off of leaseholds 355,560 -- --
Bad debts 171,407 140,090 126,170
Interest and bank charges 881,398 282,085 59,312
Depreciation and amortization 3,040,407 2,249,321 1,429,219
- --------------------------------------------------------------------------------------------------------------------
20,698,943 13,398,052 8,445,276
- --------------------------------------------------------------------------------------------------------------------
Loss before the undernoted items (9,294,680) (1,495,681) (496,353)
Loss on sale of subsidiary [note 10] -- -- (130,000)
Loss from equity investment in Engyro [note 18] (301,100) -- --
Income from investment in Viewer Services [note13[b]] -- -- 28,576
Minority interest (27,061) 29,476 3,537
Provision for income taxes [note 7] -- -- (150,000)
- --------------------------------------------------------------------------------------------------------------------
Loss from continuing operations (9,622,841) (1,466,205) (744,240)
Loss from discontinued operations (net of income tax) [note 13[a]] (1,603,384) (857,416) (227,257)
- --------------------------------------------------------------------------------------------------------------------
Net loss and comprehensive loss for the year (11,226,225) (2,323,621) (971,497)
====================================================================================================================
Earnings (loss) per share [note 11]
Basic $(1.34) $(0.81) $(0.36)
Diluted $(1.34) $(0.81) $(0.36)
====================================================================================================================
The accompanying notes are an integral part of these statements
F-4
CHELL GROUP CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED AUGUST 31, 2001, 2000 AND 1999
(Expressed in Canadian dollars)
Capital in Accumulated Total
excess of par retained earnings Shareholders'
Preferred Shares Common shares value (deficit) Equity
------------------------------------------
Shares Amount Shares Amount
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, August 31, 1998 900,000 10,917 2,625,170 162,484 8,837,948 2,021,829 11,033,178
Payment for services rendered -- -- 5,500 387 26,557 -- 26,944
Interlynx acquisition (note 13[a]) -- -- 27,778 1,920 93,171 -- 95,091
Conversion of promissory notes -- -- 98,193 6,844 602,207 -- 609,051
Net loss -- -- -- -- -- (971,497) (971,497)
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, August 31, 1999 900,000 10,917 2,756,641 171,635 9,559,883 1,050,332 10,792,767
GalaVu acquisition (note 13[e]) -- -- 100,000 6,897 288,463 -- 295,360
Change in preferred share conversion
rate -- -- -- 7,887 329,892 337,779
Exercise of 68,500 stock options -- -- 68,500 4,703 276,431 -- 281,134
Net loss -- -- -- -- -- (2,323,621) (2,323,621)
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, August 31, 2000 900,000 10,917 2,925,141 191,122 10,454,669 (1,273,289) 9,383,419
Purchase of assets and shares
(note 13[f]) -- -- 5,426,772 372,923 2,229,291 -- 2,602,214
Issued in lieu of salary -- -- 131,974 9,484 315,577 -- 325,061
Settlement of debt -- -- 36,602 2,694 109,085 -- 111,779
Preferred shares converted (900,000) (10,917) 300,000 13,065 (9) -- 2,139
Warrants -- -- -- -- 370,065 -- 370,065
Consulting services rendered -- -- 145,000 10,405 456,218 -- 466,623
Exercise of 62,750 stock options -- -- 62,750 4,416 208,637 -- 213,053
Net loss -- -- -- -- -- (11,226,225) (11,226,225)
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, August 31, 2001 -- -- 9,028,239 604,109 14,143,533 (12,499,514) (2,248,128)
====================================================================================================================================
The accompanying notes are an integral part of these statements
F-5
CHELL GROUP CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED AUGUST 31
(Expressed in Canadian dollars)
===============================================================================================================================
2001 2000 1999
(Restated - Note 17)
$ $ $
===============================================================================================================================
OPERATING ACTIVITIES
Net loss for the year (11,226,225) (2,323,621) (971,497)
Adjustments to reconcile net loss to net cash
Provided by (used in) operating activities:
Compensation costs related to the change in the conversion rate of
preferred shares -- 337,779 --
Depreciation and amortization 3,040,407 2,249,321 1,429,219
Accretion of interest on non-interest bearing promissory notes 183,513 173,076 31,084
Loss from investment in Viewer Services -- -- (28,576)
Write-off of leasehold improvements 355,560 -- --
Services rendered for shares 659,359 -- --
Warrants issued 174,084 -- --
Write-off of prepaids arising from Chell asset purchase 367,235 -- --
Write-off of assets arising from discontinued operations 939,513 -- --
Changes in assets and liabilities:
Decrease (increase) in short-term investments 250,051 (7,801) 1,780,407
Decrease (increase) in accounts receivable, trade 790,018 (614,830) (8,275)
Decrease (increase) in income taxes receivable (11,977) (143,227) --
Decrease in inventory 100,626 54,652 47,220
Decrease (increase) in prepaid expenses 98,779 119,616 (103,356)
Decrease (increase) in other accounts receivable 133,580 (30,796) (153,020)
Decrease (increase) in other assets 111,072 (202,799) --
Decrease (increase) in assets from discontinued operations 103,710 (267,046) (78,177)
Increase (decrease)in accounts payable and accrued liabilities 1,072,245 919,707 (304,370)
- -------------------------------------------------------------------------------------------------------------------------------
Cash (used in) provided by operating activities 2,858,450 264,031 1,640,659
- -------------------------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES
Purchase of property and equipment (1,430,962) (1,162,146) (601,633)
Proceeds from disposal of property and equipment -- -- 23,557
Proceeds from sale of Interlynx [Note 13[a]] 50,000 -- --
Investment in Viewer Services -- -- (36,054)
Increase in deposit on purchase (1,689,710) -- --
- -------------------------------------------------------------------------------------------------------------------------------
Cash used in investing activities (3,070,672) (1,162,146) (614,130)
- -------------------------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES
Increase in notes and loans payable 5,006,134 21,908 38,485
Repayment of notes and loans payable (102,447) (67,436) (48,007)
Proceeds from exercise of options 26,243 281,134 --
- -------------------------------------------------------------------------------------------------------------------------------
Cash (used in) provided by financing activities 4,929,930 235,606 (9,522)
- -------------------------------------------------------------------------------------------------------------------------------
Net (decrease) increase in cash and cash equivalents during the period (999,192) (662,509) 1,017,007
Cash and cash equivalents, beginning of period 1,355,613 2,018,122 1,001,115
- -------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of period 356,421 1,355,613 2,018,122
===============================================================================================================================
Income taxes paid 98,491 59,956 265,771
Interest paid 146,781 121,579 67,356
2001 Fiscal Year - Non cash items arose from the purchase of Chell.com
assets during the 2001 Fiscal Year. They are $1,936,272 of property & equipment,
$107,589 of goodwill, $45,044 of prepaids, $1,404 in other accounts receivable
and in addition shares were issued (Note 13f). Other assets of $174,084 arose
from the issue of warrants, shares were issued for consulting fees and salaries
in the amount of $659,359, shares were issued for a debt payment on the GalaVu
purchase in the
F-6
amount of $115,165, write-off of leaseholds of $355,560 and write-off of
prepaids from Chell purchase of $367,235.
2000 Fiscal Year - Non cash items arose from the purchase of GalaVu
Entertainment Network Inc. during the 2000 Fiscal Year. They are: $3,300,000 of
long-term debt, and the associated unamortized discount of ($637,302), accretion
of interest of $173,076 in accrued liabilities; assumption of liabilities of
$529,440, $337,779 one-time compensation charge arising from the change in the
preferred share conversion rate and the issuance of shares amounting to
$295,360.
The accompanying notes are an integral part of these statement
1. DESCRIPTION OF BUSINESS AND OPERATIONS
Chell Group Corporation [the "Company"] was incorporated under the laws of the
State of New York on May 12, 1986. The Company is the holding company for NTN
Interactive Network Inc. ["Interactive"], GalaVu Entertainment Network Inc.
["GalaVu"] and Chell Merchant Capital Group ["CMCG"], all of which are
wholly-owned operating companies. The Company also owns all of the outstanding
stock of 3484751 Canada Inc., a corporation the Company established and
incorporated under the Canada Business Corporations Act on April 20, 1998.
Interactive owns all of the outstanding stock of Magic Lantern Communications
Ltd. ["Magic"]. Magic and its subsidiaries are involved in the marketing and
distribution of educational video and media resources. 3484751 Canada Inc. was
incorporated for the sole purpose of owning a property, purchased in 1998, on
behalf of the Company, which provides Magic and GalaVu with operating
facilities.
CMCG is incorporated under the Ontario Business Corporations Act and is a
technology buyout/operating company applying private equity principles and
capital market expertise to consolidate earnings and strategically grow the
solid, but undervalued public and private companies it acquires. CMCG's
acquisitions are strategically designed to support its long-term vision of the
technology market.
Interactive is incorporated under the Canada Business Corporations Act and has
signed a license agreement [the "NTNC license"] with NTN Communications, Inc.,
an unrelated Delaware company, for exclusive representation of their interactive
communications for all industry sectors in Canada. This interactive
entertainment network allows viewers to participate actively with a variety of
television programs, trivia and sports games. Present subscribers to the
Company's networks are hotels, restaurants, bars and university clubs. Each
subscriber either purchases the system hardware directly or rents the system
from Interactive. Interactive purchases the subscriber system from NTN
Communications, Inc. and various other suppliers. Following the installation,
each subscriber pays a monthly fee to Interactive for the program content and
maintenance services, which range from $650 to $750. The monthly fees for rental
systems range from approximately $255 to $290.
GalaVu is incorporated under the Ontario Business Corporations Act and is a
technology-based entertainment provider of interactive in-room entertainment
systems for small and mid-sized hotels. GalaVu's interactive system is based
upon proprietary technology and provides a suite of products including movies on
demand, premium television programming and other information and entertainment
services.
The Company's primary market to date has been Canada.
As shown in the financial statements, the Company incurred a net loss from
continuing operations of $9,622,841 during the year ended August 31, 2001 and,
as of that date, had a working capital deficiency of $4,432,000. The Company's
business plans for 2002 contemplates obtaining additional working capital
through refinancings or restructurings of its existing loan agreements, reducing
operating overhead (which has already begun through workforce consolidation),
and the possible sale of some of its existing subsidiaries. Management is of the
opinion that they will be able to obtain enough working capital and that,
together with funds provided by operations, there will be sufficient working
capital for the Company's requirements in the future.
2. ECONOMIC DEPENDENCE
Interactive is dependent upon NTN Communications, Inc. as its sole supplier for
the transmission of program content to the Company's subscribers. In the event
that NTN Communications, Inc., which operates under the going-concern
assumption, terminates the transmission of program content, the Company
believes, but cannot
F-7
assure, that such services are likely to be continued by others. As of September
30, 2001, NTN Communications, Inc. had shareholders' equity of $1,142,000 and a
working capital deficit of $3,098,000 according to its unaudited balance sheet
included in its quarterly report. NTN Communications, Inc. has reported a
quarterly net loss for September 2001 of $732,000, a quarterly net loss for June
2001 of $949,000 and a quarterly net loss for March 2001 of $1,578,000. It
reported a net loss for the year ended December 31, 2000 of $9,589,000. All such
amounts are quoted in U. S. dollars [note 9].
3. SIGNIFICANT ACCOUNTING POLICIES
Basis of presentation
These consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America. They
are expressed in Canadian dollars which is the currency of the primary economic
environment in which operations are conducted.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenue and expenses during the reporting period. Actual
results could differ from those estimates.
Basis of consolidation
These consolidated financial statements include the accounts of the Company, its
wholly-owned subsidiaries Interactive, Magic, GalaVu, 3484751 Canada Inc.,
Interlynx, CMCG and Chell.com USA Inc. Magic conducts its operations directly
and through its wholly-owned subsidiaries, 1113659 Ontario Ltd. ["Viewer
Services"] and Tutorbuddy Inc. ["Tutorbuddy"], and its 75% ownership of Sonoptic
Technologies Inc. ["STI"]. Effective June 16, 1999, Magic acquired an additional
50% of the shares of Viewer Services, thereby making Viewer Services a
wholly-owned subsidiary of Magic. On September 10, 1997, effective September 1,
1997, Interactive acquired 51% of the outstanding shares of Interlynx. On June
1, 1999, Interactive acquired the remaining 49% of the outstanding shares of
Interlynx. Effective June 30th 2001, the Company signed an agreement to sell
Interlynx, a wholly-owned subsidiary of NTN for $50,000 and a promissory note of
$45,000. The Company's financial statements have been restated to reflect
Interlynx as a discontinued operation for all periods presented. The Company
uses the equity method for investments in which it owns less than 51%.
The 25% minority interest liability in STI has been reflected at zero due to
operating losses.
All significant intercompany transactions have been eliminated.
Foreign exchange translation
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.
F-8
Revenues
Revenue from network services is recognized on a monthly basis beginning when
the systems are installed on the purchasers' premises. The payment terms are on
a monthly basis.
Revenue from Pay-tv is recognized at the time of viewing.
Revenue from event programming is recognized upon completion of the contract.
Revenue from advertising sponsorship is recognized on a monthly basis over the
term of the contract.
Revenue from video sales and video dubbing is recognized upon shipment.
Software sales are recognized in accordance with the American Institute of
Certified Public Accountants Statement of Position (SOP) 97-2, "Software Revenue
Recognition." Pursuant to SOP 97-2, software sales are recognized on sales
contracts when all of the following conditions are met: a signed contract is
obtained, delivery has occurred, the total sales price is fixed and
determinable, collectibility is probable, and any uncertainties with regard to
customer acceptance are insignificant. For those contracts that include a
combination of software and services, sales are allocated among the different
elements based on company-specific evidence of fair value of each element. Sales
allocated to software are recognized as the above criteria are met. Sales
allocated to services are recognized as services are performed and accepted by
the customer or, for maintenance agreements, ratably over the life of the
related contract.
Cash and cash equivalents
Cash and cash equivalents include cash and term deposits, which mature in less
than three months from the date of issue. The carrying value of term deposits
approximates their fair values.
Short-term investments
Investments at August 31, 2001 and 2000 consist of debt securities and
marketable equity securities. The Company has classified its portfolio as
"trading". Trading securities are bought and held principally for the purpose of
selling them in the near term and are recorded at fair value. Unrealized gains
and losses on trading securities are included in the determination of net income
(loss) for the year. The fair value of these securities represents current
quoted market offer prices.
Inventory
Inventory consists of finished goods held for sale or rent, which are valued at
the lower of cost, using the first-in, first-out method, and net realizable
value.
Property and equipment
Property and equipment are stated at cost less accumulated depreciation.
Equipment is depreciated using a declining balance rate of 20%. Computer
equipment as well as masters and libraries are depreciated using a declining
balance rate of 30%. Automobiles are depreciated on a straight-line basis over 3
years, buildings on a straight-line basis over 25 years, software on a
straight-line basis over 3 years and rental equipment and leasehold improvements
both on a straight-line basis over 5 years.
On an ongoing basis, management reviews the valuation and depreciation of
property and equipment, taking into consideration any events and circumstances
which might have impaired the carrying value. The Company assumes there is an
impairment if the carrying amount is greater than the expected net future cash
flows. The amount of impairment, if any, is measured based on projected
discounted future cash flows, using a discount rate that reflects the Company's
average cost of funds.
F-9
Software development costs
The Company capitalizes the costs of software development when technological
feasibility of the computer software product is established. Capitalization of
software ceases when the product is available for release to customers.
Capitalized costs are amortized on the basis of products sold.
Licenses and goodwill
Licenses are stated at cost less accumulated amortization. Amortization for the
NTNC license is provided over a 25-year period using the straight-line basis to
December 31, 2015. Accumulated amortization amounted to $137,512 [2000-
$125,010].
On August 28, 1998, the Company entered into an agreement [the "Players
license"] for $78,401 [U.S.$50,000] with Players Network Inc. ["Players"],
whereby the Company was appointed by Players as the exclusive Canadian
distributor of its products. The Company was also granted the irrevocable
option, by Players, to purchase from treasury up to 50,000 common shares in the
capital stock of Players, at a purchase price of $1.75 per share (U.S.). This
option expired on August 28, 2000 and was not exercised. The agreement provided
the Company the right to terminate the agreement for the 30-day period
immediately following the end of the first year of the term of the agreement. In
the event the agreement is so terminated, the Company would receive, from
treasury, 50,000 common shares in the capital stock of Players. The agreement
was not terminated. Amortization of this license is provided over a 10-year
period using the straight-line basis to 2009. Accumulated amortization amounted
to $23,539 [2000 - $15,693].
Goodwill is stated at cost less accumulated amortization. Amortization is
provided using the straight-line basis over a period varying from 10 to 20
years, depending on the transaction that generated the goodwill. Accumulated
amortization amounted to $831,944 [2000 - $691,120], net of amounts included in
discontinued operations.
On an ongoing basis, management reviews the valuation and amortization of the
licenses and goodwill, taking into consideration any events and circumstances
which might have impaired the fair value. The Company assumes there is an
impairment if the carrying amount is greater than the expected net future cash
flows. The amount of impairment, if any, is measured based on projected
discounted future cash flows, using a discount rate that reflects the Company's
average cost of funds. (See "Recent Pronouncements" below)
Other assets
Other assets are stated at cost net of amortization. Amortization is provided
using a straight-line basis over the estimated life of the assets.
Income taxes
The Company accounts for deferred income tax assets and liabilities based on the
difference between the financial statement and tax basis of assets and
liabilities using enacted tax rates in accordance with SFAS No. 109. [see note
7].
Earnings per share
Basic earnings per share are computed by dividing income available to common
shareholders by the weighted average number of common shares outstanding for the
period excluding contingent shares issued in accordance with SFAS No. 128.
Diluted earnings per share are calculated in accordance with the treasury stock
method and are based on the weighted average number of common shares and
dilutive common share equivalents outstanding.
Employee stock options
The Company accounts for its stock option plans and its employee stock purchase
plan in accordance with the provisions of the Accounting Principles Board's
Opinion No. 25, "Accounting for Stock Issued to Employees"
F-10
["APB 25"]. [see "Recent Pronouncements" below and note 10[c]].
Recent pronouncements
In June 2001, the Financial Accounting Standards Board (FASB) issued Statements
of Financial Accounting Standards, No. 141, Business Combinations, and No. 142,
Goodwill and Other Intangible Assets, effective for fiscal years beginning after
December 15, 2001. Under the new rules, the pooling of interests method of
accounting for business combinations is no longer allowed and goodwill and
intangible assets deemed to have indefinite lives will no longer be amortized
but will be subject to annual impairment tests in accordance with the
Statements. Other intangible assets will continue to be amortized over their
useful lives.
In March 2000, FASB issued Interpretation No. 44 (FIN 44), "Accounting for
Certain Transactions involving Stock Compensation, an Interpretation of APB
Opinion No. 25." FIN 44 clarifies the application of APB No. 25 for certain
issues, including the definition of an employee, the treatment of the
acceleration of stock options and the accounting treatment for options assumed
in business combinations. FIN 44 became effective on July 1, 2000, but is
applicable for certain transactions dating back to December 1998. The adoption
of FIN 44 did not have a material impact on the Company's financial position or
results of operations.
In December 1999, the Securities and Exchange Commission (SEC) issued Staff
Accounting Bulletin (SAB) No. 101, "Revenue Recognition in Financial
Statements." (SAB No. 101). SAB No. 101 expresses the views of the SEC staff in
applying generally accepted accounting principles to certain revenue recognition
issues. The Company has adopted the provisions of SAB No. 101 in the first
quarter of fiscal 2001 and its adoption had no material impact on its financial
position or its results of operations.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities."(SFAS No. 133). SFAS No. 133, as amended by
SFAS No. 138, establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts (collectively referred to as derivatives) and for hedging activities.
