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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(XXXX ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 1996
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 0-21510
SANCTUARY XXXXX MULTIMEDIA CORPORATION
(Exact name of registrant as specified in its charter)
BRITISH COLUMBIA, CANADA 00-0000000
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
0000 XXXXX XXXXX XXXXXX
XXX XXXXX, XXXXXXXXXX 00000
(Address of principal executive offices) (Zip Code)
(000) 000-0000
(Registrant's telephone number, including area code)
Indicate by check xxxx whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
The number of Common Shares of the registrant outstanding as of February
12, 1997 was 23,241,164.*
Except where the context otherwise requires, as used herein, the term
"Company" means Sanctuary Xxxxx Multimedia Corporation and its subsidiaries.
---------------
* Does not include 4,000,000 voting Performance Shares which are held in escrow.
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PART I -- FINANCIAL INFORMATION
Item 1 -- Condensed Consolidated Financial Statements (unaudited)
Condensed consolidated balance sheets -- December 31, 1996 and March 31, 1996...... 3
Condensed consolidated statements of operations -- three months ended December 31,
1996 and 1995..................................................................... 4
Condensed consolidated statements of operations -- nine months ended December 31,
1996 and 1995..................................................................... 5
Condensed consolidated statements of cash flows -- nine months ended December 31,
1996 and 1995..................................................................... 6
Notes to condensed consolidated financial statements............................... 7
Item 2 -- Management's Discussion and Analysis of Financial Condition and Results of
Operations......................................................................... 11
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings............................................................. 22
Item 2. Changes in Securities......................................................... 22
Item 4. Submission of Matters to a Vote of Securities Holders......................... 22
Item 6. Exhibits and Reports on Form 8-K.............................................. 23
Signatures............................................................................ 24
FORWARD-LOOKING STATEMENTS
The following description of the Company's business in this Report contains
forward looking statements within the meaning of section 27A of the Securities
Act of 1933, as amended, and section 21E of the Securities Exchange Act of 1934,
as amended. Actual results could differ materially from those projected.
2
3
SANCTUARY XXXXX MULTIMEDIA CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 1996 AND MARCH 31, 1996 (UNAUDITED)
DECEMBER 31, MARCH 31,
1996 1996
------------ ------------
ASSETS
CURRENT ASSETS:
Cash.......................................................... $ 1,053,133 $ 8,455
Accounts receivable........................................... 803,724 800,701
Inventories................................................... 884,615 1,384,840
Prepaid royalties............................................. 83,941 127,000
Prepaid expenses.............................................. 425,628 294,203
------------- -------------
Total current assets.................................. 3,251,041 2,615,199
PROPERTY AND EQUIPMENT.......................................... 600,546 1,834,266
DEFERRED ROYALTIES & OTHER ASSETS............................... 299,807 144,396
------------- -------------
TOTAL ASSETS.................................................... $ 4,151,394 $ 4,593,861
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Bank debt..................................................... $ 155,135 $ 2,226,781
Notes payable................................................. 1,563,666
Accounts payable.............................................. 999,260 3,087,886
Accrued expenses.............................................. 752,267 1,395,359
Royalty obligations........................................... 307,043 611,905
Current portion of capital lease obligations.................. 20,289 28,715
------------- -------------
Total current liabilities............................. 2,233,994 8,914,312
8% CONVERTIBLE DEBENTURES DUE 1999.............................. 5,302,000
LONG-TERM ROYALTY OBLIGATIONS................................... 114,000 534,000
CAPITAL LEASE OBLIGATIONS....................................... 13,781
------------- -------------
Total liabilities..................................... 7,649,994 9,462,093
------------- -------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY (DEFICIT):
Authorized, 100,000,000 common shares, no par value; issued
and outstanding, 27,241,164 shares at December 31, 1996 and
22,158,580 shares at March 31, 1996........................ 34,742,521 31,763,839
Accumulated deficit........................................... (37,489,250) (35,874,113)
Accumulated translation adjustments........................... (751,871) (757,958)
------------- -------------
Total stockholders' equity (deficit).................. (3,498,600) (4,868,232)
------------- -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT).......... $ 4,151,394 $ 4,593,861
============= =============
See notes to condensed consolidated financial statements.