SFAS No. 133 requires the recognition of all derivatives as either assets or
liabilities in the statement of financial position and the measurement of those
instruments at fair value. The Company was required to adopt this standard in
the first quarter of fiscal year 2001 pursuant to SFAS No. 137 (issued in June
1999), which delayed the adoption of SFAS No. 133 until that time. The Company's
adoption of SFAS No. 133 did not have a material impact on the its financial
position or its results of operations.
4. SHORT-TERM INVESTMENTS
Short-term investments consist of the following:
2001 2000
$ $
--------------------------------------------------------------------
Shares 19,676 --
Money market funds -- 166,175
Debt securities
U.S. treasury securities -- 103,552
--------------------------------------------------------------------
19,676 269,727
====================================================================
5. NOTE RECEIVABLE
The details of the note receivable are as follows:
2001 2000
$ $
--------------------------------------------------------------------
Long-term
Connolly-Daw Holdings Inc. 160,000 160,000
--------------------------------------------------------------------
160,000 160,000
====================================================================
F-11
The unsecured note receivable from Connolly-Daw Holdings Inc. ["Connolly-Daw"]
bears interest at the bank's prime rate, calculated and payable monthly, not in
advance. The note is payable on demand, however, the Company does not intend to
call the note within the next fiscal year. The President and Secretary of
Connolly-Daw are the Controller and Chief Executive Officer of Magic. The bank's
prime rate was 5.75% at August 31, 2001 [2000 - 7.5%].
6. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
2001 2000
=========================================== ==========================================
Accumulated Net book Accumulated Net book
Cost depreciation value Cost depreciation value
$ $ $ $ $ $
-------------------------------------------------------------------------------------------------------------------------
Land 785,500 -- 785,500 785,500 -- 785,500
Buildings 1,480,401 260,489 1,219,912 1,480,401 227,505 1,252,896
Rental Equipment 3,911,487 3,574,523 336,964 3,880,304 2,886,104 994,200
Equipment 6,233,095 2,663,991 3,569,104 5,357,321 1,585,572 3,771,749
Software 810,166 301,571 508,595 591,253 151,069 440,184
Automobiles 13,383 12,559 824 13,383 8,829 4,554
Computer Equipment 1,088,304 474,908 613,396 370,084 246,661 123,423
Masters and Libraries 937,056 467,547 469,509 545,949 281,560 264,389
Leasehold improvements 1,020,353 263,875 756,478 113,301 60,576 52,725
-------------------------------------------------------------------------------------------------------------------------
16,279,745 8,019,463 8,260,282 13,137,496 5,447,876 7,689,620
=========================================================================================================================
During the year, depreciation of property and equipment was $2,667,248 [2000 -
$2,035,985; 1999 - $1,212,038].
7. INCOME TAXES AND DEFERRED INCOME TAXES
The provision for income taxes consists of the following:
2001 2000 1999
$ $ $
--------------------------------------------------------------------
Current
Federal -- -- 98,000
Provincial -- -- 52,000
--------------------------------------------------------------------
-- -- 150,000
====================================================================
The difference between the provision for income taxes and the amount computed by
applying the combined basic federal and provincial income tax rate of 42.1%
[2000 - 43.9%; 1999 - 44.6%] to income before income taxes is as set out below:
2001 2000 1999
Taxes on continuing operations $ $ $
---------------------------------------------------------------------------------------
Statutory rate applied to pre-tax loss (4,051,216) (509,125) (285,001)
Benefit of current year's losses not recognized 3,734,669 405,563 344,782
Expenses not deductible for tax purposes 316,547 117,745 167,333
Non-taxable accounting income -- -- (42,482)
Other -- (14,183) (34,632)
---------------------------------------------------------------------------------------
-- -- 150,000
=======================================================================================
F-12
2001 2000 1999
Taxes on discontinued operations $ $ $
---------------------------------------------------------------------------------------------------
Statutory rate applied to loss from discontinued operations (675,025) (376,406) (101,357)
Loss of subsidiary sold during the year (539,922) -- --
Capital loss on sale of subsidiary 1,064,133 -- --
Benefit of current year's losses not recognized 150,814 376,406 101,357
---------------------------------------------------------------------------------------------------
-- -- --
===================================================================================================
As at August 31, 2001, the Company's deferred tax assets primarily relating to
the benefit of realizing losses available for carry forward and the timing
difference of the write-off of property and equipment, net of a valuation
allowance of $5,600,000, were nil (2000 - nil after a valuation allowance of
$1,600,000).
At October 1, 1996, Magic and its subsidiaries had aggregate operating losses of
$676,000. The purchase price of Magic has not been allocated to the operating
losses since a valuation allowance has been charged against the entire amount.
During 1999, $152,000 of these losses were applied to reduce taxable income. In
2000 and 2001 Magic did not have taxable income.
Accordingly, when realized, the tax benefit of the unrecognized loss
carryforwards will be applied to reduce goodwill related to the acquisitions of
Magic. The goodwill related to Magic was reduced by $51,687 as a result of
utilizing pre-acquisition losses during 1999.
At August 31, 2001, the Company and certain subsidiaries have non-capital loss
carryforwards of approximately $12,000,000 that can be carried forward against
future taxable income and capital losses of approximately $2,500,000 that can be
carried forward indefinitely against capital gains realized in future years. The
non-capital losses begin to expire in 2002.
F-13
8. LOANS AND NOTES PAYABLE
Loans and notes payable consists of the following:
2001 2000
$ $
-----------------------------------------------------------------------------
Loans Payable
Provincial Holdings Ltd. ["PHL"] [i] 750,000 750,000
Province of New Brunswick ["PNB"] [ii] -- 19,381
Atlantic Canada Opportunities Agency ["ACOA"] [iii] 27,700 36,930
ACOA [iv] 32,985 38,485
ACOA [v] 18,608 21,908
Royal Bank of Canada [vi] 1,206,478 1,243,151
-----------------------------------------------------------------------------
2,035,771 2,109,855
-----------------------------------------------------------------------------
Notes Payable
Richard Wolfe 69,778 --
Debenture & Note Payable [vii & viii] 4,890,750 --
Promissory notes - GalaVu [note 13[e]] 2,662,698 2,662,698
-----------------------------------------------------------------------------
7,623,226 2,662,698
-----------------------------------------------------------------------------
Liens notes -- 2,119
-----------------------------------------------------------------------------
9,658,997 4,774,672
=============================================================================
[i] In June 1995, PHL advanced $750,000 to STI. This loan is collateralized
by a demand promissory note signed by STI and bears interest at 6% per
annum, compounded annually, commencing October 1995. Interest was
forgiven by PHL for the period from October 1, 1995 to September 30,
2000. The carrying value of the loan approximates its fair value.
Subsequent to September 2000, the loan bears interest at 6.75% compounded
annually.
The loan is subject to an agreement dated March 15, 1995 which, inter
alia, provides for repayment in full of principal plus interest at the earlier
of [a] the commencement of redemption of shares pursuant to a redemption
agreement [note 9[d]] or [b] September 30, 2002 subject to any extension agreed
to, or [c] on any breach of STI's obligations under the loan agreement or any
other agreement with PHL.
[ii] In June 1995, PNB advanced $100,000 to STI. The loan was subject to a
loan agreement dated May 25, 1995 and was secured by a demand promissory
note which bears interest at 9.7% per annum, calculated half-yearly, not
in advance. Subject to a forgiveness agreement outlined below, the
principal plus interest was repayable at the earlier of [a] January 31,
1998 or earlier at the option of STI or [b] any breach of STI's
obligations under the loan agreement.
A forgiveness agreement dated May 24, 1995 provides that the principal
plus interest may be forgiven in whole or in part, the amount dependent upon
STI's number of full-time employees during the 1997 calendar year. The loan was
fully forgiven during the year ended August 31, 2001.
[iii] ACOA advanced this unsecured non-interest bearing loan to STI in April
1995. The loan is repayable in five equal quarterly installments of
$7,040 commencing May 1, 2000 and one final installment of $1,730. The
fair value of the loan approximates its carrying value.
[iv] ACOA advanced this unsecured non-interest bearing loan to STI in May
1999. The loan can be increased to a maximum of $108,356. The balance
drawn on this loan at August 31, 2001 is $32,985. Commencing on October
1, 2000, the loan was repayable as follows: six consecutive monthly
installments of $500, followed by; six consecutive monthly installments
of $1,000, followed by; six consecutive monthly installments of $1,500,
followed by; six consecutive monthly installments of $2,000, followed by;
three consecutive monthly installments of $2,500, followed by; one final
installment of $985.
F-14
The fair value of the loan approximates its carrying value.
[v] ACOA advanced this unsecured non-interest bearing loan to STI in
September 2000. The loan can be increased to a maximum of $23,038. The
balance drawn on this loan at August 31, 2001 is $18,608. If the loan is
increased to the maximum, the loan would be repayable in seventy-nine
equal consecutive, monthly installments of $275, followed by one final
installment of $183. The fair value of the loan approximates its carrying
value.
[vi] In April 1998, the Royal Bank of Canada made available a Matched Fund
Term Loan in the amount of $1,319,000 in order to finance the purchase of
10 Meteor Drive, including leaseholds, and to refinance the demand
installment loan on 775 Pacific Road, a property owned by Magic.
Borrowings are repayable by blended monthly payments of principal and
interest based on a 20-year amortization period with the balance due and
payable at the end of the 5-year term on April 27, 2003. The interest
rate in effect for the first 5-year term of the loan is 6.98%. The fair
value of the loan approximates its carrying value.
The loan is collateralized by a fixed debenture of $1,000,000,
hypothecated to Magic's land and buildings, a guarantee and postponement of
claim of $650,000 signed by Magic, a collateral first mortgage in the amount of
$490,000 covering the property at 10 Meteor Drive, and a general security
agreement covering all the assets of Interactive, other than real property.
[vii] On January 15, 2001, the Company received US$1,500,000 in return for a
promissory note. The note bears interest at 2% per month and US$1,000,000
of the principal and accrued interest is due and payable on December 5,
2001. The remaining balance will be paid in seven monthly payments of
$100,000 commencing January 15th, 2001 with a final payment of $8,750 due
on August 5, 2002.
[viii] On October 3, 2000, the Company closed the sale of a US$3,000,000
Convertible 10% Debenture to the VC Advantage Limited Partnership
("VCALP"). As at August 31, 2001, US$1,700,000 has been advanced. This
unsecured convertible debenture is due three years from issue. The
Convertible Debenture bears interest at 10% per annum, payable upon
conversion, redemption or maturity. The unpaid principal of the debenture
bears interest from the date that it is actually advanced until paid.
Interest is payable in cash or stock at our option. The Convertible
Debenture is convertible into common stock, at US$3.00 per share, in
amounts specified by the VCALP. The maximum number of common shares VCALP
will receive is one million. On the close date, the Company also issued
50,000 warrants to purchase 50,000 common shares at US$3.00 per share to
VCALP. The warrants have a term of four years. On November 30, 2000 the
convertible debenture was assigned by VCALP to CALP II Limited
Partnership.
Approximate future annual principal payments for long-term debt, exclusive of
the above lien notes, are as follows:
$
----------------------------------------------------
2002 3,774,658
2003 2,615,493
2004 3,243,653
2005 8,800
2006 8,800
2007 and thereafter 7,593
----------------------------------------------------
9,658,997
====================================================
F-15
9. COMMITMENTS
[a] Commissions expense to NTN Communications, Inc.
Pursuant to an agreement dated March 23, 1990, Interactive pays
commissions to NTN Communications, Inc. when the related revenues are earned at
the rate of U.S. $2,205 per year per subscriber. Interactive also pays NTN
Communications, Inc. a royalty fee equal to 25% of the net revenues as defined
in the agreement derived from all services except for certain hospitality and
special projects that existed at March 23, 1990; a royalty fee equal to the
production quotation submitted by NTN Communications, Inc. plus 10% of the gross
profit of special projects [special broadcasts for a non-continuous selective
event]; and a one-time royalty fee equal to NTN Communications, Inc.'s
production costs for any new programming developed by Interactive to be added to
the existing programming schedule. The agreement expires on December 31, 2015.
Total amounts expensed in the year under this agreement were $1,865,674 [2000 -
$1,822,684; 1999 - $2,011,202].
[b] Commissions expense - other
Commissions expense to sub-licensees is recognized when the related revenues are
earned and are calculated as follows:
[i] 30% of all fees received by Interactive under any Commercial User
Agreement as then in effect if such agreement is executed through
the efforts of the sub-licensee where the establishment subject to
the Commercial User Agreement is located within the territory during
the first term of any such agreement;
[ii] 10% of all net fees received by Interactive from National
Advertisers [sponsors] based on the number of Commercial User
locations within the territory; and
[iii] 5% of all net fees received by Interactive under any Residential
User Agreement within the territory, which may only be solicited by
Interactive directly.
All commission payments are made to sub-licensees no later than the 15th
of the month immediately following the month in which user fees and sponsor
fees, from which said commissions are earned, are received and collected by
Interactive.
[c] Lease commitments
The future minimum annual lease payments under operating leases are as follows:
Vehicles $
--------------------------------------------------------
2002 19,915
2003 4,794
2004 9,189
2005 --
2006 --
2007 and thereafter --
--------------------------------------------------------
33,898
========================================================
F-16
Office Equipment $
-------------------------------------------------------
2002 150,578
2003 76,327
2004 54,197
2005 --
2006 --
2007 and thereafter
-------------------------------------------------------
281,102
=======================================================
Premises $
-------------------------------------------------------
2002 493,190
2003 380,564
2004 380,564
2005 71,086
2006 --
2007 and thereafter --
-------------------------------------------------------
1,325,404
=======================================================
Operating lease expenses were $570,616 for 2001, $382,610 for 2000, and $201,366
for 1999.
[d] Redemption of shares of subsidiary
STI, a subsidiary, has entered into a redemption agreement dated March 15, 1995
with its minority shareholder [25% of common shares held], PHL. Shares held by
PHL may be redeemed by STI in minimum numbers of five after December 31, 1997
provided STI has repaid all indebtedness to PHL and PNB, or the PNB indebtedness
has been forgiven, and must be redeemed in full on or before September 20, 2002.
The redemption price is calculated at the higher of [i] the purchase price per
share [$0.04], or [ii] the purchase price per share plus the increase per share
in retained earnings of the corporation to the date of redemption, calculated by
adding back to the retained earnings the pro rata share applicable to the number
of shares being redeemed, of all interest paid or accrued on the loan by PHL and
to the corporation in the amount of $750,000 and deducting therefrom the
interest actually paid, pro rata to the number of shares being redeemed. There
has been no repayment on the loan as at August 31, 2001.
As at August 31, 2001, the value of the shares, if redeemed, totaled a nominal
amount.
[e] Standby letters of credit
GalaVu has a $100,000 standby letter of credit in favour of one of its
suppliers. Any amounts drawn on this facility are charged to our bank account.
These facilities have not been used in 2001, 2000 or 1999.
[f] Employment agreements
The Company and certain subsidiaries have entered into employment agreements
with certain executive management employees with terms of between one and two
years. These agreements expire in fiscal 2002. The remaining commitment for 2002
is approximately $208,000.
On September 19, 2000, the Company entered into an employment agreement with
Cameron Chell, pursuant to which Mr. Chell serves as the Company's President and
Chief Executive Officer. The agreement provides for an initial base compensation
of $360,000, together with automobile expenses of $8,400. In addition to the
fixed remuneration, the Company shall provide Mr. Chell with the services of an
Executive Assistant on an ongoing basis and an Accountant for a reasonable
period of time to allow for the completion of outstanding accounting work
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
F-17
his salary and automobile allowance in an effort to reduce our cash
requirements. These were eliminated with the understanding that the compensation
of Mr. Chell will be mutually agreed upon between the parties.
10. SHARE CAPITAL
[a] Authorized shares
The Company's authorized share capital comprises 50,000,000 common shares
(increased from 20,000,000 shares on February 28, 2001),with a par value of
$0.063 [U.S. $0.0467] per share and 1,500,000 non-cumulative preferred shares
with a par value of $0.012 [U.S. $0.010] per share. The preferred shares are
voting and convertible, such that 3 preferred shares are exchangeable for 1
common share, at the option of the holders. The conversion rate in 1999 was such
that 4.67 preferred shares were exchanged for 1 common share, at the option of
the holders.
[b] Issued and outstanding shares
As at August 31, 2001, there were no preferred shares outstanding [2000 -
900,000 aggregating - $10,917] . On March 30, 2001, these 900,000 preferred
shares were converted to 300,000 common shares.
Common shares issued and outstanding for accounting purposes are as follows:
Common shares
------------------------ Capital in excess
Number Amount of par value Total
# $ $ $
=================================================================================================================
Balance as at August 31, 1998 2,625,170 162,484 8,837,948 9,000,432
Payment for services rendered 5,500 387 26,557 26,944
Interlynx acquisition [note 13[a]] 27,778 1,920 93,171 95,091
Conversion of promissory notes [i] 98,193 6,844 602,207 609,051
-----------------------------------------------------------------------------------------------------------------
Balance as at August 31, 1999 2,756,641 171,635 9,559,883 9,731,518
GalaVu acquisition [note 13 [e]] 100,000 6,897 288,463 295,360
Exercise of 68,500 stock options 68,500 4,703 276,431 281,134
Change in preferred shares conversion rate -- 7,887 329,892 337,779
-----------------------------------------------------------------------------------------------------------------
Balance as at August 31, 2000 2,925,141 191,122 10,454,669 10,645,791
Purchase of assets and shares from Chel.com
Ltd. and Cameron Chell [note 13[f]] 5,426,772 372,923 2,229,291 2,602,214
Issued in lieu of salary 131,974 9,484 315,577 325,061
Settlement of debt 36,602 2,694 109,085 111,779
Preferred shares converted 300,000 13,065 (9) 13,056
Warrants -- -- 370,065 370,065
Consulting fees rendered 145,000 10,405 456,218 466,623
Exercise of 62,750 stock options 62,750 4,416 208,637 213,053
-----------------------------------------------------------------------------------------------------------------
Balance as at August 31, 2001 9,028,239 604,109 14,143,533 14,747,642
=================================================================================================================
[i] The consideration for the acquisition of Magic [note 13[c]] included
promissory notes with a maturity value of $1,250,000. Under the
terms of the purchase agreement, the Company elected to issue common
shares as payment against $560,000 of these notes during fiscal
1998. In fiscal 1999, the Company elected to issue shares to pay the
remaining $609,051 outstanding on the promissory notes.
[c] Long-Term Incentive Plan
The Company has adopted a Long-Term Incentive Plan [the "Plan"] designed to
compensate key employees of our Company for the performance of their corporate
responsibilities. The benefits to employees under the Plan are dependent upon
improvement in market value of the Company's common shares. The Plan offers
selected key employees the opportunity to purchase common shares through the
exercise of a stock option. An option entitles the employee to purchase common
shares from the Company at a price determined on the date the option is granted.
The option exercise price is the closing trading price of the stock on the day
prior to the grant date. The options vest over a four-year period from the grant
date, at the rate of 25% per year. Options granted prior to August 31, 1998
F-18
vest over a two-year period from the grant date, 50% after one year and 50% at
the end of the second year. The options expire five years after the grant date.
The Plan also provides that selected key employees may receive common shares as
an award of Restricted Stock. Restricted Stock consists of common shares that
are awarded subject to certain conditions, such as continued employment with the
Company or an affiliate for a specified period. Up to 20% of the outstanding
common stock, on a fully diluted basis on the date of the grant, excluding
outstanding options may be issued under the plan.
The following is a summary of outstanding stock options:
Weighted average Total
exercise price
U.S. $ #
=================================================================
Balance as at August 31, 1998 460,000
Issued 2.30 285,000
Forfeited 2.41 (18,500)
Expired 2.33 (7,500)
-----------------------------------------------------------------
Balance as at August 31, 1999 719,000
Issued 9.42 772,000
Exercised 2.79 (68,500)
Expired 2.92 (125,500)
-----------------------------------------------------------------
Balance as at August 31, 2000 1,297,000
Issued 4.33 94,500
Exercised 2.68 (62,750)
Expired 2.40 (3,750)
-----------------------------------------------------------------
Balance as at August 31, 2001 1,325,000
=================================================================
Exercise price Expiry date Total
U.S. $ #
=========================================================================
3.00 November 20, 2001 47,000
3.00 November 25, 2001 [I] 56,750
3.00 April 8, 2002 [I] 1,500
3.00 November 17, 2002 [I] 115,500
3.00 November 20, 2002 15,000
2.00 November 23, 2003 141,250
3.50 February 25, 2004 1,500
3.00 June 11, 2004 [note 13[a]] 80,000
2.00 October 14, 2004 75,000
1.81 November 23, 2004 30,000
4.375 April 3, 2005 25,000
9.75 August 11, 2005 642,000
9.75 November 1, 2005 23,000
3.50 December 6, 2005 71,500
-------------------------------------------------------------------------
Balance as at August 31, 2000 1,325,000
=========================================================================
[i] Repriced options - At a meeting of the Company's Board of Directors
on July 10, 1998, the Board determined that it was in the best
interests of the Company to offer the holders of options, pursuant
to the Company's Long-Term Incentive Plan, a reduction in the
exercise price of outstanding options to $3.00 per share if the
option holders agreed not to exercise such options for at least six
months after the repricing. Option holders were given the choice of
keeping their existing option pricing in lieu of agreeing not to
exercise such options for six months. All option holders chose to
receive repriced options. The repriced option exercise amount is the
closing trading price of the Company's stock on July 9, 1998.
The number of stock options that are exercisable at August 31, 2001 is 761,163
[2000 - 363,666].
The weighted average fair value of options granted during 2001 was U.S.
$1.17[2000 - U.S $5.51].
The Company accounts for its stock option plans and its employee stock purchase
plan in accordance with the provisions of APB 25. Accordingly, because the
exercise price of the employee stock options equals the market
F-19
price of the underlying stock on the date of grant, no compensation expense has
been recognized in the consolidated financial statements for these plans.
Pro forma information regarding net income and earnings per share is required by
FAS 123, and has been determined as if we had accounted for its employee stock
options under the fair value method of that statement. The fair value for these
options was estimated at the date of grant using a Black-Scholes option
valuation model with the following weighted average assumptions for 2001, 2000
and 1999: risk-free interest rate of 5.39% [2000 - 5.84%; 1999 - 5.32%];
dividend yield of 0% [2000 - 0%; 1999 - 0%]; volatility factor of 0.707 [2000 -
0.848; 1999 - 0.819]; and a weighted average expected life of the options of 3
years [2000 - 4 years; 1999 - 4 years].
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options that have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
our stock options have characteristics significantly different from those of
traded options, and because changes in the subjective input assumptions can
materially affect the fair value estimate, in management's opinion, the existing
models do not necessarily provide a reliable single measure of the fair value of
its employee stock options.
The Company's pro forma net loss and loss per share follows:
2001 2000 1999
-----------------------------------------------------------------------
$ $ $
Pro forma net loss (12,479,430) (2,518,310) (1,399,105)
=======================================================================
Pro forma loss per share
Basic (1.49) (0.88) (0.53)
Diluted (1.49) (0.88) (0.53)
=======================================================================
F-20
11. EARNINGS (LOSS) PER SHARE
Earnings (loss) per share were calculated in accordance with Statement of
Financial Accounting Standards No. 128. The following table sets forth the
computation of basic and diluted earnings (loss) per share for the years ended
August 31:
---------------------------------------------------------------------------------------------------------
2001 2000 1999
$ $ $
=========================================================================================================
Numerator
Net income (loss) [numerator for basic earnings (loss)
per share] $(11,226,225) $(2,323,621) $ (971,497)
Accretion of interest on non-interest bearing convertible
promissory notes (anti-dilutive) $ 183,513 $ 173,076 $ 31,084
Numerator for diluted earnings (loss) per share $(11,042,712) $(2,150,545) $ (940,413)
Denominator
For basic weighted average number of shares 8,393,589 2,873,042 2,635,050
Effect of dilutive securities
Convertible preferred shares -- -- --
Convertible promissory notes -- -- --
Employee stock options -- -- --
Denominator for diluted earnings (loss) per share -
adjusted weighted average number of shares and
assumed conversions 8,393,589 2,873,042 2,635,050
Basic loss per share $ (1.34) $ (0.81) $ (0.36)
Diluted loss per share $ (1.34) $ (0.81) $ (0.36)
=========================================================================================================
During the year ended August 31, 2001, 900,000 preferred shares convertible to
300,000 common shares were exercised and are no longer outstanding. In addition,
options to purchase 1,325,000 common shares were outstanding. These securities
were not included in the diluted loss per share calculation because the effect
would be anti-dilutive.
At August 31, 2000, 900,000 preferred shares convertible to 300,000 common
shares were outstanding. In addition, options to purchase 1,297,000 common
shares were outstanding. These securities were not included in the diluted loss
per share calculation because the effect would be anti-dilutive.
At August 31, 1999, 900,000 preferred shares convertible to 192,857 common
shares were outstanding. In addition, options to purchase 719,000 common shares
were outstanding. These securities were not included in the diluted loss per
share calculation because the effect would be anti-dilutive.
12. CONTINGENT LIABILITIES
On June 12, 1992, the Company filed a lawsuit against an unrelated company,
Interactive Network Inc. of Mountainview, California, U.S.A. and its president.
The suit seeks a non-infringement declaration with respect to a Canadian patent.
This action was discontinued on September 9, 1998.
On June 18, 1992, Interactive Network Inc., a third party, instituted
proceedings against Communications, NTN Interactive Network Inc. and the Company
in the Federal Court of Canada and in the California Supreme Court claiming
patent infringement. It is the opinion of our Company's management and counsel,
that this patent infringement claim will be successfully defended.
Canada Customs and Revenue Agency is currently in discussions with the Company
regarding a potential liability
F-21
with respect to withholding tax on certain amounts paid to Communications. An
assessment of approximately $600,000 has been made to date by Canada Customs and
Revenue Agency and the Company has filed a notice of objection. Management and
counsel believe that it has valid defenses with respect to these matters and,
accordingly, no amount has been recorded in these consolidated financial
statements. In the event that such matters are settled in favour of Canada
Customs and Revenue Agency, the amounts could be material and would be recorded
in the period in which they became determinable.
The Company and its property are not a party or subject to any other material
pending legal proceedings, other than ordinary routine litigation incidental to
its business. To the knowledge of management no other proceedings of a material
nature have been or are contemplated against the Company.
13. BUSINESS ACQUISITIONS/DISPOSITIONS
[a] Interlynx Multimedia Inc.
Effective September 1, 1997, the Company acquired 51% of Interlynx and its
subsidiary for a purchase price of $622,000. The purchase price was satisfied by
$357,000 in cash and the issue of 55,209 shares with a value of $4.80 per share.
The acquisition was recorded using the purchase method of accounting and,
accordingly, the purchase price has been allocated as set out below:
$
-------------------------------------------------------------------
Goodwill 1,136,029
Net liabilities assumed (491,028)
Acquisition costs capitalized (23,001)
-------------------------------------------------------------------
Purchase price 622,000
===================================================================
The excess of cost over net tangible assets (net of liabilities) acquired of
$1,136,029 was allocated to goodwill, which is being amortized over twenty
years.
The Company's 51% share of the operating results of Interlynx are included in
our consolidated statements of operations and retained earnings from the date of
acquisition.
Effective June 1, 1999 the Company acquired the remaining 49% of Interlynx. The
consideration for the purchase included the issuance of 27,778 common shares of
the Company's stock and the issuance of options to purchase 80,000 common shares
of our stock at a strike price of U.S. $3.00. These options were issued out of
the existing employee stock option plan [note 10[c]]. In addition to the
employee stock option plan conditions, entitlement to these options is subject
to the achievement of annual operating profit levels [profit before income taxes
and minority interest] for the three fiscal years ending August 31, 2000, August
31, 2001 and August 31, 2002. At the end of the fiscal year ending August 31,
2000 if annual operating profits are at least $332,000, 26,666 of the options
will be deemed earned. If annual operating profits for the year ending August
31, 2001 are at least $558,000, an additional 26,667 of the options will be
deemed earned. This level of operating profit was not achieved during fiscal
2001 or 2000.
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
====================================================================
F-22
The excess of cost over tangible assets acquired of $95,091 was allocated to
goodwill, which is being amortized over twenty years.
The Company's additional 49% share of the operating results of Interlynx are
included in its consolidated statements of operations and retained earnings from
the date of acquisition.
During fiscal 2001, the Company sold Interlynx for cash consideration of $50,000
and a $45,000 promissory note receivable.
The results of Interlynx have been classified as discontinued operations in the
accompanying financial statements for all years presented.
Summarized operating results of discontinued operations are as follows:
Year Ended
August 31,
2001 2000 1999
--------- --------- ---------
Sales $ 313,555 $ 586,756 $ 596,951
Loss before income taxes (665,673) (857,416) (227,257)
Income tax expense -- -- --
Net (loss) from discontinued operations, net of tax (665,673) (857,416) (227,257)
(Loss) on disposal of discontinued operations, net of tax $(937,711) $ -- $ --
[b] 1113659 Ontario Ltd.
Effective June 16, 1999, the Company acquired through its wholly-owned
subsidiary, Magic, an additional 50% of the shares of Viewer Services, thereby
making Viewer Services a wholly-owned subsidiary of Magic. This acquisition was
recorded using the purchase method of accounting for a consideration of $1 and
the assumption of net liabilities of approximately $144,000. Since the Company
had decided not to continue with this business, the net assets originally
recorded were expensed.
[c] Magic Lantern Communications Ltd.
Effective October 1, 1996, the Company acquired 100% of Magic and its
subsidiaries for a purchase price of $1,553,315 calculated on a discounted
basis. Magic is a Canadian corporation that distributes educational videos and
provides related services. The acquisition was recorded using the purchase
method of accounting and, accordingly, the purchase price has been allocated as
set out below:
$
-------------------------------------------------------------------
Goodwill 2,219,623
Net liabilities assumed (575,126)
Acquisition costs capitalized (91,182)
-------------------------------------------------------------------
Purchase price 1,553,315
===================================================================
F-23
The excess of cost over tangible assets acquired of $2,219,623 was allocated to
goodwill, which is being amortized over twenty years.
The purchase price was satisfied by $450,000 in cash and the issue of two
non-interest bearing promissory notes with a maturity value of $1,250,000. The
first promissory note of $703,133 is repayable by cash payments of $78,133 on
August 31, 1998, $312,500 on August 31, 1999 and $312,500 on August 31, 2000.
Notwithstanding the foregoing, the Company has the right to elect up until June
30, 1998 to issue common shares in lieu of the aforesaid payments as follows:
12,276 shares on August 31, 1998, 49,097 shares on August 31, 1999 and 49,096
shares on August 31, 2000. Should the Company not elect to deliver common
shares, the noteholder has the right, exercisable between July 1, 1998 and July
31, 1998, to require us to issue the common shares as described. The balance due
of $78,133 on August 31, 1998 was satisfied by the issuance of 12,276 common
shares. The balances due on August 31, 1999 and 2000 were satisfied by the
issuance on August 31, 1999 of 49,097 and 49,096 shares respectively [note
10[b]], thereby fully extinguishing the first promissory note. The fair value of
this promissory note at August 31, 1998 approximated its carrying value.
The second promissory note of $546,867 is payable by cash payments of $312,500
on August 31, 1997 and $234,367 on August 31, 1998. Notwithstanding the
foregoing, the Company has the right to elect up until June 30, 1997 to issue
common shares in lieu of the aforesaid payments as follows: 49,097 shares on
August 31, 1997 and 36,821 shares on August 31, 1998. The payment of $65,000 and
the issuance of 38,158 common shares satisfied the balance due of $312,500 on
August 31, 1997 on September 5, 1997. The balance due of $234,367 on August 31,
1998 was satisfied by the issuance of 36,821 common shares [note 10[b]]. The
fair value of this promissory note approximates its carrying value.
The operating results of Magic are included in the Company's consolidated
statements of operations and retained earnings from the date of acquisition.
[d] Image Media Ltd. and Pilot Software
Effective August 18, 1997, the Company acquired certain of the business assets
of Image Media Ltd. and 802117 Ontario Inc., operating as Pilot Software, for
cash of $590,000. This acquisition was recorded using the purchase method of
accounting and, accordingly, the purchase price has been allocated as follows:
$
--------------------------------------------------------------------
Equipment 481,000
Goodwill 45,000
Inventory 37,000
Sundry receivable 27,000
--------------------------------------------------------------------
Purchase price 590,000
====================================================================
The goodwill arising from this acquisition is amortized over 10 years.
[e] GalaVu Entertainment Network Inc.
On September 13, 1999, pursuant to an Asset Purchase Agreement dated as of the
10th day of September, 1999, the Company, through its wholly-owned subsidiary,
GalaVu, acquired, effective as of September 13th, 1999, substantially all of the
property and assets [excluding accounts receivable] of GalaVu Entertainment Inc.
The purchase price was satisfied by the issuance of 100,000 common shares of the
Company's stock and the issuance of a promissory note [the "Note"]. The Note is
secured by a general security interest in all of GalaVu's present and
after-acquired assets. The Note shall be payable in cash or in common shares of
the Company's stock annually, for the term consisting of each of the next five
fiscal years in an amount equal to 50% of the earnings before interest, taxes,
depreciation and amortization of GalaVu for the immediately preceding annual
period. Pursuant to the provisions of the Note, the minimum amount to be
received by the holder of the Note is as follows: fiscal 2001 - $300,000, fiscal
2002 - $500,000, fiscal 2003 - $750,000, fiscal 2004 - $875,000 and fiscal
2005 - $875,000.
F-24
The present value of the Note, discounted at the Company's average borrowing
rate (6.5%) amounted to $2,662,698. The fair value of the Note at August 31,
2001 approximated its carrying value. The interest accretion on the discounted
note amounted to $173,076 during fiscal 2001. This acquisition was recorded
using the purchase method of accounting and accordingly the purchase price has
been allocated as follows:
$
-------------------------------------------------------------------
Property and equipment 3,487,498
Assumption of liabilities (529,440)
-------------------------------------------------------------------
Purchase price 2,958,058
===================================================================
For the year ended August 31, 2001, GalaVu's gross revenue and loss before
taxes were as follows:
Gross Revenue $6,517,940
Loss before taxes ($441,636)
Per share data:
Basic loss (0.15)
Diluted (0.15)
[f] Purchase of assets and shares from Chel.com Ltd. and Cameron Chell
On September 19, 2000, pursuant to an Agreement of Purchase and Sale dated as of
August 4, 2000, the Company and its subsidiary Chell Merchant Capital Group
acquired, certain assets from Chell.com Ltd. ("Chell.com") and the following
shares for an aggregate purchase price of US$27,002,086:
(a) 480,000 shares of cDemo were acquired by the Company which
represents approximately 14.3% of cDemo's issued and outstanding
stock;
(b) 875,000 shares of Engyro Inc. were acquired by the Company which
represents approximately 34% of Engyro's issued and outstanding
stock; and
(c) 60,000 Common Shares of Chell.com (USA) Inc., a Nevada corporation
were acquired by the Company which represents 100% of Chell.com
(USA)'s outstanding stock.
(d) 962,500 Common Shares of eSupplies, Inc., which were held in escrow
as discussed below, were subsequently released.
Pursuant to the Purchase and Sale Agreement, the Company acquired the
above-referenced shares for an aggregate purchase price of US$25,234,583. The
Company also acquired certain assets from Chell.com including office leases,
office equipment and computers, insurance contracts, employment contracts and
service agreements for a price of US$1,767,503. Accordingly the combined
aggregate purchase price for the Chell.com assets, the 480,000 shares of cDemo,
the 875,000 shares of Engyro Inc., and the 60,000 Common Shares of Chell.com
(USA) Inc. was US$27,002,086. The sole director and shareholder of Chell.com is
Cameron Chell. Chell Merchant Capital Group also assumed a liability owing by
Chell.com to Canadian Advantage Limited Partnership II, in the amount of
US$1,767,499 on the condition that Canadian Advantage Limited Partnership II
accept full settlement of such indebtedness by Chell Merchant Capital Group
issuing 451,868 exchangeable shares. The aggregate purchase price payable by the
Company under the Purchase and Sale Agreement of US$27,002,086 was paid by the
Company issuing a total of 5,396,733 Common Shares at the deemed price of
US$3.91155 per share and 1,506,439 shares of CMCG which were exchangeable for
the Company's Common Shares on a one-for-one basis. The 1,476,398 exchangeable
shares of CMCG that were originally issued for the 962,500 eSupplies shares had
been held in escrow pursuant to an escrow agreement dated October 11, 2000 among
Cameron Chell, the Company and Wolff Leia Huckell, Barristers and Solicitors.
These CMCG exchangeable shares were to be released from escrow after receiving
written notice from the Company that the new course of business being taken by
eSupplies fit with the Company's business model and provided significant value
to the Company. Since the Company has subsequently determined that eSupplies'
business profile does not fit with the Company's business profile, the CMCG
F-25
exchangeable shares have been cancelled and the 962,500 eSupplies shares have
been returned to Cameron Chell. Subsequent to the cancellation of the eSupplies
transaction, the aggregate purchase price was reduced to US$21,227,081.
This acquisition was not reflected in the financial statements for the year
ended August 31, 2000 since shareholder approval to ratify the above purchase
transaction was not voted on and approved until September 8, 2000. As a result
of the above, Cameron Chell and Chell.com now own approximately 59% of the
Company's outstanding common stock, that is the Company has in effect been
acquired in a reverse acquisition.
This acquisition of the Company by Cameron Chell and Chell.com and the
acquisition by the Company of the equity interests, as described in the first
paragraph, are reflected at historical cost in the Company's separate financial
statements.
The Company has reflected the minority equity investments using the equity
method of accounting (see note 18).
[g] Purchase of Richard Wolff Enterprises, Inc. assets
Pursuant to an asset purchase agreement dated September 1, 2000, Magic acquired
the assets and business operations of Richard Wolff Enterprises, Inc. ("RWE"), a
company based in Illinois, for a purchase price of $289,590 calculated on a
discounted basis. As a result, Magic has expanded its library of educational
titles and now has access to the international distribution infrastructure
formerly held by RWE. The acquisition was accounted for using the purchase
method of accounting and accordingly, the purchase price has been allocated to
property and equipment. The purchase price was satisfied by $154,825 in cash and
the issuance of four promissory notes with maturity values aggregating $147,350.
These promissory notes mature over a period of two years. The fair values of
these promissory notes approximate their carrying value.
The asset purchase agreement also contains a purchase price adjustment clause
whereby the price may be adjusted upwards to a maximum of an additional
US$100,000 if certain revenue levels are achieved. Specifically, if gross
revenues for the acquired business exceed US$500,000 for the 12 month period
ending August 31, 2001, Magic will pay to RWE US$50,000, and if gross revenues
exceed US$600,000 for the second 12 month period ending August 31, 2002, Magic
will pay to RWE an additional US$50,000. This condition has not currently been
met.
The operating results related to the acquisition are included in the Company's
consolidated statements of operations and retained earnings from the date of
acquisition. Pro-forma information has not been provided for the prior year
because it is not material.
Note 14. Deposit on purchase of Applicationstation.com, Inc. shares
On November 22, 2000, the Company entered into an agreement with Chell.com
Ltd. to participate in the purchase of a 51% interest in the shares of
ApplicationStation.com, Inc. The Company has provided a deposit of $1,689,710 to
Chell.com Ltd. for its 25% share of the 51% interest in the shares of
ApplicationStation.com, Inc. In the event that closing of the transaction does
not occur and the deposit on purchase is not returned, Chell.com Ltd. has
pledged 550,000 shares of Chell Merchant Capital Group as security for such
amount. Should the purchase be completed, the Company's investment will be
reflected using the equity method of accounting.