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SANCTUARY XXXXX MULTIMEDIA CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
THREE MONTHS ENDED DECEMBER 31, 1996 AND 1995 (UNAUDITED)
1996 1995
----------- ------------
SALES:
Consumer titles................................................ $ 808,882 $ (2,362,010)
Licensing revenue.............................................. 392,900 404,557
Publisher services............................................. 22,500
----------- ------------
Total sales -- net..................................... 1,201,782 (1,934,953)
----------- ------------
COST OF SALES:
Consumer titles................................................ 311,875 6,228,199
Technology amortization........................................ 96,783
Publisher services............................................. 205,449
----------- ------------
Total cost of sales.................................... 311,875 6,530,431
----------- ------------
GROSS MARGIN..................................................... 889,907 (8,465,384)
----------- ------------
OPERATING EXPENSES:
Research and development....................................... 404,461 1,276,386
Marketing and sales............................................ 980,305 2,429,858
Administration................................................. 743,255 955,067
Depreciation................................................... 76,512 315,506
----------- ------------
Total operating expenses............................... 2,204,533 4,976,817
----------- ------------
OPERATING LOSS................................................... (1,314,626) (13,442,201)
----------- ------------
OTHER INCOME (EXPENSE)
Foreign exchange loss.......................................... (1,234) 2,450
Interest expense -- net........................................ (148,266) (4,208)
Net loss on sale and disposal of assets........................ (47,997)
Other income (expense)......................................... (25,734) 3,456
----------- ------------
Total other income (expense)........................... (223,231) 1,698
----------- ------------
NET LOSS......................................................... $(1,537,857) $(13,440,503)
=========== ============
PRIMARY AND FULLY DILUTED NET LOSS PER SHARE..................... $ (0.07) $ (0.74)
SHARES USED IN COMPUTATION....................................... 23,241,164 18,123,179
See notes to condensed consolidated financial statements.
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SANCTUARY XXXXX MULTIMEDIA CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
NINE MONTHS ENDED DECEMBER 31, 1996 AND 1995 (UNAUDITED)
1996 1995
----------- ------------
SALES:
Consumer titles.................................................. $ 2,337,333 $ 7,800,636
Licensing revenue................................................ 1,960,790 1,308,792
Publisher services............................................... 366,554
----------- ------------
Total sales.............................................. 4,298,123 9,475,982
----------- ------------
COST OF SALES:
Consumer titles.................................................. 1,239,608 10,911,894
Technology amortization.......................................... 451,997
Publisher services............................................... 484,763
----------- ------------
Total cost of sales...................................... 1,239,608 11,848,654
----------- ------------
GROSS MARGIN....................................................... 3,058,515 (2,372,672)
----------- ------------
OPERATING EXPENSES:
Research and development......................................... 1,113,824 3,487,629
Marketing and sales.............................................. 2,234,805 6,525,990
Administration................................................... 1,721,586 2,758,873
Depreciation..................................................... 288,429 640,762
----------- ------------
Total operating expenses................................. 5,358,644 13,413,254
----------- ------------
OPERATING LOSS..................................................... (2,300,129) (15,785,926)
----------- ------------
OTHER INCOME (EXPENSE)
Foreign exchange gain (loss)..................................... (4,503) 6,526
Interest expense-net............................................. (263,013) (37,192)
Net gain on sale and disposal of assets.......................... 827,164 203
Other income..................................................... 125,344 14,940
----------- ------------
Total other income (expense)............................. 684,992 (15,523)
----------- ------------
NET LOSS........................................................... $(1,615,137) $(15,801,449)
=========== ============
PRIMARY AND FULLY DILUTED NET LOSS PER SHARE....................... $ (0.07) $ (0.92)
SHARES USED IN COMPUTATION......................................... 21,925,843 17,240,435
See notes to condensed consolidated financial statements.