F-26
15. SEGMENTED INFORMATION
The Company operates in the entertainment, education and merchant services
industries. Corporate relates to costs that are not associated with a specific
industry segment, but are required for the operations of the company. Business
segment information for the years ended August 31, 2001, 2000 and 1999 are as
follows:
=========================================================================
2001 2000 1999
$ $ $
=========================================================================
External revenue
Entertainment 13,588,788 14,121,764 7,569,929
Education 4,616,991 4,971,823 5,192,378
Merchant Service -- -- --
Corporate 16,595 13,703 61,384
-------------------------------------------------------------------------
18,222,374 19,107,290 12,823,691
-------------------------------------------------------------------------
Inter-segment revenue
Education 183,329 275,941 --
Corporate -- 128,283 223,435
-------------------------------------------------------------------------
183,329 404,224 223,435
-------------------------------------------------------------------------
Operating profit (loss)
Entertainment (208,371) 515,167 446,681
Education (1,084,531) (792,665) (623,400)
Merchant Service (5,887,912) -- --
Corporate (2,113,866) (1,218,183) (319,634)
-------------------------------------------------------------------------
(9,294,680) (1,495,681) (496,353)
-------------------------------------------------------------------------
Identifiable assets
Entertainment 5,459,008 7,009,552 4,725,971
Education 3,793,863 3,526,317 4,290,025
Merchant Service 1,489,711 -- --
Corporate 654,823 895,894 837,653
-------------------------------------------------------------------------
11,397,405 11,431,763 9,853,649
-------------------------------------------------------------------------
Corporate assets
Entertainment 3,170,363 4,352,448 3,699,785
Education (666,589) 844,142 (22,367)
Merchant Service 99,754 -- --
Corporate 2,141,512 355,590 1,063,713
-------------------------------------------------------------------------
4,745,040 5,552,180 4,741,131
-------------------------------------------------------------------------
Capital expenditures
Entertainment 729,486 842,955 350,836
Education 650,576 319,191 250,797
Merchant Service 50,900 -- --
-------------------------------------------------------------------------
1,430,962 1,162,146 601,633
-------------------------------------------------------------------------
Depreciation & Amortization
Entertainment 1,960,652 1,808,715 967,188
Education 507,218 408,856 428,377
Merchant Service 431,967 -- --
Corporate 140,570 31,750 33,654
-------------------------------------------------------------------------
3,040,407 2,249,321 1,429,219
-------------------------------------------------------------------------
Operating profit (loss) is equal to profit (loss) before income taxes and
minority interest, and includes deductions for items such as interest and
depreciation and amortization. Identifiable assets by industry are those assets
used in our operations in each industry. Corporate assets are principally cash
and cash equivalents, short-term investments and intangible assets. Net assets
from discontinued operations are not included in the schedule.
Our business segments all operate primarily in Canada.
The 2000 and 1999 comparative segmented information has been reclassified from
statements previously presented to conform with the presentation of the 2001
segmented information.
F-27
16. RELATED PARTY TRANSACTIONS
Included in other receivables is approximately $25,086 [2000 - $155,000] of
amounts due from employees and shareholders. The amounts are non-interest
bearing and are due on demand. Included in accounts payable is $210,611 owing to
Cameron Chell. This balance is non-interest bearing.
CMCG has consulting agreements with two unconsolidated affiliates, namely
Engyro, Inc. and cDemo Inc. The agreement with Engyro covers the period from
November 26. 1999 to January 15, 2001. The monthly fee was $720,000. The
agreement with cDemo covers the period January 22, 2000 to January 21, 2001. The
monthly fee was also $720,000 in this agreement. No revenue related to these
contracts has been recognized in the consolidated financial statements of Chell
Group Corporation due to uncertainty related to the collection of these
revenues. Such contracts have now expired and have not been renewed. In
addition, we never received any revenue from such contracts. The contracts were
cancelled with no outstanding obligations or liabilities.
17. RESTATED FINANCIAL STATEMENTS
On April 4th, 2000, the ratio at which preferred shares could be converted
to common shares was changed from 4.67 to 1 to 3 to 1. The resulting change from
192,857 to 300,000 common shares upon conversion resulted in a one-time
compensation charge of $337,779. In order to reflect this change, the fiscal
2000 financial statements have been restated.
The following table presents the impact of the restatement.
-------------------------------------------------------------------------
As Previously As Restated
Reported
=========================================================================
Year ended August 31, 2000 Balance sheet:
Share Capital
Common shares 183,235 191,122
Capital in excess of par value 10,124,777 10,454,669
Deficit (935,510) (1,273,289)
Statement of operations:
Selling, general and admin 10,726,556 11,064,335
Net loss (1,985,842) (2,323,621)
=========================================================================
18. INVESTMENTS IN AND ADVANCES TO UNCONSOLIDATED SUBSIDIARIES:
Investments in unconsolidated subsidiaries purchased during the year ended
August 31, 2001 and other investees in which the Company has a 20% to 50%
interest or otherwise exercise significant influence are carried at cost,
adjusted for the Company's proportionate share of their undistributed earnings
or losses.
Investments carried at equity consist of the following at August 31, 2001:
Percent
Owned
cDemo Inc. 14.3%
Engyro Inc. 22.1%
At August 31, 2001, the Company's proportionate share of undistributed losses
exceeded its investment and advances by $301,100. Accordingly, the Company's
investment has been reduced to zero and $301,100 has been recorded as an expense
in the statement of operations.
F-28
19. COMPARATIVE CONSOLIDATED FINANCIAL STATEMENTS
The 2000 and 1999 comparative consolidated financial statements have been
reclassified from statements previously presented to conform to the presentation
of the 2001 consolidated financial statements.
F-29
CHELL GROUP CORPORATION
AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL INFORMATION
FOR THE SIX MONTHS ENDED FEBRUARY 28, 2002
Financial Statements: Page
----
Consolidated Balance Sheets -
as at February 28, 2002 (unaudited) and August 31, 2001 F-31
Consolidated Statements of Operations and Retained Earnings (Deficit) -
For the Three Months and Six Months Ended February 28, 2002 and
February 28, 2001 (unaudited) F-32
Consolidated Statements of Cash Flows -
For the Six Months Ended February 28, 2002 and
February 28, 2001 (unaudited) F-33
Notes to Consolidated Financial Statements F-34
F-30
CHELL GROUP CORPORATION
CONSOLIDATED BALANCE SHEETS
AS AT FEBRUARY 28, 2002 AND AUGUST 31, 2001
(Expressed in Canadian dollars)
====================================================================================================
February 28, 2002 August 31, 2001
(unaudited) [restated Note 10]
$ $
- ----------------------------------------------------------------------------------------------------
ASSETS
Current
Cash and cash equivalents 97,381 356,421
Short-term investments -- 19,676
Accounts receivable, trade - net of allowance for doubtful
accounts of $225,071; August - $150,000 9,486,825 996,557
Other receivables 459,968 84,814
Income taxes receivable 165,005 140,607
Inventory 1,825,015 957
Prepaid expenses 310,793 301,470
- ----------------------------------------------------------------------------------------------------
Total current assets 12,344,987 1,900,502
- ----------------------------------------------------------------------------------------------------
Property and equipment, net 7,710,280 6,305,405
Licenses, net of accumulated amortization 236,524 229,900
Goodwill, net of accumulated amortization 13,609,273 37,421
Investment in Wareforce (note 6) 176,518 --
Deposit on purchase 1,689,710 1,689,710
Other assets, net of amortization 614,540 388,032
Net assets from discontinued operations 2,488,932 3,790,424
- ----------------------------------------------------------------------------------------------------
38,870,764 14,341,393
====================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current
Accounts payable - trade 11,893,626 2,044,182
Accrued liabilities 2,006,124 1,259,158
Current portion of long-term debt 9,905,300 3,625,587
- ----------------------------------------------------------------------------------------------------
Total current liabilities 23,805,050 6,928,927
- ----------------------------------------------------------------------------------------------------
Long-term debt - net of current portion 4,978,074 5,134,339
Deferred income taxes payable 30,000 30,000
- ----------------------------------------------------------------------------------------------------
Total liabilities 28,813,124 12,093,266
- ----------------------------------------------------------------------------------------------------
Commitments and Contingent liabilities
Shareholders' equity
Share capital
Preferred shares (note 6) 7,294 --
14,922,540 common shares [August 2001 - 9,028,239] 1,040,524 604,109
Capital in excess of par value 25,366,699 14,143,533
Deficit (16,356,877) (12,499,514)
- ----------------------------------------------------------------------------------------------------
Total shareholders' equity 10,057,640 2,248,128
- ----------------------------------------------------------------------------------------------------
38,870,764 14,341,394
====================================================================================================
The accompanying notes are an integral part of these statements
F-31
CHELL GROUP CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(Expressed in Canadian dollars - unaudited)
=============================================================================================================================
For Three Months Ended For Six Months Ended
February 28, February 28, 2001 February 28, February 28, 2001
2002 (Restated Note 10) 2002 (Restated Note 11)
$ $ $ $
=============================================================================================================================
REVENUE
Product sales 9,062,129 -- 9,062,129 --
Service sales 558,243 -- 558,243 --
Network services 1,564,091 1,798,207 3,274,309 3,544,330
Pay-TV 1,204,140 1,511,369 2,736,561 3,296,475
Other (2,592) 49,889 9,647 75,122
- ----------------------------------------------------------------------------------------------------------------------------
12,386,011 3,359,465 15,640,889 6,915,927
- ----------------------------------------------------------------------------------------------------------------------------
COST OF SALES
Product sales 8,290,472 -- 8,290,472 --
Service sales 497,354 -- 497,354 --
Network services 633,988 625,717 1,223,105 1,205,529
Pay-TV 636,693 665,252 1,301,516 1,393,520
- ----------------------------------------------------------------------------------------------------------------------------
10,058,507 1,290,969 11,312,447 2,599,049
- ----------------------------------------------------------------------------------------------------------------------------
EXPENSES
Selling, general and administrative expenses 3,232,791 4,471,381 4,819,575 8,578,934
Interest and bank charges 918,818 198,812 1,236,522 280,115
Write off of leasehold improvements -- -- -- 355,560
Depreciation and amortization 530,571 631,948 1,137,948 1,295,790
- ----------------------------------------------------------------------------------------------------------------------------
4,682,180 5,302,141 7,194,045 10,510,399
- ----------------------------------------------------------------------------------------------------------------------------
Loss before undernoted (2,354,676) (3,233,645) (2,865,603) (6,193,521)
Provision for income taxes -- -- -- --
- ----------------------------------------------------------------------------------------------------------------------------
Loss from continuing operations (2,354,676) (3,233,645) (2,865,603) (6,193,521)
Loss from discontinued operations (net of income (385,880) (188,328) (854,744) (519,021)
tax)
- ----------------------------------------------------------------------------------------------------------------------------
Loss and comprehensive loss for the period (2,740,556) (3,421,973) (3,720,347) (6,712,542)
============================================================================================================================
Earnings (loss) per share: (Note 4)
Basic and diluted from continuing operations (0.21) (0.39) (0.26) (0.74)
Basic and diluted from discontinued operations (0.04) (0.02) (0.08) (0.06)
- ----------------------------------------------------------------------------------------------------------------------------
Net loss per share (0.25) (0.41) (0.34) (0.80)
============================================================================================================================
The accompanying notes are an integral part of these statements
F-32
CHELL GROUP CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED FEBRUARY 28, 2002 AND FEBRUARY 28, 2001
(Expressed in Canadian dollars - unaudited)
=============================================================================================================
February 28, 2002 February 28, 2001
(restated - Note 11)
$ $
=============================================================================================================
OPERATING ACTIVITIES
Net loss and comprehensive loss for the period (3,720,347) (6,712,542)
Adjustments to reconcile net loss to net cash
(used in) operating activities:
Depreciation and amortization 1,137,948 1,295,790
Deemed interest on raised funds 542,567 --
Accretion of interest on non-interest bearing promissory notes 86,538 86,538
Write-off of leasehold improvements -- 355,560
Services rendered for shares 73,962 429,766
Warrants issued -- 152,702
Write-off of prepaids arising from Chell asset purchase 90,682 367,235
Changes in assets and liabilities:
Decrease in short-term investments 19,676 250,195
(Increase) decrease in accounts receivable, trade (627,929) 101,969
(Increase) in income taxes receivable (22,962) (98,475)
(Increase) in inventory (281,717) (29,322)
Decrease (increase) in prepaid expenses 43,211 (94,275)
(Increase) decrease in other accounts receivable (375,154) 122,035
(Increase) decrease in other assets (317,190) 188,285
(Increase) in net assets from discontinued operations (222,103) (164,055)
Increase (decrease) in accounts payable and accrued liabilities 3,553,740 (75,301)
- -------------------------------------------------------------------------------------------------------------
Cash (used in) provided by operating activities (19,078) (3,649,405)
- -------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES
Purchase of property and equipment (312,750) (653,940)
Increase in deposit on purchase -- (1,689,710)
Investment in Logicorp (1,500,000) --
Increase in notes receivable -- (301,100)
- -------------------------------------------------------------------------------------------------------------
Cash (used in) investing activities (1,812,750) (2,644,750)
- -------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES
Increase in notes and loans payable 3,396,080 5,151,986
Repayment of notes and loans payable (1,976,871) (18,012)
Proceeds from exercise of options 153,579 26,243
- -------------------------------------------------------------------------------------------------------------
Cash provided by (used in) financing activities 1,572,788 5,160,217
- -------------------------------------------------------------------------------------------------------------
Net (decrease) in cash and cash equivalents during the period (259,040) (1,133,938)
Cash and cash equivalents, beginning of period 356,421 1,355,613
- -------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of period 97,381 221,675
=============================================================================================================
- -------------------------------------------------------------------------------------------------------------
Income Taxes Paid -- 98,491
Interest Paid 206,194 55,508
During the 2002 second fiscal quarter, Logicorp was purchased for
$13,953,080, the non-cash component amount to $2,300,000 in accounts payable,
$395,124 in common shares and $9,757,956 in capital in excess of par value. In
addition, $500,000 debt related to the purchase of GalaVu was paid with shares.
Non cash items arose from the purchase of Chell.com assets during the 2001
First Fiscal Quarters. They are $1,936,272 of property & equipment, $107,589 of
goodwill, $42,706 of prepaids, $1,404 in other accounts receivable and in
addition 5,426,772 shares were issued from the purchase of Cameron Chell and
Chell.com assets. In addition, the depreciation from discontinued operations of
$352,340.
The accompanying notes are an integral part of these statements
F-33
CHELL GROUP CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE SIX MONTHS ENDED FEBRUARY 28, 2002 AND FEBRUARY 28, 2001
(UNAUDITED)
Note 1. Basis of Presentation
The accompanying financial statements for the interim periods are
unaudited and reflect all adjustments (consisting only of normal recurring
adjustments) which are, in the opinion of management, necessary for a fair
presentation of the financial position and operating results for the periods
presented. These financial statements should be read in conjunction with the
financial statements and notes thereto, together with Management's Discussion
and Analysis of Financial Condition and Results of Operations, contained in the
Annual Report on Form 10-K of Chell Group Corporation (the "Company")
(Commission No.:0-18066), filed with the Securities and Exchange Commission on
November 30, 2001. The results of operations for the six months ended February
28, 2002 are not necessarily indicative of the results for the full fiscal year
ending August 31, 2002.
Note 2. General
The financial statements of the Company for the three and six months ended
February 28, 2002 (the "2002 Second Fiscal Quarter" and "2002 First Fiscal
Half"), include the operations of the Company's wholly-owned subsidiaries Chell
Merchant Capital Group Inc. ("CMCG"), Chell.com (USA) Inc., NTN Interactive
Network Inc. ("NTNIN"), 3484751 Canada Inc., GalaVu Entertainment Network Inc.
("GalaVu"), and discontinued operations from NTNIN's wholly-owned subsidiary
Magic Lantern Communications Ltd. ("Magic"), which was sold effective in March
2002. The financial statements for the three months ended February 28, 2002 also
include the operations of Logicorp Data Systems Ltd. and Logicorp Service Group
Ltd., which will be together referred to as "Logicorp". Logicorp was purchased
effective in January 2002.
The financial statements of the Company for the three and six months ended
February 28, 2001 (the "2001 First Fiscal Quarter" and "2001 First Fiscal
Half"), include the operations of the Company's wholly-owned subsidiaries CMCG,
Chell.com (USA), NTNIN, 3484751 Canada Inc., GalaVu and NTNIN's wholly-owned
subsidiary Magic. Discontinued operations are the results of NTNIN's
wholly-owned subsidiaries Interlynx, which was sold effective in July 2001, and
Magic, which was sold effective in March 2002.
Prior period's figures have been restated (see note 11) and may have been
reclassified to be consistent with any reclassifications in the current period.
F-34
Note 3. Business Segment Data for the three and six months ended
February 28, 2002 and February 28, 2001
=====================================================================================================
For Three Months Ended For Six Months Ended
February 28, February 28, February 28, February 28,
2002 2001 2002 2001
$ $ $ $
=====================================================================================================
External revenue
Entertainment 2,770,321 3,349,190 6,023,574 6,899,442
Systems Integration 9,620,372 -- 9,620,372 --
Merchant Services -- -- -- --
Corporate (4,682) 10,275 (3,057) 16,485
- -----------------------------------------------------------------------------------------------------
12,386,011 3,559,465 15,640,889 6,915,927
- -----------------------------------------------------------------------------------------------------
Inter-segment revenue
Entertainment -- -- -- --
Systems Integration -- -- -- --
Merchant Services -- -- -- --
Corporate -- -- -- --
- -----------------------------------------------------------------------------------------------------
-- - -- --
- -----------------------------------------------------------------------------------------------------
Operating profit (loss)
Entertainment (658,599) (299,654) (611,728) (332,113)
Systems Integration (65,560) -- (65,560) --
Merchant Services (269,103) (2,028,649) (522,749) (4,828,305)
Corporate (1,361,414) (905,342) (1,665,566) (1,033,103)
- -----------------------------------------------------------------------------------------------------
(2,354,676) (3,233,645) (2,865,603) (6,193,521)
- -----------------------------------------------------------------------------------------------------
Net income (loss)
Entertainment (658,599) (299,654) (611,728) (332,113)
Systems Integration (65,560) -- (65,560) --
Merchant Services (269,103) (2,028,649) (522,749) (4,828,305)
Corporate (1,361,414) (905,342) (1,665,566) (1,033,103)
Discontinued Operations (385,880) (188,328) (854,744) (519,021)
--------------------------------------------------------------------------------------------------
(2,740,556) (3,421,973) (3,720,347) (6,712,542)
=====================================================================================================
=====================================================================================================
As at
February 28, February 28,
2002 2001
$ $
=====================================================================================================
Total assets
Entertainment 6,162,483 7,549,286
Systems Integration 25,163,648 --
Merchant Services 1,103,300 2,124,984
Corporate 3,952,401 2,913,200
Discontinued Operations 2,488,932 5,048,067
- -----------------------------------------------------------------------------------------------------
38,870,764 17,635,536
=====================================================================================================
F-35
Note 4. Earnings per share
Earnings 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 per share for the three months and six
months ended February 28, 2002 and February 28, 2001:
=========================================================================================================================
For Three Months Ended For Six Months Ended
February 28, February 28, February 28, February 28,
2002 2001 2002 2001
$ $ $ $
=========================================================================================================================
Numerator:
Net loss (numerator for basic and diluted
loss per share) from continuing operations (2,354,676) (3,233,645) (2,865,603) (6,193,521)
Net loss (numerator for basic and diluted
loss per share) from discontinued operations (385,880) (188,328) (854,744) (519,021)
- -------------------------------------------------------------------------------------------------------------------------
Net loss (numerator for basic and diluted
loss per share) (2,740,556) (3,421,973) (3,720,347) (6,712,542)
=========================================================================================================================
Denominator for basic and diluted loss per
share -adjusted weighted average number of
shares and assumed conversions 10,976,487 8,356,045 10,976,487 8,356,045
=========================================================================================================================
Basic and diluted loss per share from
continuing operations (0.21) (0.39) (0.26) (0.74)
Basic and diluted loss per share from
discontinued operations (0.04) (0.02) (0.08) (0.06)
- -------------------------------------------------------------------------------------------------------------------------
Net loss per share (0.25) (0.41) (0.34) (0.80)
=========================================================================================================================
Note 5. Business Acquisition
Effective January 1, 2002, the Company acquired 100% of Logicorp Data
Systems Ltd., Logicorp Service Group Ltd., 123557 Alberta Ltd. and 591360
Alberta Ltd. (collectively " Logicorp") for a purchase price of $13,953,080
calculated on a discounted basis. Logicorp is a Canadian systems integrator
handling all aspects of IT systems integration and solutions development,
including network integration and management, desktop support, hardware/software
procurement, systems architecture design and consulting. The acquisition was
recorded using the purchase method of accounting and, accordingly the purchase
price has been allocated as set out below:
$
---------------------------------------------------------
Goodwill 13,501,419
Net tangible assets 451,661
---------------------------------------------------------
13,953,080
---------------------------------------------------------
The purchase price was satisfied by $1,500,000 in cash, the issuance of
two non-interest bearing promissory notes with a maturity value of $2,300,000
and the issuance of 5,355,000 exchangeable shares of CMCG. These shares are
exchangeable on a one for one basis for the Common shares of the Company. The
first promissory note with a maturity value of $1,800,000 is due June 30, 2002.
Prior to payment of the first promissory note, the Company can elect to adjust
the purchase price by substituting the $1,800,000 note for an
F-36
interest-free promissory note in the amount of $2,040,000 one half of which
would be due June 30, 2002 and the second half would be due December 31, 2002.
The second promissory note has a maturity value of $500,000 and is due March 31,
2003.
In addition, the purchase price may be adjusted upwards because the
Company is required to pay an amount by which the earnings before taxes,
interest, depreciation and amortization (EBITDA) of Logicorp exceeds $1,000,000
for the year ended December 31, 2002. The purchase price may be adjusted
downward by three times the amount that EBITDA for this period is less than
$1,000,000.
The purchase price will be further adjusted on June 30, 2002, in the event
that the weighted average closing stock price of the Company's common shares for
the 10 trading days prior to June 30, 2002 is less than US$1.00. The Company
will issue additional common shares equal to the difference in the weighted
common share price and US$1.00 to a maximum of US$0.15 per share multiplied by
5,355,000 shares. However, if the weighted common share price is less than
US$0.50, then the maximum adjustment to the purchase price will be US$0.20 per
share multiplied by 5,355,000 shares.
The operating results of Logicorp are included in the Company's
consolidated statements of operations from the effective date of acquisition.
Pro forma information
The following pro forma information on results of operations assumes that
Logicorp was purchased at the beginning of each period presented.
===================================================================================================================
For Three Months Ended For Six Months Ended
February 28, February 28, February 28, February 28,
2002 2001 2002 2001
$ $ $ $
===================================================================================================================
Revenues 13,090,941 13,223,204 26,886,710 31,738,981
Loss before extraordinary items (2,120,348) (2,058,831) (2,745,812) (5,763,594)
Loss before extraordinary items per share (0.16) (0.24) (0.25) (0.42)
Net loss (2,506,228) (2,247,159) (3,600,556) (6,282,615)
Net loss per share (0.19) (0.27) (0.33) (0.46)
===================================================================================================================
Note 6. Investment in Wareforce.com, Inc.
Effective February 6, 2002, the Company issued 454,545 Series B preferred
shares in exchange for 454,545 Series A 6% convertible preferred shares of
Wareforce.com, Inc. ("Wareforce). The Wareforce preferred shares have a stated
value of US$10.00 per share and can be converted to common shares at 95% of the
market price of Wareforce's common shares. The conversion of these preferred
shares is limited such that the Company cannot convert if this conversion
results in the Company owning more than 5% of the then outstanding common shares
of Wareforce. The investment in Wareforce has been valued based on the market
value of Wareforce common shares. This transaction was entered into in part to
act as an incentive for the holders of the Series B preferred shares to
participate in the private placement discussed
F-37
in Note 7. Which at February 29, 2002 aggregated $176,518.
The Series B preferred shares have a par value of US$.01 per share and a
stated value of US$10.00 per share. The aggregate stated value is US$4,545,450
convertible to common shares of the Company at US$1.00. There is a limitation on
the conversion feature whereby shares are not convertible if the conversion
would result in the holder owning more than 5% of the outstanding common shares
of the Company.
Note 7. Convertible Promissory Notes
The Company has issued 8% convertible notes in the amount of $3,191,568
under a private placement memorandum. These notes are due August 9, 2002. These
notes may be voluntarily converted into Common Stock at a price between US$0.80
and US$1.00 per share, calculated as 50% of the average of the closing bid
prices for the Common Stock for ten trading days immediately prior to the
automatic conversion, but within the price range specified. The notes are
automatically converted into Common Stock if prior to their maturity, there are
closings of the acquisition of two or more of the following companies: (a)
Wareforce.com, Inc. (b) Stardrive Solutions, Inc. and (c) Logicorp Data Systems
Ltd. The automatic conversion will be at a price between US$0.50 and US$2.50,
calculated as 50% of the average of the closing bid prices for the Common Stock
for ten trading days immediately prior to the automatic conversion, but within
the price range specified. If all of these convertible notes were converted at
the lowest conversion price of US$0.50, the number of common shares issued would
be 4,039,960 resulting in a dilution of the current common stockholders.
Subsequent to February 28, 2002 all of the 8% convertible notes were converted
to Common Stock at US$0.95 resulting in the issuance of approximately 2,126,000
shares.
Note 8. Beneficial Conversion Feature
Convertible Promissory Notes
The beneficial conversion feature of the 8% promissory notes issued in
February 2002 has been recognized by recording additional paid in capital and
interest expense for the three months ended February 28, 2002. The amount of the
beneficial conversion and interest expense is calculated as of the date of
issuance as the difference between the conversion price and the fair value of
the common stock into which the notes are convertible. The Company recognized
beneficial conversion interest expense and corresponding additional paid in
capital in the amount of approximately $543,000 for the three months ending
February 28, 2002.
Series B Preferred Shares
The beneficial conversion feature of the Series B preferred shares issued
in February 2002 has been recognized by recording additional paid in capital and
a deemed dividend for the three months ended February 28, 2002. The amount of
the beneficial conversion and deemed dividend is calculated as of the date of
issuance as the difference between the conversion price and the fair value of
the common stock into which the notes are convertible. The Company recognized a
deemed dividend and corresponding additional paid in capital in
F-38
the amount of approximately $137,000 for the three months ending February 28,
2002.
F-39
Note 9. Subsequent Events
Financing
A term sheet for the following transactions has been signed, however all
of the conditions for completion of these transactions have not been met. It is
anticipated that during the Third fiscal quarter, these transactions will be
completed and will be effective September 1, 2001. The Company will issue
secured notes in the aggregate principal amount of U.S$3,370,000. In addition
options to purchase 812,000 common shares will be issued.
(a) The first part of this transaction will be an exchange of the
convertible debentures held by CALP II Limited Partnership ("CALP
II") on behalf of Canadian Advantage Limited Partnership ("CALP")
and Advantage (Bermuda) Fund Ltd. ("ABFL") for notes and warrants.
The existing convertible debentures of the Company, in the aggregate
principal amount of US$1,700,000, are currently held by CALP II on
behalf of CALP and ABFL. Together with interest at 10% from October
3, 2000, the total amount owing under these convertible debentures
at August 31, 2001 was approximately US$1,870,000. The convertible
debentures will be cancelled. The Company will issue notes to CALP
and ABFL in the aggregate principal amount of US$1,870,000. These
notes will have a five year term bearing interest at 10% per annum
payable semi-annually in arrears. The interest is payable in stock
of the Company calculated at 100% of the market price as at the date
such payment is due. Prepayment is permitted at any time on 30 days
prior notice. The notes will be secured by a general security
agreement against the assets of the Company in priority to all other
claims subject to the existing security of the Bank of Montreal and
the CIBC. The note will be held as to US$1,365,100 by CALP and as to
US$504,900 by ABFL.
Five year options to purchase 625,000 shares of common stock of the
Company at an exercise price of US$3.00 will be issued by Chell.com
Ltd. to CALP and ABFL. Three year options to purchase 187,000 shares
of the Company's common stock at an exercise price of US$2.00 will
also be issued by Chell.com Ltd. The sole shareholder of Chell.com
Ltd. is Cameron Chell, the controlling shareholder of the Company.
Therefore the costs associated with these options will be recorded
by the Company. The financing cost associated with these options
will be approximately US$345,000 and will amortized over the five
year term of the notes payable to CALP and ABFL.
(b) The second part of the transaction is the purchase of 250,000 units
in VC Advantage (Bermuda) Fund Ltd. in exchange for a US$1,500,000
note. The note will have a term of five years and will bear interest
at 3% per annum payable semi-annually in arrears. The interest is
payable in stock of the Company calculated at 100% of the market
price as at the date such payment is due. The note will be
discounted for financial reporting purposes to reflect the Company's
cost of borrowing. This discount will result in a maximum of
approximately US$178,000
F-40
additional interest expense over the five year term of the note.
Prepayment is permitted at any time on 30 days prior notice. The
note will be secured by a general security agreement against the
assets of the Company ranking pari passu to the notes in the first
part of this transaction.
BOTB Corporation, an Alberta corporation of which Cameron
Chell is the sole beneficial shareholder, whose sole asset is
a residence in Laguna Beach, California, will provide the
Company a guarantee with a minimum value of $1,500,000 for the
units purchased and will provide a second mortgage on this
property to secure the guarantee.
Conversion of CALP and ABFL Notes Payable
During the Third fiscal quarter, agreements were reached with CALP and
ABFL to convert the above-noted notes payable and accrued interest into shares
of the Common Stock of the Company, at the rate of US$0.80. The Company will
issue 2,405,678 shares of Common Stock in full satisfaction of the principal
amount of US$1,870,000 plus accrued interest of US$54,542.
Sale of Magic Lantern
Commencing in the second fiscal quarter, the Company began negotiations to
sell Magic Lantern and its subsidiaries. Effective March 18, 2002, the Company
completed this sale for cash consideration of $1,850,000. The Company's
financial statements have been restated to reflect Magic as a discontinued
operation for all periods presented.
=================================================================================================================
For Three Months Ended For Six Months Ended
February 28, February 28, February 28, February 28,
2002 2001 2002 2001
$ $ $ $
===============================================================================================================
Revenues 804,707 1,000,803 1,507,993 2,367,520
Loss before extraordinary items (358,880) (23,064) (854,744) (179,304)
Loss before extraordinary items per share (0.03) (0.00) (0.08) (0.02)
Net loss (358,880) (23,064) (854,744) (179,304)
Net loss per share (0.03) (0.00) (0.08) (0.02)
===============================================================================================================
Note 10. New Accounting Pronouncements
In August 2001, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 144, Accounting for the Impairment or
Disposal of Long-lived Assets (SFAS 144), that is applicable to financial
statements issued for fiscal years beginning after December 15, 2001. The new
rules on asset impairment supersede SFAS 121, Accounting for the impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, and portions of
Accounting Principles Board Opinion 30, "Reporting the Results of Operations."
This Standard provides a single accounting model for long-lived assets to be
disposed of and significantly changes the criteria that would have to be met to
F-41
classify an asset as held-for-sale. Classification as held-for-sale is an
important distinction since such assets are not depreciated and are stated at
the lower of fair value and carrying amount. This Standard also requires
expected future operating losses from discontinued operations to be displayed in
the period(s) in which the losses are incurred, rather than as of the
measurement date as presently required. The Company is currently assessing the
potential impact of SFAS 144 on the operating results and financial position.
In June 2001, the Financial Accounting Standards Board issued Statements
of Financial Accounting Standards No. 141, Business Combinations, and No. 142,
Goodwill and Other Intangible Assets, effective for fiscal years beginning after
December 15, 2001. Under the new rules, business combinations can no longer be
reflected by using the pooling of interests method of accounting and goodwill
(and intangible assets deemed to have indefinite lives) will no longer be
amortized but will be subject to annual impairment tests in accordance with the
Statements. Other intangible assets will continue to be amortized over their
useful lives.
The Company will apply the new rules on accounting for goodwill and other
intangible assets beginning in the first quarter in the year beginning September
1, 2002 (Fiscal 2003). During fiscal 2003, the Company will perform the first of
the required impairment tests of goodwill and indefinite lived intangible assets
as of September 1, 2002 and has not yet determined what the effects of these
tests will be on the earnings and financial position of the Company.
Note 11. Restatement of financial statements
In Fiscal 2001, the Company sold its wholly-owned subsidiary, Interlynx.
In Fiscal 2002, the Company sold its wholly-owned subsidiary and it's associated
subsidiaries, Magic Lantern Communications, Sonoptic Technologies Inc. and
Tutorbuddy Inc. The Company's financial statements have been restated to reflect
Interlynx and Magic Lantern as discontinued operations for all periods
presented.
Note 12. Changes in share capital
During the six months ended February 28, 2002, the following transactions
resulted in the issuance of 5,914,301 common shares of the Company. The
acquisition of Logicorp result in the issuance of 5,355,000 common shares of the
Company. In addition 463,051 shares were issued as payment for debt. Also during
the six months ended February 28, 2002, options totaling 96,250 were exercised
resulting in the issuance of additional 96,250 common shares of the Company.
F-42
================================================================================
LOGICORP SERVICE GROUP LTD.
================================================================================
FINANCIAL STATEMENTS
JUNE 30, 2001
[LOGO] LOGICORP
F-43
================================================================================
LOGICORP SERVICE GROUP LTD.
================================================================================
2001
CONTENTS
Page
----
AUDITORS' REPORT F-45
FINANCIAL STATEMENTS
Balance Sheet F-46
Statements of Earnings and Deficit F-47
Statement of Cash Flows F-48
Notes to the Financial Statements F-49-51
F-44
Grant Thornton LLP
Chartered Accountants
Canadian Member Firm of
Grant Thornton International
Auditors' Report
To the Directors of Logicorp Service Group Ltd.
We have audited the balance sheet of Logicorp Service Group Ltd. as at June 30,
2001 and the statements of loss 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 Canada and the United States of America. Those standards require that we plan
and perform an audit to obtain reasonable assurance whether the financial
statements are free of material misstatements. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation.
In our opinion, these financial statements present fairly, in all material
respects, the financial position of the company as at June 30, 2001 and the
results of its operations and cash flows for the year then ended in conformity
with accounting principles generally accepted in Canada and the United States of
America.
Edmonton, Canada /s/ Grant Thornton LLP
September 6, 2001 Chartered Accountants
2400 Scotia Place 1
10060 Jasper Avenue
Edmonton, Alberta
T5J 3R8
Tel: (780) 422-7114
Fax (780) 426-3208
e-mail: edmonton@GrantThornton.ca
See accompanying notes to the financial statements
F-45
BALANCE SHEET
AS AT JUNE 30
ASSETS
2001 2001
- --------------------------------------------------------------------------------
CURRENT
Cash and cash equivalents $ 6,374 $ 3,940
Accounts receivable 42,964 98,298
Income taxes receivable -- 28,613
Prepaid expenses -- 43
- --------------------------------------------------------------------------------
49,338 130,894
DUE FROM AFFILIATED COMPANY (Note 2) 561,532 524,445
GOODWILL 1 1
================================================================================
$ 610,871 $ 655,340
LIABILITIES
CURRENT
Salaries and wages payable $ 253 $ 6,293
Income taxes payable 13,602 --
Due to related parties (Note 3) 161,581 150,000
- --------------------------------------------------------------------------------
175,436 156,293
DEFERRED REVENUE (Note 4) 458,446 521,965
- --------------------------------------------------------------------------------
633,882 678,258
- --------------------------------------------------------------------------------
SHAREHOLDERS' DEFICIENCY
SHARE CAPITAL (Note 5) 31 31
DEFICIT (23,042) (22,949)
- --------------------------------------------------------------------------------
(23,011) (22,918)
- --------------------------------------------------------------------------------
$ 610,871 $ 655,340
================================================================================
APPROVED ON BEHALF OF THE BOARD:
_____________________________ Director
_____________________________ Director
See accompanying notes to the financial statements
F-46
STATEMENTS OF EARNINGS AND DEFICIT
FOR THE PERIOD ENDED JUNE 30
2001 2000
(12 Months) (4 Months)
- --------------------------------------------------------------------------------
REVENUE (Note 6) $ 1,674,325 $ 633,456
- --------------------------------------------------------------------------------
COST OF SALES
Product 274,546 85,918
Logistical and administrative support (Note 6) 780,392 474,000
Salaries, wages and benefits 291,680 101,186
- --------------------------------------------------------------------------------
1,346,618 661,104
- --------------------------------------------------------------------------------
GROSS PROFIT 327,707 (27,648)
- --------------------------------------------------------------------------------
EXPENSES
Advertising and promotion 397 --
Bad debt expense 50,060 --
Interest and bank charges 128 1,491
Office expense 819 41
Salaries and benefits 76,440 33,856
Training 703 728
Travel -- 580
- --------------------------------------------------------------------------------
128,547 36,696
- --------------------------------------------------------------------------------
EARNINGS (LOSS) FROM OPERATIONS 199,160 (64,344)
- --------------------------------------------------------------------------------
OTHER REVENUE
Interest revenue 821 --
- --------------------------------------------------------------------------------
NET EARNINGS (LOSS) BEFORE INCOME TAX 199,981 (64,344)
PROVISION FOR (RECOVERY OF) INCOME TAXES 38,493 (7,568)
- --------------------------------------------------------------------------------
NET EARNINGS (LOSS) 161,488 (56,776)
(DEFICIT) RETAINED EARNINGS, beginning of period (22,949) 33,827
DIVIDENDS (161,581) --
- --------------------------------------------------------------------------------
DEFICIT, end of period $ (23,042) $ (22,949)
================================================================================
See accompanying notes to the financial statements
F-47
STATEMENT OF CASH FLOWS
FOR THE PERIOD ENDED JUNE 30
2001 2000
(12 Months) (4 Months)
- --------------------------------------------------------------------------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
OPERATING ACTIVITIES
Net earnings (loss) $ 161,488 $ (56,776)
CHANGES IN NON-CASH WORKING CAPITAL BALANCES
Accounts receivable 55,334 (26,568)
Prepaid expenses 43 94
Salaries and wages payable (6,040) 146
Income taxes payable/receivable 42,215 (15,551)
Payable to related parties 11,581 --
Deferred revenue (63,519) (138,720)
- --------------------------------------------------------------------------------
201,102 (237,375)
- --------------------------------------------------------------------------------
FINANCING ACTIVITIES
Advances from (to) affiliated company (37,087) 240,126
Dividends (161,581) --
- --------------------------------------------------------------------------------
(198,668) 240,126
INCREASE IN CASH AND CASH EQUIVALENTS 2,434 2,751
CASH AND CASH EQUIVALENTS, beginning of period 3,940 1,189
- --------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS, end of period $ 6,374 $ 3,940
================================================================================
Supplementary cash flow information:
Income taxes paid $ 2,039 $ 6,117
F-48
- --------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Nature of operations
The company is a computer service organization which specializes in
the supply and integration of computer products. The company serves
both large and small organizations and is particularly valued by
organizations having complex data and communication configurations.
(b) Revenue recognition
For product sold, revenue is recognized when the product is shipped.
For maintenance contracts, revenue is recognized when the service
has been provided.
(c) Use of estimates
In preparing the company's financial statements, management is
required to make estimates and assumptions that affect the reported
amounts of assets and liabilities, the disclosure of contingent
assets and liabilities at the date of the financial statements and
reported amounts of revenue and expenses during the period. Actual
results could differ from these estimates.
(d) Cash and cash equivalents
Cash and cash equivalents include cash on hand and balances with
banks, net of bank overdrafts.