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SANCTUARY XXXXX MULTIMEDIA CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED DECEMBER 31, 1996 AND 1995 (UNAUDITED)
1996 1995
----------- ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss......................................................... $(1,615,137) $(15,801,449)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization.................................... 292,300 1,352,930
Stock option and warrant compensation............................ 110,445 132,543
Sale of intellectual property rights in consideration for a
reduction in royalty obligations.............................. (429,688)
Net gain on sale and disposal of assets............................ (827,164)
Changes in assets and liabilities:
Accounts receivable........................................... (3,023) 590,729
Inventories................................................... 500,225 (1,196,885)
Prepaid royalties, expenses and other......................... (183,186) 3,042,108
Accounts payable and accrued expenses......................... (2,652,877) 2,698,467
----------- ------------
Net cash used in operating activities.................... (4,808,105) (9,181,557)
----------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of assets..................................... 1,919,500
Purchase of property and equipment............................... (30,951) (686,160)
----------- ------------
Net cash provided (used) in investing activities......... 1,888,549 (686,160)
----------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of warrants............................... 750,000
Issuance of convertible debentures............................... 5,302,000
Issuance of common stock net of issue costs...................... 8,011,284
Net borrowings (payments) on bank debt........................... (2,071,646) 1,600,000
Payments on long-term debt....................................... (22,207)
----------- ------------
Net cash provided in financing activities................ 3,958,147 9,611,284
----------- ------------
EFFECT OF EXCHANGE RATE CHANGES ON CASH............................ 6,087 (635)
----------- ------------
NET INCREASE IN CASH............................................... 1,044,678 (257,068)
CASH, BEGINNING OF PERIOD.......................................... 8,455 268,552
----------- ------------
CASH, END OF PERIOD................................................ $ 1,053,133 $ 11,484
=========== ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest...................................................... $ 85,955 $ 73,972
Income taxes.................................................. 800 1,600
SUPPLEMENTAL SCHEDULE OF NON-CASH FINANCING AND INVESTING
INFORMATION:
Conversion of notes payable into common stock.................... $ 1,563,666
Sale of intellectual property rights and issuance of common stock
for a reduction in royalty obligations........................ 550,000
Conversion of account payable into common stock.................. 195,000
See notes to condensed consolidated financial statements.
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SANCTUARY XXXXX MULTIMEDIA CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF OPERATIONS AND CHANGE IN FISCAL YEAR-END
Sanctuary Xxxxx Multimedia Corporation and its subsidiaries (the "Company")
develop, market and distribute interactive multimedia software products
("consumer titles") targeted at the children's education market. Products are
sold primarily through distributors into retail outlets. Sales are also made
directly to schools, hardware manufacturers and bundlers (OEM), and to
international distributors. Revenue is also generated from licensing and other
activities related to the Company's products and intellectual properties. Prior
to 1996, the Company published interactive entertainment products and provided
interactive multimedia services to trade and textbook publishers.
In 1996, the Board of Directors determined that it would be in the best
interests of the Company and its shareholders to change the Company's reporting
and tax fiscal year end to March 31 from December 31. The change was effected
April 1, 1996. Accordingly, the accompanying condensed consolidated financial
statements include the three and nine month periods ended December 31, 1996 and
1995.
The accompanying unaudited condensed consolidated financial statements have
been prepared in conformity with U.S. generally accepted accounting principles
("GAAP") for interim financial statements and include all adjustments which, in
the opinion of management, are necessary for a fair statement of the
consolidated financial position, results of operations and cash flows as of and
for the interim periods. Such adjustments consist of items of a normal recurring
nature except as described herein. The unaudited condensed consolidated
financial statements included herein should be read in conjunction with the
Company's audited financial statements for the year ended December 31, 1995 on
Form 10-K/A-3 as filed January 16, 1997.
2. HISTORICAL OPERATING LOSSES AND CERTAIN MANAGEMENT ACTIONS
The net loss for the nine months ended December 31, 1996 was $1,615,137
compared to a net loss of $15,801,449 for the nine months ended December 31,
1995. The net loss from operations for the nine months ended December 31, 1996
totalled $2,300,129 compared to a net operating loss of $15,785,926 for the same
period one year ago. Net cash used by operating activities was $4,808,105 for
the nine months ended December 31, 1996 compared to $9,181,557 for the same
period one year ago. At February 12, 1997 the Company had $925,000 in cash and
bank borrowings totalling $174,000.
A number of factors contributed to the Company's net loss in the three
months ended December 31, 1995. Sales of the Company's products in the December
1995 quarter were significantly below expectations and the Company experienced
significantly higher than expected returns. In light of the continued
competitive pressures in the marketplace, inventory levels in the retail
channel, the introduction of competitive products, downward pricing pressures
and the focusing of the Company's operations and cash resources on products
targeted at the children's education markets in the December 1995 quarter, the
Company accelerated write-offs of certain prepaid and deferred royalties and
made additional provisions for returns, price protection and inventory
obsolescence as follows:
Estimated sales returns and price protection............ $ 5,475,002
Write-offs of unrecoverable prepaid and deferred
royalties............................................. 4,260,532
Provision for inventory obsolescence.................... 1,033,389
Write-offs of licenses and other intangibles............ 235,000
-----------
Total......................................... $11,003,923
===========
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SANCTUARY XXXXX MULTIMEDIA CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1996 - 1997 Management Actions
During 1996 and early 1997, the Company instituted measures to improve
operations and cash flows. Specific items accomplished through February 12, 1997
included the following:
- Appointment of a new Chairman, President and Chief Executive Officer,
Vice President of Marketing, and a Controller.
- Reduction of head count from 148 employees at December 31, 1995 to 32 at
February 12, 1997 and elimination of many part-time, temporary and
contract positions.
- Ceasing publication of new entertainment titles.
- Closure of the Publisher Services Division.
- Sale of substantially all of the fixed assets of the Entertainment
Division. This included the sale of a studio in Victoria, British
Columbia during May 1996 for $1,900,000, of which $500,000 was used to
reduce bank borrowings. The gain on the sale of the studio, included in
other income for the nine month period ended December 31, 1996, totaled
$897,260.
- Reduction by $2,398,000 of the outstanding borrowings under the bank line
of credit from its January 1996 peak level of $2,572,000 to $174,000 at
February 12, 1997.
- A 10% reduction in senior management salaries.
- Termination of all software development projects through outside
developers.
- The hiring of Strategic Marketing Partners to represent the Company's
product line in the retail distribution channel.
- Sale in June 1996 of certain entertainment product rights to one of its
licensors in consideration for a $429,688 reduction in royalty
obligations. Such sale was included as licensing revenue in the nine
month period ended December 31, 1996. The transaction also encompassed
the issuance of 175,000 shares of the Company's common stock in
consideration of an additional $120,000 reduction in royalty obligations.
- Sale of other entertainment product rights (included in licensing
revenue) for $150,000 in the nine month period ended December 31, 1996.
- Closure of the Company's office in Toronto, Ontario in January 1997.
Bank Line of Credit
The Company has a revolving bank line of credit which expires April 3, 1997
and provides for working capital borrowings not to exceed $750,000. Borrowings
under the line of credit are limited to 65% of eligible trade accounts
receivable. Interest is payable based on the bank's prime rate plus 2.50% (4% if
the Company is out of compliance with its borrowing base) and was 10.75% at
December 31, 1996.
The credit agreement contains restrictions on the Company's ability to
incur or guarantee indebtedness, enter into mergers or acquisitions, pay
dividends or lease property. The agreement also requires the Company to maintain
minimum levels of profitability and tangible net worth and to maintain certain
defined ratios of cash flow, liquidity and leverage and limit capital
expenditures. Amounts outstanding under the revolving credit agreement are
secured by substantially all of the Company's assets.
As a result of significant losses, the Company was in violation of certain
covenants of its bank line of credit at December 31, 1995 and thereafter. In
addition, the Company had borrowed in excess of the amounts
8
9
SANCTUARY XXXXX MULTIMEDIA CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
then allowed under the credit agreement. As of August 15, 1996, the credit
agreement was amended to waive all previous covenant violations and to provide
the revolving credit described above.
In connection with two 1996 amendments to the bank credit agreement, the
Company issued the Bank warrants to purchase 400,000 shares (subject to
adjustment to not more than 600,000 shares in certain events) of common stock at
prices from $.50 to $.5625 per share.
For the quarter ended December 31, 1996, the Company did not to comply with
the earnings covenant set forth in the bank agreement. In January 1997 the bank
informed the Company that it would not enforce its default rights under the
agreement at this time and that it has elected not to renew the line of credit
when it matures April 3, 1997.
September 1996 Convertible Subordinated Debenture Issue
In September 1996, the Company privately placed for cash $5,302,000 in 8%
convertible debentures due July 31, 1999. A substantial portion of the proceeds
were used to repay bank and trade indebtedness. Interest is payable annually in
arrears and is to be paid only in shares of the Company's common stock valued at
a price equal to the average closing price for the ten trading days prior to the
date of payment. Interest will continue to accrue until the debentures are paid
or converted.
The debentures are convertible into shares of the Company's common stock at
the rate of one share for each $.55 of principal (9,640,000 shares) plus accrued
interest (subject to substantial adjustment in certain events -- see below). The
debentures are automatically convertible on July 31, 1999 or upon occurrence of
either of the following events: (a) the Company's obtaining any equity financing
in an amount not less than $2,000,000 at prices not less than $1.00 per share or
(b) the common stock of the Company having closed trading at a price of $1.375
or more per share for any 21 trading days in any consecutive 40 day trading
period. From April 1, 1997 to July 31, 1999 the debentures are convertible at
the option of the holder. The debentures are subordinate to senior debt and to
the security interest of the Company's bank. The Company may prepay the
debentures at any time without penalty.