2. DUE FROM AFFILIATED COMPANY
The amounts due from Logicorp Data Systems Ltd. are unsecured,
non-interest bearing and have no specific terms of repayment.
3. DUE TO RELATED PARTIES
Amounts due to related parties are unsecured, non-interest bearing and
have no specific terms of repayment.
4. DEFERRED REVENUE
Deferred revenue represents maintenance contracts for which the company
has received consideration, but has yet to provide the services called for
under the contract.
F-49
- --------------------------------------------------------------------------------
5. SHARE CAPITAL
Authorized
Unlimited Class A common voting shares
Unlimited Class B common non-voting shares
Unlimited Class I preferred non-voting shares redeemable at issue price
Unlimited Class II preferred non-voting shares
2001 2000
- --------------------------------------------------------------------------------
Issued
3,000 Class A common voting shares $ 30 $ 30
1 Class I preferred non-voting share 1 1
- --------------------------------------------------------------------------------
$ 31 $ 31
================================================================================
6. RELATED PARTY TRANSACTIONS
The company is affiliated with Logicorp Data Systems Ltd. by virtue of
common control. During the period the company sold services to Logicorp
Data Systems Ltd. and was charged fees from Logicorp Data Systems Ltd. as
follows:
2001 2000
(12 Months) (4 Months)
- --------------------------------------------------------------------------------
Services sold $ 1,674,325 $ 633,456
Logistical and administrative support fees charged $ 780,392 $ 474,000
The administrative support fee consists of rent allocation, business
taxes, insurance, administrative wages and other administration charges
from Logicorp Data Systems Ltd.
7. COMPARATIVE FIGURES
Certain balances of the preceding period have been reclassified to conform
with the current period's financial statement presentation.
F-50
8. FINANCIAL INSTRUMENTS
Credit risk
The company is subject to credit risk through trade receivables. The
company maintains provisions for potential credit losses and any such
losses to date have been within management's expectations.
Fair value of financial instruments
The carrying value of cash and cash equivalents, accounts receivable,
salaries and wages payable approximate fair value because of the near term
maturity of these instruments. It was not practicable to determine the
fair value of amounts due from the affiliated company or to related
parties as there is no secondary market for these financial instruments.
9. ECONOMIC DEPENDENCE
All of the company's sales were to Logicop Data Systems Ltd., a related
company.
F-51
================================================================================
LOGICORP SERVICE GROUP LTD.
================================================================================
FINANCIAL STATEMENTS
JUNE 30, 2000
[LOGO] LOGICORP
F-52
================================================================================
LOGICORP SERVICE GROUP LTD.
================================================================================
JUNE 30, 2000
CONTENTS
Page
----
AUDITOR'S REPORT F-54
FINANCIAL STATEMENTS
Balance Sheet F-55
Statements of Loss and Deficit F-56
Statement of Cash Flows F-57
Notes to Financial Statements F-58-60
F-53
Grant Thornton LLP
Chartered Accountants
Canadian Member Firm of
Grant Thornton International
Auditors' Report
To the Directors of Logicorp Service Group Ltd.
We have audited the balance sheet of Logicorp Service Group Ltd. as at June 30,
2000 and the statements of income and retained earnings and cash flows for the
period 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 1n accordance with auditing standards generally accepted
in Canada and the United States of America. Those standards require that we plan
and perform an audit to obtain reasonable assurance whether the financial
statements are free of material misstatements. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation.
In our opinion, these financial statements present fairly, in all material
respects, the financial position of the company as at June 30, 2000 and the
results of its operations and cash flows for the period then ended in conformity
with accounting principles generally accepted In Canada and the United Sates of
America.
Edmonton, Canada /s/ Grant Thornton LLP
September 6, 2001 Chartered Accountants
2400 Scotia Place 1
10060 Jasper Avenue
Edmonton, Alberta
T5J 3R8
Tel: (780) 422-7114
Fax (780) 426-3208
e-mail: edmonton@GrantThornton.ca
F-54
================================================================================
LOGICORP SERVICE GROUP LTD.
================================================================================
BALANCE SHEET
AS AT
ASSETS
JUNE 30, 2000 Feb 29, 2000
- --------------------------------------------------------------------------------
CURRENT
Cash and cash equivalents $ 3,940 $ 1,189
Accounts receivable 98,298 71,730
Income taxes receivable 28,613 13,062
Prepaid expenses 43 137
- --------------------------------------------------------------------------------
130,894 86,118
DUE FROM AFFILIATED COMPANY (Note 2) 524,445 764,571
GOODWILL 1 1
- --------------------------------------------------------------------------------
$ 655,340 $ 850,690
================================================================================
LIABILITIES
CURRENT
Salaries and wages payable $ 6,293 $ 6,147
Due to related parties (Note 3) 150,000 150,000
- --------------------------------------------------------------------------------
156,293 156,147
DEFERRED REVENUE (Note 4) 521,965 660,685
- --------------------------------------------------------------------------------
678,258 816,832
- --------------------------------------------------------------------------------
SHAREHOLDERS' DEFICIENCY
SHARE CAPITAL (Note 5) 31 31
(DEFICIT) RETAINED EARNINGS (22,949) 33,827
- --------------------------------------------------------------------------------
(22,918) 33,858
- --------------------------------------------------------------------------------
$ 655,340 $ 850,690
================================================================================
APPROVED ON BEHALF OF THE BOARD:
_____________________________ Director
_____________________________ Director
See accompanying notes to the financial statements
F-55
================================================================================
LOGICORP SERVICE GROUP LTD.
================================================================================
STATEMENTS OF LOSS AND DEFICIT
FOR THE PERIOD ENDED
JUNE 30, 2000 Feb 29, 2000
(4 Months) (12 Months)
- --------------------------------------------------------------------------------
SALES $ 633,456 $ 1,804,346
- --------------------------------------------------------------------------------
COST OF SALES
Product 85,918 112,007
Administrative support 474,000 1,035,000
Salaries, wages and benefits 101,186 373,793
- --------------------------------------------------------------------------------
661,104 1,520,800
- --------------------------------------------------------------------------------
GROSS PROFIT (27,648) 283,546
- --------------------------------------------------------------------------------
EXPENSES
Advertising and promotion -- 5,895
Interest and bank charges 1,491 3,800
Office expense 41 8,973
Professional fees -- 591
Salaries and benefits 33,856 30,050
Training 728 11,809
Travel 580 19,931
----------------------------------------------------------------------------
36,696 81,049
----------------------------------------------------------------------------
(LOSS) INCOME FROM OPERATIONS (64,344) 202,497
- --------------------------------------------------------------------------------
OTHER REVENUE
Interest revenue -- 68
- --------------------------------------------------------------------------------
NET (LOSS) INCOME BEFORE INCOME TAXES (64,344) 202,565
(RECOVERY OF) PROVISION FOR INCOME TAXES (7,568) 32,624
- --------------------------------------------------------------------------------
NET (LOSS) INCOME (56,776) 169,941
RETAINED EARNINGS, beginning of period 33,827 13,886
DIVIDENDS -- (150,000)
- --------------------------------------------------------------------------------
(DEFICIT) RETAINED EARNINGS, end of period $ (22,949) $ 33,827
================================================================================
See accompanying notes to the financial statements
F-56
================================================================================
LOGICORP SERVICE GROUP LTD.
================================================================================
STATEMENT OF CASH FLOWS
FOR THE PERIOD ENDED
JUNE 30, 2000 Feb 29, 2000
(4 Months) (12 Months)
- --------------------------------------------------------------------------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
OPERATING ACTIVITIES
Net (loss) income $ (56,776) $ 169,941
CHANGES IN NON-CASH WORKING CAPITAL BALANCES
Accounts receivable (26,568) 14,105
Prepaid expenses 94 735
Salaries and wages payable 146 5,140
Income taxes receivable (15,551) (34,407)
Deferred revenue (138,720) 562,666
- --------------------------------------------------------------------------------
(237,375) 718,180
FINANCING ACTIVITIES
Advances from (to) affiliated company 240,126 (568,278)
Dividends -- (150,000)
- --------------------------------------------------------------------------------
240,126 (718,278)
- --------------------------------------------------------------------------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 2,751 (98)
CASH AND CASH EQUIVALENTS, beginning of period 1,189 1,287
- --------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS, end of period $ 3,940 $ 1,189
================================================================================
Supplementary cash flow information:
Income taxes paid 6,117 32,624
F-57
NOTES TO THE FINANCIAL STATEMENTS
JUNE 30, 2000
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Nature of operations
The company is a computer service organization which specializes in
the supply and integration of computer products. The company serves
both large and small organizations and is particularly valued by
organizations having complex data and communication configurations.
(b) Revenue Recognition
For product sold, revenue is recognized when the product is shipped.
For maintenance contracts, revenue is recognized when the service
has been provided.
(c) Use of Estimates
In preparing the company's financial statements, management is
required to make estimates and assumptions that affect the reported
amounts of assets and liabilities, the disclosure of contingent
assets and liabilities at the date of the financial statements and
reported amounts of revenue and expenses during the period. Actual
results could differ from these estimates.
(d) Cash and cash equivalents
Cash and cash equivalents include cash on hand and balances with
banks, net of bank overdrafts.
2. DUE FROM AFFILIATED COMPANY
The amounts due from Logicorp Data Systems Ltd. are unsecured,
non-interest bearing and have no specific terms of repayment.
3. DUE TO RELATED PARTIES
Amounts due to related parties are non-interest bearing and have no
specific terms of repayment.
4. DEFERRED REVENUE
Deferred revenue represents maintenance contracts for which the company
has received consideration, but has yet to provide the services called for
under the contract.
F-58
- --------------------------------------------------------------------------------
5. SHARE CAPITAL
Authorized
Unlimited Class A common voting shares
Unlimited Class B common non-voting shares
Unlimited Class II preferred non-voting shares
Unlimited Class I preferred non-voting shares
redeemable at issue price
June 30, 2000 Feb 29, 2000
- --------------------------------------------------------------------------------
Issued
3,000 Class A common voting shares $ 30 $ 30
1 Class I preferred non-voting share 1 1
- --------------------------------------------------------------------------------
$ 31 $ 31
================================================================================
6. RELATED PARTY TRANSACTIONS
The company is affiliated with Logicorp Data Systems Ltd. by virtue of
common control. During the period the company sold services to Logicorp
Data Systems Ltd. and was charged fees from Logicorp Data Systems Ltd. as
follows:
June 30, 2000 Feb 29, 2000
(4 Months) (12 Months)
- --------------------------------------------------------------------------------
Services Sold $ 633,456 $ 1,804,346
Administrative support fees charged $ 474,000 $ 1,035,000
The administrative support fee consists of rent allocation, business
taxes, insurance, administrative wages and other administration charges
from Logicorp Data Systems Ltd.
7. COMPARATIVE FIGURES
Certain balances of the preceding period have been reclassified to conform
with the current period's financial statement presentation.
F-59
- --------------------------------------------------------------------------------
8. FINANCIAL INSTRUMENTS
Credit risk
The company is subject to credit risk through trade receivables. The
company maintains provisions for potential credit losses and any such
losses to date have been within management's expectations.
Fair value of Financial Instruments
The carrying value of cash and cash equivalents, accounts receivable,
salaries and wages payable approximate fair value because of the near term
maturity of these instruments. It was not practicable to determine the
fair value of amounts due from the affiliated company or to related
parties as there is no secondary market for these financial instruments.
9. ECONOMIC DEPENDENCE
All of the company's sales were to Logicop Data Systems Ltd., a related
company.
10. CHANGE OF FISCAL YEAR
The company has changed its fiscal year from February 29 to June 30 to
better reflect the natural operating cycle of the business.
F-60
================================================================================
LOGICORP DATA SYSTEMS LTD.
================================================================================
FINANCIAL STATEMENTS
JUNE 30, 2001
[LOGO] LOGICORP
F-61
================================================================================
LOGICORP DATA SYSTEMS LTD.
================================================================================
JUNE 30, 2001
CONTENTS
Page
----
AUDITOR'S REPORT F-63
FINANCIAL STATEMENTS
Balance Sheet F-64
Statement of Loss and Retained Earnings F-65
Statement of Cash Flows F-66
Notes to Financial Statements F-67-71
Schedule of Direct Selling Expenses F-72
F-62
Grant Thornton LLP
Chartered Accountants
Canadian Member Firm of
Grant Thornton International
Auditors' Report
To the Directors of Logicorp Data Systems Ltd.
We have audited the balance sheet of Logicorp Data Systems Ltd. as at June 30,
2001 and the statements of loss 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 Canada and the United States of America. Those standards require that we plan
and perform an audit to obtain reasonable assurance whether the financial
statements are free of material misstatements. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation.
In our opinion, these financial statements present fairly, in all material
respects, the financial position of the company as at June 30, 2001 and the
results of its operations and cash flows for the year then ended in conformity
with accounting principles generally accepted in Canada and the United States of
America.
Edmonton, Canada /s/ Grant Thornton LLP
September 6, 2001 Chartered Accountants
2400 Scotia Place 1
10060 Jasper Avenue
Edmonton, Alberta
T5J 3R8
Tel: (780) 422-7114
Fax (780) 426-3208
e-mail: edmonton@GrantThornton.ca
F-63
BALANCE SHEET
AS AT JUNE 30
ASSETS
2001 2000
- --------------------------------------------------------------------------------
CURRENT
Accounts receivable (Note 2) $ 8,536,751 $ 7,722,714
Inventory (Note 3) 733,139 812,832
Income taxes receivable 35,693 37,945
Prepaid expenses 99,227 121,316
- --------------------------------------------------------------------------------
9,404,810 8,694,807
CAPITAL ASSETS (Note 4) 2,173,535 1,751,837
- --------------------------------------------------------------------------------
$11,578,345 $10,446,644
================================================================================
LIABILITIES
CURRENT
Bank indebtedness (Note 5) $ 3,322,930 $ 2,270,523
Accounts payable and accrued liabilities 5,882,472 6,217,742
Current portion of amounts Due to RCA Trusts 48,000 48,000
- --------------------------------------------------------------------------------
9,253,402 8,536,265
DUE TO AFFILIATED COMPANY (Note 6) 561,532 524,445
DUE TO RCA TRUSTS (Note 7) 1,020,454 863,195
DUE TO RELATED PARTIES (Note 8) 298,628 73,628
- --------------------------------------------------------------------------------
11,134,016 9,997,533
- --------------------------------------------------------------------------------
SHAREHOLDER'S EQUITY
SHARE CAPITAL (Note 9) 99 99
RETAINED EARNINGS 444,230 449,012
- --------------------------------------------------------------------------------
444,329 449,111
- --------------------------------------------------------------------------------
$11,578,345 $10,446,644
================================================================================
Commitments (Note 11)
APPROVED ON BEHALF OF THE BOARD:
_____________________________ Director
_____________________________ Director
F-64
STATEMENT OF LOSS AND RETAINED EARNINGS
FOR THE PERIOD ENDED JUNE 30
2001 2000
(12 Months) (4 Months)
- ----------------------------------------------------------------------------------
SALES $ 60,460,114 $ 18,989,310
COST OF SALES 56,912,928 17,878,719
- ----------------------------------------------------------------------------------
GROSS PROFIT 3,547,186 1,110,591
SELLING EXPENSES(Page 10) 1,417,906 514,761
- ----------------------------------------------------------------------------------
EARNINGS FROM OPERATIONS 2,129,280 595,830
GENERAL AND ADMINISTRATIVE EXPENSES
Advertising and promotion 55,706 25,267
Amortization 86,350 9,954
Insurance 34,773 13,887
Interest and bank charges 538 4
Licences, memberships and taxes 16,959 3,850
Office expenses 58,668 9,789
Professional fees 95,554 59,852
Rent 105,333 29,661
Salaries and benefits 1,155,525 338,093
Telephone 22,465 5,590
Training 24,668 3,736
Travel 69,801 24,757
-------------------------------------------------------------------------------
NET EARNINGS BEFORE OTHER REVENUE AND (EXPENSE) 1,726,340 524,440
------------------------------------------------------------------------------
402,940 71,390
OTHER REVENUE AND (EXPENSE)
Interest revenue 3,593 2,791
Retirement compensation agreements (400,000) --
- ----------------------------------------------------------------------------------
NET EARNINGS BEFORE INCOME TAX 6,533 74,181
PROVISION FOR INCOME TAXES 11,315 7,903
- ----------------------------------------------------------------------------------
NET (LOSS) EARNINGS (4,782) 66,278
RETAINED EARNINGS, beginning of year 449,012 382,734
- ----------------------------------------------------------------------------------
RETAINED EARNINGS, end of year $ 444,230 $ 449,012
==================================================================================
F-65
STATEMENT OF CASH FLOWS
FOR THE PERIOD ENDED JUNE 30
2001 2000
(12 Months) (4 Months)
- --------------------------------------------------------------------------------
CASH PROVIDED BY OPERATING ACTIVITIES
Net (loss) Earnings $ (4,782) $ 66,278
Items not requiring an outlay of cash:
Amortization 249,336 69,005
- --------------------------------------------------------------------------------
244,554 135,283
CHANGES IN NON-CASH WORKING CAPITAL BALANCES
Accounts receivable (814,037) 1,089,473
Inventories 79,693 (110,692)
Prepaid expenses and deferred charges 22,089 (40,512)
Accounts payable and accrued liabilities (335,270) (1,591,078)
Income taxes payable 2,252 1,583
- --------------------------------------------------------------------------------
(800,719) (515,943)
FINANCING ACTIVITIES
Advances from (to) shareholders 225,000 --
Advances from related parties 37,087 (240,126)
Increase (decrease) in Due to RCA Trusts 157,259 (38,353)
- --------------------------------------------------------------------------------
1,471,753 578,424
INVESTING ACTIVITIES
Additions to capital assets (671,034) (62,481)
- --------------------------------------------------------------------------------
INCREASE IN CASH -- --
CASH AND CASH EQUIVALENTS, beginning of year -- --
- --------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS, end of year $ -- $ --
================================================================================
F-66
================================================================================
LOGICORP DATA SYSTEMS LTD.
================================================================================
NOTES TO THE FINANCIAL STATEMENTS
JUNE 30, 2001
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Naure of operations
The company is a computer service organization which specializes in
the supply and integration of computer products, with branches in
Vancouver, Calgary, Edmonton and Saskatoon. The company serves both
large and small organizations and is particularly valued by
organizations having complex data and communication configurations.
(b) Cash and Cash equivalents
Cash and cash equivalents include cash on hand and balances with
bank.
(c) Inventory
Inventory is valued at the lower of cost and net realizable value.
Cost is determined on a first-in, first-out basis.
(d) Capital Assets
Capital assets are recorded at cost. Amortization is provided
annually at rates calculated to write-off the assets over their
estimated useful lives as follows:
Automotive equipment 30% diminishing balance
Computer equipment 30% diminishing balance
Computer software 30% diminishing balance
Leasehold improvements 20% diminishing balance
Office equipment 20% diminishing balance
Small tools 100% diminishing balance
(e) Revenue Recognition
For product sold, revenue is recognized when the product is shipped.
For maintenance contracts, revenue is recognized when the service
has been provided.
(f) Use of Estimates
In preparing the company's financial statements, management is
required to make estimates and assumptions that affect the reported
amounts of assets and liabilities, the disclosure of contingent
assets and liabilities at the date of the financial statements and
reported amounts of revenue and expenses during the period. Actual
results could differ from these estimates.