The Company issued to each purchaser of the debentures a warrant to
purchase one share of common stock for each $2.00 invested or 2,651,000 shares
in total. Each warrant may be exercised at a price of $.6875 per share until
September 1999. The number of shares issuable upon exercise of these warrants
and the exercise price thereof are subject to substantial adjustments in certain
events -- see below. Pursuant to the warrant issue, the Company incurred a
deferred charge totaling $265,100 with an offsetting increase to paid-in
capital. The deferred charge is being expensed ratably over the life of the
warrants.
In December 1996, the Company agreed in principle, and subject to required
approvals, to exchange $550,000 principal amount of 8% convertible debentures
for shares of Series A Convertible Preferred Stock on terms to be negotiated.
The holders of stock issued upon conversion of debentures or Series A
Preferred Stock or exercise of warrants have certain rights to have these shares
registered.
* * * *
At February 12, 1997 the Company had cash of $925,000 and bank borrowings
of $174,000. The Company intends to raise funds through a rights offering (see
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Recent Developments") and has filed a registration statement with
the Securities and Exchange Commission. The purpose of the rights offering is to
raise necessary working capital for the Company. In the event the rights
offering is delayed, the Company believes it has the ability to raise additional
capital on a near term basis from both existing shareholders and other sources.
In the event of a rights offering management believes that the Company's
existing cash resources, cash flows from operations and additional proceeds from
debt or equity financing or exercise of outstanding
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SANCTUARY XXXXX MULTIMEDIA CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
warrants, will enable the Company to repay the bank on April 3, 1997 and meet
its financial obligations and conduct its operations through September 30, 1997.
There can be no assurance that any intended rights offering will be conducted or
if conducted, be successful. If the rights offering is not conducted or is
unsuccessful, there can be no assurance that the Company will be able to raise
working capital from other sources. Failure to do so will have a material
adverse effect on the Company's financial condition and results of operations.
3. ACCOUNTS RECEIVABLE
The Company allows customers to exchange and/or return products. In order
to promote sell-through and limit product returns, the Company also provides
"price protection" on slow moving products. In addition, the Company's products
are sold with a ninety-day warranty against defects. The Company has recorded
reserves for sales returns and allowances and price protection based on
historical experience and management's current estimates of potential returns
and necessary price protection.
Accounts receivable consisted of:
DECEMBER 31, MARCH 31,
1996 1996
------------ -----------
Accounts receivable -- trade.................... $ 1,928,412 $ 4,814,104
Less allowances for:
Doubtful accounts............................. (75,000) (207,352)
Sales returns and allowances.................. (1,049,688) (3,806,051)
----------- -----------
Accounts receivable -- net...................... $ 803,724 $ 800,701
=========== ===========
4. INVENTORIES
Inventories consisted of:
DECEMBER 31, MARCH 31,
1996 1996
------------ -----------
Finished goods...................................... $ 974,301 $ 1,967,558
Raw materials....................................... 614,327 866,957
---------- -----------
1,588,628 2,834,515
Less allowance for obsolete, slow-moving and
non-salable inventory............................. (704,013) (1,449,675)
---------- -----------
Inventories -- net.................................. $ 884,615 $ 1,384,840
========== ===========
5. COMMON STOCK OPTIONS AND WARRANTS
At February 12, 1997 there were outstanding options to purchase 1,567,750
shares of common stock at $0.50 to $5.75 per share and warrants to purchase
4,931,000 shares of common stock at $0.50 to $0.875 per share (See note 2).
6. PERFORMANCE SHARES
In October 1991, in connection with the sale of 1,800,000 common shares to
the Company's founders and principal stockholders, the Company issued 4,000,000
common "performance" shares (the "Performance Shares") at CDN $0.01 per share to
certain of these individuals. These Performance Shares were issued pursuant to
Local Policy #3-07 of the British Columbia Securities Commission ("BCSC") and
Policy 19 of the Vancouver Stock Exchange, which provide the guidelines for the
issuance of performance shares. In July 1996, a total of 1,200,000 of these
shares were sold and transferred to certain members of current and former
management at their then estimated fair market value of $.03 per share.