F-67
- --------------------------------------------------------------------------------
2. ACCOUNTS RECEIVABLE
2001 2000
- --------------------------------------------------------------------------------
Trade accounts receivable 8,591,938 7,722,714
Allowance for doubtful accounts (55,187) --
- --------------------------------------------------------------------------------
8,536,751 7,722,714
================================================================================
3. INVENTORY
2001 2000
- --------------------------------------------------------------------------------
Inventory for resale 825,231 890,863
Provision for obsolete inventory (92,092) (78,031)
- --------------------------------------------------------------------------------
733,139 812,832
================================================================================
4. CAPITAL ASSETS
Accumulated 2001 2000
Cost Amortization Net Book Net Book
Value Value
- -------------------------------------------------------------------------------------------
Automobiles $ 23,300 $ 12,027 $ 11,273 $ 318
Computer equipment 1,159,056 332,860 826,196 923,767
Computer software 888,611 28,985 859,626 325,399
Leasehold improvements 142,004 60,883 81,121 80,531
Office furniture and equipment 662,885 267,566 395,319 421,822
Small tools 791 791 -- --
- -------------------------------------------------------------------------------------------
$2,876,647 $ 703,112 $2,173,535 $1,751,837
===========================================================================================
5. BANK INDEBTEDNESS
Bank indebtedness bears interest at 7.07% and consists of the following:
2001 2000
- --------------------------------------------------------------------------------
Bank overdraft $ 927,112 $ 615,523
Operating line of credit 2,395,818 1,655,000
- --------------------------------------------------------------------------------
$ 3,322,930 $ 2,270,523
================================================================================
As collateral for the bank indebtedness the company has provided a General
Security Agreement, a guarantee and postponement of claim for amounts owed
to Directors, related companies and RCA Trusts. in addition, the company's
Directors have provided guarantees in the amount of $1,050,000. Credit
available under the operating line of credit is $3,000,000. The operating
line of credit is reviewed annually by the bank. The next scheduled review
date is Nov 30, 2001.
6. DUE TO AFFILIATED COMPANY
The amounts due to Logicorp Service Group Inc. are unsecured, non-interest
bearing and have no specific terms of repayment.
F-68
- --------------------------------------------------------------------------------
7. DUE TO RCA TRUSTS
The retirement compensation trusts were set up pursuant to section 248(1)
of the Income Tax Act of Canada to provide retirement income to the three
individuals who own Logicorp. Logicorp has no current or future obligation
to fund theses trusts other than the obligation stated here.
2001 2000
- -----------------------------------------------------------------------------------------------
Amounts due to retirement compensation agreements (RCA) trusts $ 1,068,454 $ 911,195
Less amounts due within one year 48,000 48,000
- -----------------------------------------------------------------------------------------------
$ 1,020,454 $ 863,195
===============================================================================================
The amounts due to the RCA Trusts are secured by promissory notes
repayable in quarterly installments of $12,000 plus interest at prime + 4
3/4%.
Estimated principal repayments in each of the next five years is as
follows:
2002 $ 48,000
2003 48,000
2004 48,000
2005 48,000
Subsequent 876,454
8. DUE TO RELATED PARTIES
Amounts due to related parties are unsecured, non-interest bearing and
have no specific terms of repayment.
2001 2000
- --------------------------------------------------------------------------------
Due to (from) Directors $ 19,794 $ (55,206)
Due to Director's Family Trusts 200,000 100,000
Due to other related parties 78,834 28,834
- --------------------------------------------------------------------------------
$ 298,628 $ 73,628
================================================================================
F-69
- --------------------------------------------------------------------------------
9. SHARE CAPITAL
Class A common voting shares
Class B common voting shares
Class C preferred shares
2001 2000
- --------------------------------------------------------------------------------
Issued
1,980 Class A common voting shares $ 99 $ 99
================================================================================
10. RELATED PARTY TRANSACTIONS
The company is affiliated with Logicorp Service Group Inc. by virtue of
common control. During the year the company purchased services from
Logicorp Service Group Inc. and charged fees to Logicorp Service Group
Inc. as follows:
2001 2000
- --------------------------------------------------------------------------------
Services Purchased 1,674,325 $ 633,456
Administrative support charged $ 780,392 $ 474,000
The administrative support consists of rent allocation, business taxes,
insurance, administrative wages and other administration charges paid by
the company on behalf of Logicorp Service Group Ltd..
11. LEASE COMMITMENTS
The company leases office space and equipment for its operations in
Edmonton, Calgary, Vancouver and Saskatoon. Lease terms vary from four to
six years. Base lease payable for the next five years as follows.
2002 $ 530,000
2003 530,000
2004 530,000
2005 530,000
2006 530,000
12. FINANCIAL INSTRUMENTS
Financial instruments consist of accounts receivable, bank indebtedness,
accounts payable and accrued liabilities, amounts due to affiliated
company, amounts due to RCA trusts and amounts due to related parties.
Credit risk
The company is subject to credit risk through trade receivables. Credit
risk is minimized by a large customer base and its geographic dispersion.
The company maintains provisions for potential credit losses and any such
losses to date have been within management's expectations.
Fair value of financial instruments
The carrying value of accounts receivable, bank indebtedness, accounts
payable and accrued liabilities approximate fair value because of the near
term maturity of these instruments. It was not practicable to determine
the fair value of amounts due to affiliated company, RCA trusts or related
parties as there is no secondary market for these financial instruments.
F-70
- --------------------------------------------------------------------------------
Interest rate risk
Bank indebtedness bears interest at a floating rate. The floating rate
debt is subject to interest rate cash flow risk, as the required cash
flows to service the debt will fluctuate as a result of changes in market
rates. It is management's opinion that interest rate risk is not
significant.
13. COMPARATIVE FIGURES
Certain of the prior year's figures have been reclassified to conform
reporting standards acceptable in the United States of America. As such,
internally used inventory for sale previously classified as inventory in
current assets, has been classified as capital assets in the long-term
section.
In the previous year the company changed its fiscal year end from February
29 to June 30 to better reflect the natural operating cycle of the
business. As a result, the comparative figures contain four months of
operating results.
F-71
SCHEDULE OF DIRECT SELLING EXPENSES
FOR THE PERIOD ENDED JUNE 30
2001 2000
(12 Months) (4 Months)
- --------------------------------------------------------------------------------
DIRECT SELLING EXPENSES
Advertising and promotion 135,445 71,397
Amortization 162,986 59,051
Bad debt expense 43,589 --
Insurance 18,214 4,312
Interest and bank charges 310,484 59,795
Licences, memberships and taxes 28,181 9,464
Office expenses 195,273 49,288
Presentation expense -- 10,000
Professional fees 13,317 25,079
Rent 55,665 18,268
Salaries and benefits 334,014 138,333
Telephone 69,217 20,607
Training 33,294 9,597
Travel 18,227 39,570
- --------------------------------------------------------------------------------
1,417,906 514,761
================================================================================
F-72
================================================================================
LOGICORP DATA SYSTEMS LTD.
================================================================================
FINANCIAL STATEMENTS
JUNE 30, 2000
[LOGO] LOGICORP
F-73
================================================================================
LOGICORP DATA SYSTEMS LTD.
================================================================================
JUNE 30, 2000
CONTENTS
Page
----
AUDITOR'S REPORT F-75
FINANCIAL STATEMENTS
Balance Sheet F-76
Statement of Loss and Retained Earnings F-77
Statement of Cash Flows F-78
Notes to Financial Statements F-79-83
Schedule of Direct Selling Expenses F-84
F-74
Grant Thornton LLP
Chartered Accountants
Canadian Member Firm of
Grant Thornton International
Auditors' Report
To the Directors of Logicorp Data Systems Ltd.
We have audited the balance sheet of Logicorp Data Systems Ltd. as at June 30,
2000 and the statements of income and retained earnings and cash flows for the
period 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 Canada and the United States of America. Those standards require that we plan
and perform an audit to obtain reasonable assurance whether the financial
statements are free of material misstatements. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation.
In our opinion, these financial statements present fairly, in all material
respects, the financial position of the company as at June 30, 2000 and the
results of its operations and cash flows for the period then ended in conformity
with accounting principles generally accepted in Canada and the United States of
America.
Edmonton, Canada /s/ Grant Thornton LLP
September 6, 2001 Chartered Accountants
2400 Scotia Place 1
10060 Jasper Avenue
Edmonton, Alberta
T5J 3R8
Tel: (780) 422-7114
Fax (780) 426-3208
e-mail: edmonton@GrantThornton.ca
F-75
BALANCE SHEET
AS AT
ASSETS
JUNE 30, 2000 Feb 29, 2000
- --------------------------------------------------------------------------------
CURRENTAccounts receivable $ 7,722,714 $ 8,812,187
Inventory (Note 2) 812,832 702,140
Income taxes receivable 37,945 39,528
Prepaid expenses 121,316 80,804
- --------------------------------------------------------------------------------
8,694,807 9,634,659
CAPITAL ASSETS (Note 3) 1,751,837 1,758,360
- --------------------------------------------------------------------------------
$10,446,644 $11,393,019
================================================================================
LIABILITIES
CURRENT
Bank indebtedness (Note 4) $ 2,270,523 $ 1,413,620
Accounts payable and accrued liabilities 6,217,742 7,808,819
Current portion of amounts Due to RCA Trusts 48,000 48,000
- --------------------------------------------------------------------------------
8,536,265 9,270,439
DUE TO AFFILIATED COMPANY (Note 5) 524,445 764,571
DUE TO RCA TRUSTS (Note 6) 863,195 901,548
DUE TO SHAREHOLDERS (Note 7) 73,628 73,628
- --------------------------------------------------------------------------------
9,997,533 11,010,186
SHAREHOLDER'S EQUITY
SHARE CAPITAL (Note 8) 99 99
RETAINED EARNINGS 449,012 382,734
- --------------------------------------------------------------------------------
449,111 382,833
- --------------------------------------------------------------------------------
$10,446,644 $11,393,019
================================================================================
Commitments (Note 10)
APPROVED ON BEHALF OF THE BOARD:
_____________________________ Director
_____________________________ Director
F-76
STATEMENT OF INCOME AND RETAINED EARNINGS
FOR THE PERIOD ENDED
JUNE 30, 2000 Feb 29, 2000
(4 Months) (12 Months)
- --------------------------------------------------------------------------------
SALES $ 18,989,310 $ 53,501,788
COST OF SALES 17,878,719 49,854,443
- --------------------------------------------------------------------------------
GROSS PROFIT 1,110,591 3,647,345
SELLING EXPENSES(Page 10) 514,761 1,726,496
- --------------------------------------------------------------------------------
EARNINGS FROM OPERATIONS 595,830 1,920,849
GENERAL AND ADMINISTRATIVE EXPENSES
Advertising and promotion 25,267 87,611
Amortization 9,954 57,328
Insurance 13,887 42,949
Interest and bank charges 4 10,270
Licences, memberships and taxes 3,850 6,731
Office expenses 9,789 49,520
Professional fees 59,852 84,335
Rent 29,661 26,732
Salaries and benefits 338,093 1,056,149
Telephone 5,590 13,315
Training 3,736 22,764
Travel 24,757 38,617
- --------------------------------------------------------------------------------
NET EARNINGS BEFORE OTHER REVENUE AND (EXPENSE) 524,440 1,496,321
- --------------------------------------------------------------------------------
71,390 424,528
OTHER REVENUE AND (EXPENSE)
Interest revenue 2,791 3,449
Retirement compensation agreements -- (450,000)
- --------------------------------------------------------------------------------
NET EARNINGS (LOSS) BEFORE INCOME TAX 74,181 (22,023)
PROVISION FOR INCOME TAXES 7,903 --
- --------------------------------------------------------------------------------
NET EARNINGS (LOSS) 66,278 (22,023)
RETAINED EARNINGS, beginning of period 382,734 404,757
- --------------------------------------------------------------------------------
RETAINED EARNINGS, end of period $ 449,012 $ 382,734
================================================================================
F-77
STATEMENT OF CASH FLOWS
FOR THE PERIOD ENDED
JUNE 30, 2000 Feb 29, 2000
(4 Months) (12 Months)
- --------------------------------------------------------------------------------
CASH PROVIDED BY OPERATING ACTIVITIES
Net Earnings (loss) $ 66,278 $ (22,023)
Items not requiring an outlay of cash:
Amortization 69,005 231,357
- --------------------------------------------------------------------------------
135,283 209,334
CHANGES IN NON-CASH WORKING CAPITAL BALANCES
Accounts receivable 1,089,473 (1,559,053)
Inventories (110,692) 1,928,631
Prepaid expenses and deferred charges (40,512) (10,248)
Accounts payable and accrued liabilities (1,591,077) 792,304
Income taxes payable 1,583 (48,036)
- --------------------------------------------------------------------------------
(515,942) 1,312,932
- --------------------------------------------------------------------------------
FINANCING ACTIVITIES
Advances from (to) shareholders -- 75,000
Advances (to) from related parties (240,126) 568,278
(Decrease) increase in Due to RCA Trusts (38,353) 234,738
(Increase) decrease in Bank indebtedness 856,903 (389,533)
- --------------------------------------------------------------------------------
578,424 488,483
- --------------------------------------------------------------------------------
INVESTING ACTIVITIES
Additions to capital assets (62,482) (1,801,415)
- --------------------------------------------------------------------------------
INCREASE IN CASH -- --
CASH AND CASH EQUIVALENTS, beginning of period -- --
- --------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS, end of period $ -- $ --
================================================================================
F-78
================================================================================
LOGICORP DATA SYSTEMS LTD.
================================================================================
NOTES TO THE FINANCIAL STATEMENTS
JUNE 30, 2000
- --------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Nature of operations
The company is a computer service organization which specializes in
the supply and integration of computer products, with branches in
Vancouver, Calgary, Edmonton and Saskatoon. The company serves both
large and small organizations and is particularly valued by
organizations having complex data and communication configurations.
(b) Cash and Cash equivalents
Cash and cash equivalents include cash on hand and balances with
bank.
(c) Inventory
Inventory is valued at the lower of cost and net realizable value.
Cost is determined on a first-in, first-out basis.
(d) Capital Assets
Capital assets are recorded at cost. Amortization is provided
annually at rates calculated to write-off the assets over their
estimated useful lives as follows:
Automotive equipment 30% diminishing balance
Computer equipment 30% diminishing balance
Computer software 30% diminishing balance
Leasehold improvements 20% diminishing balance
Office equipment 20% diminishing balance
Small tools 100% diminishing balance
(e) Revenue Recognition
For product sold, revenue is recognized when the product is shipped.
For maintenance contracts, revenue is recognized when the service
has been provided.
(f) Use of Estimates
In preparing the company's financial statements, management is
required to make estimates and assumptions that affect the reported
amounts of assets and liabilities, the disclosure of contingent
assets and liabilities at the date of the financial statements and
reported amounts of revenue and expenses during the period. Actual
results could differ from these estimates.
F-79
- --------------------------------------------------------------------------------
2. INVENTORY
JUNE 30, 2000 Feb 29, 2000
- --------------------------------------------------------------------------------
Inventory for resale 890,863 780,171
Provision for obsolete inventory (78,031) (78,031)
- --------------------------------------------------------------------------------
812,832 702,140
================================================================================
3. CAPITAL ASSETS
Accumulated JUNE 30, 2000 Feb 29, 2000
Cost Amortization Net Book Net Book
Value Value
Automobiles $ 10,300 $ 9,982 $ 318 $ 353
Computer equipment 1,125,923 202,156 923,767 931,258
Computer software 346,397 20,998 325,399 190,485
Leasehold improvements 123,452 42,921 80,531 188,481
Office furniture and equipment 598,753 176,931 421,822 447,783
Small tools 791 791 -- --
- --------------------------------------------------------------------------------------------
$2,205,616 $ 453,779 $1,751,837 $1,758,360
============================================================================================
4. BANK INDEBTEDNESS
Bank indebtedness bears interest at 8.5% and consists of the following:
JUNE 30, 2000 Feb 29, 2000
- --------------------------------------------------------------------------------
Bank overdraft $ 615,523 $ 488,620
Operating line of credit 1,655,000 925,000
- --------------------------------------------------------------------------------
$ 2,270,523 $ 1,413,620
================================================================================
As collateral for the bank indebtedness the company has provided a General
Security Agreement, guarantee and postponement of claim in the amount of
$425,000 from Logicorp Service Group Inc. and guarantees in the amount of
$1,800,000 from the Company's Directors. Credit available under the
operating line of credit is $2,000,000. The operating line of credit is
reviewed annually by the bank. The next scheduled review date is Nov 30,
2000.
F-80
- --------------------------------------------------------------------------------
5. DUE TO AFFILIATED COMPANY
The amounts due to Logicorp Service Group Inc. are unsecured, non-interest
bearing and have no specific terms of repayment.
6. DUE TO RCA TRUSTS
The retirement compensation trusts were set up pursuant to section 248(1)
of the Income Tax Act of Canada to provide retirement income to the three
individual shareholders who own Logicorp. Logicorp has no current or
future obligation to fund theses trusts other than the obligation stated
here.
JUNE 30, 2000 Feb 29, 2000
- -----------------------------------------------------------------------------------------------
Amounts due to retirement compensation agreements (RCA) trusts $ 911,195 $ 949,548
Less amounts due within one year 48,000 48,000
- -----------------------------------------------------------------------------------------------
$ 863,195 $ 901,548
===============================================================================================
The amounts due to the RCA Trusts are secured by promissory notes
repayable in quarterly installments of $12,000 plus interest at prime + 4
3/4%.
Estimated principal repayments in each of the next five years is as
follows:
2000 $ 48,000
2001 48,000
2002 48,000
2003 48,000
Subsequent 719,195
7. DUE FROM (TO) SHAREHOLDERS
Amounts due from (to) shareholders are unsecured, non-interest bearing and
have no specific terms of repayment.
8. SHARE CAPITAL
Class A common voting shares
Class B common voting shares
Class C preferred shares
JUNE 30, 2000 Feb 29, 2000
- --------------------------------------------------------------------------------
Issued
1,980 Class A common voting shares $ 99 $ 99
================================================================================
F-81
- --------------------------------------------------------------------------------
9. RELATED PARTY TRANSACTIONS
The company is affiliated with Logicorp Service Group Inc. by virtue of
common control. During the year the company purchased services from
Logicorp Service Group Inc. and charged fees to Logicorp Service Group
Inc. as follows:
JUNE 30, 2000 Feb 29, 2000
- --------------------------------------------------------------------------------
Services Purchased 633,456 $ 1,804,344
Administrative support charged $ 474,000 $ 1,035,000
The administrative support consists of rent allocation, business taxes,
insurance, administrative wages and other administration charges paid by
the company on behalf of Logicorp Service Group Inc.
10. LEASE COMMITMENTS
The company leases office space and equipment for its operations in
Edmonton, Calgary, Vancouver and Saskatoon. Lease terms vary from four to
six years. Base lease payable for the next five years as follows.
2001 $ 495,000
2002 495,000
2003 495,000
2004 495,000
2005 495,000
11. FINANCIAL INSTRUMENTS
Financial instruments consist of accounts receivable, bank indebtedness,
accounts payable and accrued liabilities, amounts due to affiliated
company, amounts due to RCA trusts and amounts due to related parties.
Credit risk
The company is subject to credit risk through trade receivables. Credit
risk is minimized by a large customer base and its geographic dispersion.
The company maintains provisions for potential credit losses and any such
losses to date have been within management's expectations.
Fair value of financial instruments
The carrying value of accounts receivable, bank indebtedness, accounts
payable and accrued liabilities approximate fair value because of the near
term maturity of these instruments. It was not practicable to determine
the fair value of amounts due to affiliated company, RCA trusts or related
parties as there is no secondary market for these financial instruments.
Interest rate risk
Bank indebtedness bears interest at a floating rate. The floating rate
debt is subject to interest rate cash flow risk, as the required cash
flows to service the debt will fluctuate as a result of changes in market
rates. It is management's opinion that interest rate risk is not
significant.
F-82
- --------------------------------------------------------------------------------
12. COMPARATIVE FIGURES
Certain of the prior year's figures have been reclassified to conform
reporting standards acceptable in the United States of America. As such,
internally used inventory for sale previously classified as inventory in
current assets, has been classified as capital assets in the long-term
section.
13. CHANGE OF FISCAL YEAR
The company has changed its fiscal year end from February 29 to June 30 to
better reflect the natural operating cycle of the business. As a result,
the current period contains four months of operating results.
F-83
- --------------------------------------------------------------------------------
SCHEDULE OF DIRECT SELLING EXPENSES
FOR THE PERIOD ENDED
JUNE 30, 2000 Feb 29, 2000
(4 Months) (12 Months)
- --------------------------------------------------------------------------------
DIRECT SELLING EXPENSES
Advertising and promotion 71,397 240,732
Amortization 59,051 174,029
Bad debt expense -- 5,542
Insurance 4,311 8,894
Interest and bank charges 59,793 199,489
Licences, memberships and taxes 9,464 35,658
Office expenses 49,287 164,965
Presentation expense 10,000 --
Professional fees 25,079 42,052
Rent 18,270 (4,000)
Salaries and benefits 138,335 387,539
Telephone 20,607 129,013
Training 9,597 80,983
Travel 39,569 261,600
- --------------------------------------------------------------------------------
514,760 1,726,496
================================================================================
F-84
- --------------------------------------------------------------------------------
591360 Alberta Ltd.
Amended Financial Statements
For the years ended June 30, 2001 and 2000
F-85
591360 Alberta Ltd.
Amended Financial Statements
For the years ended June 30, 2001 and 2000
Contents
================================================================================
Auditors' Report F-87
Amended Financial Statements
Amended Balance Sheets F-88
Amended Statements of Retained Earnings F-89
Amended Statements of Operations F-90
Summary of Significant Accounting Policies F-91
Notes to Amended Financial Statements F-92-93
F-86
- --------------------------------------------------------------------------------
================================================================================
Auditors' Report
- --------------------------------------------------------------------------------
To the Shareholder of
591360 Alberta Ltd.
We have audited the amended balance sheets of 591360 Alberta Ltd. as at June 30,
2001 and 2000 and the amended statements of retained earnings and operations for
the years then ended. These amended financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these amended financial statements based on our audits.
We conducted our audits in accordance with Canadian generally accepted auditing
standards. Those standards require that we plan and perform an audit to obtain
reasonable assurance whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
In our opinion, these amended financial statements present fairly, in all
material respects, the financial position of the Company as at June 30, 2001 and
2000 and the results of its operations for the years then ended in accordance
with Canadian generally accepted accounting principles.
The previous report dated January 29, 2002 has been withdrawn and the financial
statements have been amended as explained in Note 6.
Chartered Accountants
Edmonton, Alberta
January 29, 2002
Except the amendment described in Note 6 dated May 2, 2002
F-87
- --------------------------------------------------------------------------------
================================================================================
591360 Alberta Ltd.
Amended Balance Sheets
June 30 2001 2000
- ----------------------------------------------------------------------
Assets
Current
Cash $ 464 $ 442
Long-term investment (Note 1) 146,190 92,361
Due from a company under common control (Note 3) 34,535 34,535
-------------------
$181,189 $127,338
======================================================================
Liabilities and Shareholder's Equity
Current
Accounts payable and accrued liabilities $ 3,500 $ 1,250
-------------------
Shareholder's equity
Share capital (Note 4) 10 10
Retained earnings 177,679 126,078
-------------------
177,689 126,088
-------------------
$181,189 $127,338
======================================================================
On behalf of the Board:
________________________________________
Director
The accompanying summary of significant accounting policies and notes are
an integral part of these amended financial statements
F-88
- --------------------------------------------------------------------------------
================================================================================
591360 Alberta Ltd.
Amended Statements of Retained Earnings
For the years ended June 30 2001 2000
- ----------------------------------------------------------------------------------
Retained earnings, beginning of year, as previously stated $ 118,727 $ 106,410
Change in accounting policy (Note 6) 7,351 19,629
---------------------
Retained earnings, beginning of year, as restated 126,078 126,039
Net income for the year 51,601 37,039
Dividends paid -- (37,000)
---------------------
Retained earnings, end of year $ 177,679 $ 126,078
==================================================================================
The accompanying summary of significant accounting policies and notes are
an integral part of these amended financial statements
F-89
- --------------------------------------------------------------------------------
================================================================================
591360 Alberta Ltd.
Amended Statements of Operations
For the years ended June 30 2001 2000
- --------------------------------------------------------------------------------
Equity income $ 53,829 $ 37,722
--------------------
Expenses (recovery)
Bank charges and interest (22) 22
Professional fees 2,250 661
--------------------
2,228 683
--------------------
Net income for the year $ 51,601 $ 37,039
================================================================================
The accompanying summary of significant accounting policies and notes are
an integral part of these amended financial statements
F-90
================================================================================
591360 Alberta Ltd.
Summary of Significant Accounting Policies
June 30, 2001 and 2000
- --------------------------------------------------------------------------------
Nature of Business The Company is incorporated under the laws of Alberta
and is a holding company.
Management Estimates These amended financial statements have been prepared
by management in accordance with Canadian generally
accepted accounting principles. Because the precise
determination of many assets, liabilities, revenue and
expenses is dependent on future events, the preparation
of financial statements for a period necessarily
includes the use of estimates and approximations which
have been made using careful judgement. Actual results
could differ from those estimates. These amended
financial statements have, in management's opinion,
been properly prepared within reasonable limits of
materiality and within the framework of the accounting
principles summarized below.
Financial Instruments The Company as part of its operations
carries a number of financial instruments. Unless
otherwise noted, it is management's opinion that the
Company is not exposed to significant interest,
currency or credit risks arising from these financial
instruments.
Long-term Investment The Company accounts for its investment in a company
subject to significant influence on the equity method.
F-91
591360 Alberta Ltd.
Notes to Amended Financial Statements
June 30, 2001 and 2000
- --------------------------------------------------------------------------------
1. Long-term Investment
The Company owns 1/3 of the outstanding shares of Logicorp Service Group
Ltd., a Canadian private company.
2001 2000
----------------------
Shares $ 10 $ 10
Advances receivable 153,860 100,000
Share of undistributed earnings (7,680) (7,649)
----------------------
$ 146,190 $ 92,361
======================
- --------------------------------------------------------------------------------
2. Income Taxes
The Company has losses available for income tax purposes totaling $5,283.
This amount can be used to reduce taxable income of future years, the
benefit of which has not been recorded in these amended financial
statements.
These losses expire as follows:
Year Amount
2003 $ 731
2005 907
2006 734
2007 683
2008 2,228
-------
$ 5,283
=======
- --------------------------------------------------------------------------------
3. Due From a Company Under Common Control
The balance due from a company under common control is unsecured,
non-interest bearing, with no anticipated repayments within one year.
- --------------------------------------------------------------------------------
F-92
================================================================================
4. Share Capital
Authorized
An unlimited number of Class A common, voting shares
An unlimited number of Class B common, non-voting shares
An unlimited number of Class I and II preferred, non-voting shares
Issued
2001 2000
-------------------
1,000 Class A common shares $ 10 $ 10
===================
- --------------------------------------------------------------------------------
5. Statement of Cash Flows
A statement of cash flows was not presented since the cash flow
information is readily apparent from other financial statements or is
adequately disclosed in the notes to these amended financial statements.
- --------------------------------------------------------------------------------
6. Amended Financial Statements
The Company has amended its financial statements to reflect that during
the year, the Company changed its method of accounting for the investment
in a company subject to significant influence from the cost method to the
equity method. In addition, the Company corrected the advances receivable
from this company.
The retroactive application of the above adjustments resulted in the
following changes:
2001 2000
--------------------
Increase in long-term investment $ 42,320 $ 42,351
Decrease in balance due from a company under common control (35,000) (35,000)
--------------------
Increase in assets $ 7,320 $ 7,351
====================
Increase in opening retained earnings $ 7,351 $ 19,629
Increase in equity income from long-term investment 53,829 37,722
Decrease in dividend income (53,860) (50,000)
--------------------
Increase in ending retained earnings $ 7,320 $ 7,351
====================
- --------------------------------------------------------------------------------
F-93
================================================================================
123557 Alberta Ltd.
(Formerly Merc Management Limited)
Amended Financial Statements
For the years ended October 31, 2001 and 2000
F-94
================================================================================
123557 Alberta Ltd.
Amended Financial Statements
For the years ended October 31, 2001 and 2000
Contents
================================================================================
Auditors' Report F-96
Financial Statements
Amended Balance Sheets F-97
Amended Statements of Retained Earnings F-98
Amended Statements of Operations F-99
Summary of Significant Accounting Policies F-100
Notes to Amended Financial Statements F-101-103
F-95
================================================================================
Auditors' Report
- --------------------------------------------------------------------------------
To the Shareholders of
123557 Alberta Ltd.
We have audited the amended balance sheets of 123557 Alberta Ltd. as at October
31, 2001 and 2000 and the amended statements of retained earnings and operations
for the years then ended. These amended financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these amended financial statements based on our audits.
We conducted our audits in accordance with Canadian generally accepted auditing
standards. Those standards require that we plan and perform an audit to obtain
reasonable assurance whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
In our opinion, these amended financial statements present fairly, in all
material respects, the financial position of the Company as at October 31, 2001
and 2000 and the results of its operations for the years then ended in
accordance with Canadian generally accepted accounting principles.
The previous report dated February 23, 2002 has been withdrawn and the financial
statements have been amended as explained in Note 6.
Chartered Accountants
Edmonton, Alberta
February 23, 2002
Except the amendment described in Note 6 dated May 1, 2002
F-96
================================================================================
================================================================================
123557 Alberta Ltd.
Amended Balance Sheets
October 31 2001 2000
- ------------------------------------------------------------------
Assets
Current
Cash $ -- $ 4,267
Short-term investments -- 48,522
Accounts receivable -- 1,000
Income taxes recoverable -- 4,700
Due from shareholders -- 4,355
-------------------
-- 62,844
Long-term investment (Note 1) 151,943 153,537
-------------------
$151,943 $216,381
==================================================================
Liabilities and Shareholders' Equity
Current
Accounts payable and accrued liabilities $ 2,499 $ 3,200
-------------------
Shareholders' equity
Share capital (Note 2) 20 20
Retained earnings 149,424 213,161
-------------------
149,444 213,181
-------------------
$151,943 $216,381
==================================================================
On behalf of the Board:
________________________________________
Director
________________________________________
Director
F-97
================================================================================
================================================================================
123557 Alberta Ltd.
Amended Statements of Retained Earnings
For the years ended October 31 2001 2000
- --------------------------------------------------------------------------------------
Retained earnings, beginning of year, as previously stated $ 64,852 $ 73,779
Change in accounting policy (Note 6) 148,309 133,557
----------------------
Retained earnings, beginning of year, as restated 213,161 207,336
Net income (loss) for the year (23,459) 5,825
Dividends paid (36,812) --
Adjustment on transaction with a company under common control
(Note 5) (3,466) --
----------------------
Retained earnings, end of year $ 149,424 $ 213,161
======================================================================================
The accompanying summary of significant accounting policies and notes are an
integral part of these amended financial statements.
F-98
================================================================================
================================================================================
123557 Alberta Ltd.
Amended Statements of Operations
For the years ended October 31 2001 2000
- ------------------------------------------------------------------------
Revenue
Consulting $ 9,000 $ 12,000
Investment loss (6,335) (1,315)
Equity income (loss) on long-term investment (1,594) 14,752
--------------------
1,071 25,437
--------------------
Expenses
Advertising and promotion 8,049 7,802
Automotive 4,400 4,466
Bank charges and interest 38 60
Office 2,246 3,104
Professional fees 5,185 1,114
Telephone and utilities -- 109
Travel 4,612 2,957
--------------------
24,530 19,612
--------------------
Net income (loss) for the year $(23,459) $ 5,825
========================================================================
The accompanying summary of significant accounting policies and notes are an
integral part of these amended financial statements.
F-99
================================================================================
123557 Alberta Ltd.
Summary of Significant Accounting Policies
October 31, 2001 and 2000
- --------------------------------------------------------------------------------
Nature of Business The Company is incorporated under the laws of Alberta
and is a holding company.
Management Estimates These amended financial statements have been prepared
by management in accordance with Canadian generally
accepted accounting principles. Because the precise
determination of many assets, liabilities, revenue and
expenses is dependent on future events, the preparation
of financial statements for a period necessarily
includes the use of estimates and approximations which
have been made using careful judgement. Actual results
could differ from those estimates. These amended
financial statements have, in management's opinion,
been properly prepared within reasonable limits of
materiality and within the framework of the accounting
principles summarized below.
Financial Instruments The Company as part of its operations carries a number
of financial instruments. Unless otherwise noted, it is
management's opinion that the Company is not exposed to
significant interest, currency or credit risks arising
from these financial instruments.
Short-term Investments Temporary investments are stated at the lower of cost
and market value.
Long-term Investment The Company accounts for its investment in a company
subject to significant influence on the equity method.
F-100
123557 Alberta Ltd.
Notes to Amended Financial Statements
October 31, 2001 and 2000
- --------------------------------------------------------------------------------
1. Long-term Investment
The Company owns 1/3 of the outstanding shares of Logicorp Data Systems
Ltd., a Canadian private company.
2001 2000
-------------------
Shares $ 33 $ 33
Advances receivable 3,833 3,833
Share of undistributed earnings 148,077 149,671
-------- --------
$151,943 $153,537
======== ========
- --------------------------------------------------------------------------------
2. Share Capital
Authorized
10,000 Class A common, voting shares
5,000 Class B common, non-voting shares
5,000 preferred, non-voting shares
Issued
2001 2000
-----------------
100 Class A common
shares $ 10 $ 10
10 Class B common
shares 10 10
-----------------
$ 20 $ 20
=================
- --------------------------------------------------------------------------------
F-101
3. Income Taxes
The Company has losses available for income tax purposes totaling $74,210.
This amount can be used to reduce taxable income of future years, the
benefit of which has not been recorded in these amended financial
statements.
These losses expire as follows:
Year Amount
2004 $ 14,341
2005 520
2006 30,242
2007 4,220
2008 24,887
--------
$ 74,210
========
4. Statement of Cash Flows
A statement of cash flows was not presented since the cash flow
information is readily apparent from other financial statements or is
adequately disclosed in the notes to these amended financial statements.
- --------------------------------------------------------------------------------
5. Related Party Transaction
During the year, the Company transferred a significant portion of its net
assets to a company under common control for the following proceeds, which
approximate fair market value.
Cash $ 406
Short-term investments 38,725
Accounts receivable 2,000
Income taxes recoverable 4,700
--------
Total proceeds $ 45,831
========
Assumption of accounts payable $ 5,885
Assumption of shareholders' loans 39,946
--------
Total consideration $ 45,831
F-102
This transaction has been recorded in these amended financial statements
at the carrying amount of the assets as reflected on the books of the
seller being $49,297. The difference between the consideration paid and
the carrying amount has been recorded as a reduction to retained earnings
of $3,466.
- --------------------------------------------------------------------------------
6. Amended Financial Statements
The Company has amended its financial statements to reflect that during
the year, the Company changed its method of accounting for the investment
in a company subject to significant influence from the cost method to the
equity method. In addition, the Company corrected the advances receivable
from this company.
The retroactive application of the above adjustments resulted in the
following changes:
2001 2000
---------------------
Increase in long-term investment $ 146,715 $ 148,309
=====================
Increase in opening retained earnings $ 148,309 $ 133,557
Increase in equity income (loss) on long-term investment (1,594) 14,752
---------------------
Increase in ending retained earnings $ 146,715 $ 148,309
=====================
- --------------------------------------------------------------------------------
F-103
ENGYRO, INC.
(formerly R Home Funding Co. Ltd.)
(A Company in the Development Stage)
AUDITED FINANCIAL STATEMENTS
Period from Inception (November 4, 1999)
through August 31, 2000
F-104
ENGYRO, INC.
(formerly R Home Funding Co. Ltd.)
(A Company in the Development Stage)
TABLE OF CONTENTS
Page
REPORT OF INDEPENDENT AUDITORS F-106
FINANCIAL STATEMENTS
Balance Sheet F-107
Statement of Operations F-108
Statement of Deficiency in Assets F-109
Statement of Cash Flows F-110
Notes to Financial Statements F-111-117
F-105
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, changes in deficiency of assets, 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 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 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 accounting principles generally accepted in
the United States of America.
New Haven, Connecticut
December 27, 2000, except for Notes 8 and 9, as to which the date is July 9,
2001
F-106
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
23,524
Advances to shareholder for consulting services 235,418
----------
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
----------
F-107
ENGYRO, INC.
(formerly R Home Funding Co. Ltd.)
(A Company in the Development Stage)
STATEMENT OF OPERATIONS
Period from November 4, 1999 (date of inception)
through August 31, 2000
REVENUES $ --
OPERATING EXPENSES
Product development 587,748
-----------
Marketing and selling 70,996
General and administrative 338,547
Consulting services - related party 408,695
-----------
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-108
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 Stock Preferred Development
Shares at Par Capital Subscribed Stock Stage Total
--------------------------------------------------------------------------------------------------
Balance, November 4, 1999 $ -- $ 875 $ -- $ (875) $ -- $ -- $ --
Issuance of common stock,
August 9, 2000 1,585,000 710 100 875 -- -- 1,685
Accretion of value of -- -- -- -- (22,917) -- (22,917)
preferred stock
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. 4
F-109
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
===========
F-110
NOTE 1 -- ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Organization
R Home Funding Co. Ltd., was incorporated on November 4, 1999 as a Nevada
Corporation as 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.
Related Party Transaction
Subsequent to the merger, Engyro, Inc. issued 1,585,000 shares of stock for
$1,585 including 875,000 shares 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., 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, and the amount expensed for the period is shown on the
statement of operation. Chell.com Inc. is owned 100% by The Chell Group
Corporation and its subsidiaries, while Chell.com Ltd., a shareholder of the
company, is also owned by the Chell Group Corporation.
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.
F-111
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.
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.
F-112
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-113
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) $ 3,749,000
Accumulated accretion of value of preferred stock 22,917
Less financing costs (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-114
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, key employees and
affiliates. 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.
Chell.com Ltd., a related party, holds 200,000 shares of the outstanding stock
options.
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. Chell.com Ltd., a related party, holds 97,500 shares
of the outstanding warrants.
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-115
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 -- RELATED PARTY
Other current assets include advances to shareholder of $235,418 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 $408,695.
NOTE 9 -- UNCERTAINTIES
The accompanying financial statements have been prepared in conformity with
generally accepted accounting principles, which contemplate continuation of the
Company as a going concern. However, the Company has sustained substantial
operating losses since its inception..
As the Company is in its development stage, it needs to continue to conduct
significant development and testing and to incur general and administrative
expenses. It expects these activities will result in substantial operating
losses at least 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.
F-116
While the Company expects that its existing capital resources and the funds
committed under its May 2001 letter of intent as described below will enable it
to maintain its current and planned developmental stage operations through
September 1, 2001. The Company expects that it will need to raise additional
funds in order to continue the development of its technologies and to complete
the commercialization of services resulting from those technologies. The Company
will require substantial funds to continue research and development programs, to
license or acquire technologies and to 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, strategic alliances, debt financings, bank borrowings,
or other sources. Capital requirements depend upon numerous factors including
the development of competing technologies or products, changing market
conditions, the cost of protecting intellectual property rights, progress of
research and development, and licensing and acquisition opportunities.
To date, the Company has succeeded in raising sufficient capital to support its
essential needs and, in May 2001, entered into a letter of intent with an
investor to support the Company's short term technology development objectives.
As of July 9, 2001, the Company has drawn down approximately $510,000 under this
arrangement.
In addition, the Company is aggressively pursuing additional financing from
outside investors and potential customers in order to provide the necessary
funding of its future operations.
Management believes that it is reasonably possible that the Company will obtain
the necessary financing in order to achieve its objectives and continue as a
going concern.
NOTE 10 -- SUBSEQUENT EVENT
As of July 9, 2001, the Company was in default of its office space lease. An
agreement has been reached with the lessor that will give the Company until
December 1, 2001 to remedy the default. Also, the Company is in default on a
lease for computer hardware obtained subsequent to balance sheet date. The
Company is currently working with the lessor to remedy the default on the
equipment lease.
F-117