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SANCTUARY XXXXX MULTIMEDIA CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Performance Shares are held in escrow to be released as the Company
achieves positive operating cash flow on an annual basis as defined by the BCSC
("BCSC Operating Cash Flow"). The holders of Performance Shares will be entitled
to a pro rata release from escrow on the basis of one share for every CDN $0.653
of annual positive BCSC Operating Cash Flow, subject to approval by the BCSC and
the Vancouver Stock Exchange. Performance Shares are permitted to be released
from escrow on an annual basis, and all of the Performance Shares will be
released once CDN $2,612,000 of annual positive BCSC Operating Cash Flow has
been generated by the Company.
At the time when BCSC Operating Cash Flow justifying release of the
Performance Shares, or a pro rata portion thereof, is probable, the Company will
record as compensation expense an amount equal to the difference between the CDN
$0.01 per share originally paid for the Performance Shares then issuable and the
market price of its common stock at that time. Such a pro rata or full expense
recognition will occur prior to the pro rata or full release from escrow of the
Performance Shares. If and when such expense recognition criteria becomes
probable, based on the closing price of the Company's common stock on the
Vancouver Stock exchange at February 12, 1997, of approximately US$.17 per share
(for example purposes only), the aggregate compensation expense that would be
recognized as a result of earning of all the performance shares would be
approximately $640,000. Any compensation expense recognized related to the
Performance Shares will be a noncash charge and will have no net impact on total
stockholders' equity (deficit).
The Company may pursue an early release of all or a large portion of the
Performance Shares. Such an early release from escrow would reduce a source of
continuing uncertainty surrounding the Company's consolidated financial
statements, but could also result in compensation expense in the quarter in
which the release is made.
If and when the Performance Shares are earned, the number of shares used to
calculate primary net income (loss) per share will increase by the number of
Performance Shares earned. Through February 12, 1997, no Performance Shares have
been earned or released.
The Company is negotiating in principle with holders of these performance
shares to exchange these shares for common stock or warrants or a combination of
both. The transaction is subject to approval by the Vancouver Stock Exchange.
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The following information should be read in conjunction with the unaudited
condensed consolidated financial statements and the notes thereto included in
Item 1 of this Quarterly Report, the audited consolidated financial statements
and notes thereto included in the Company's report on Form 10-K/A-3 as filed on
January 16, 1997 and Management's Discussion and Analysis of Financial Condition
and Results of Operations contained in the Company's Forms 10-Q for the three
month periods ended March 31, June 30, 1996 and September 30, 1996 as filed with
the Securities and Exchange Commission.
The following description of the Company's business in this Item and other
Items in this Report contains forward looking statements within the meaning of
section 27A of the Securities Act of 1933, as amended, and section 21E of the
Securities Exchange Act of 1934, as amended. Actual results could differ
materially from those projected as a result of the risk factors discussed herein
and elsewhere in the Company's reports on Form 10-K/A-3 for the year ended
December 31, 1995 and on Form 10-Q for the three month periods ended March 31,
1996, June 30, 1996 and September 30, 1996 and in the financial statements and
notes thereto in the Company's Report on Form 8-K dated October 30, 1996.
Recent Developments
The Company presently intends to issue to its non-Canadian holders of its
Common Stock and 8% Convertible Debentures due 1999 rights ("Rights") to
subscribe for more than 50,000,000 shares of
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12
Common Stock. The preliminary terms of this Rights offering are more
particularly described in a registration statement filed on Form S-2 with the
Securities and Exchange Commission (the "Commission") and are subject to change.
The Company will not offer the Rights until the registration statement is
declared effective by the Commission. The Company will reserve the right to not
conduct the Rights offering even if the registration statement is declared
effective.
In addition, the Company plans to change its jurisdiction of incorporation
from British Columbia, Canada to Delaware, U.S.A. and, in connection therewith,
plans to effect a consolidation of its shares. The Company intends to hold a
special meeting of shareholders to vote upon these and certain other matters.
The Company has filed with the Commission a preliminary proxy statement and
registration statement on Form S-4 with respect to these matters. No
solicitation of shareholder votes by the Company will occur with respect to
these matters until the Company files definitive proxy materials with the
Commission and the Commission declares the registration statement effective. The
Company may determine not to seek shareholder approval of these matters at any
time based upon market and business conditions.
Overview
In 1996, the Company changed its fiscal year to end March 31.
Throughout 1995, the Company generated a major portion of its revenue from
the sale of products for the home entertainment market. Due to the poor sell
through of these titles, and the resulting operating losses and cash constraints
experienced by the Company, management decided in 1996 to discontinue the
manufacture and promotion of entertainment titles and focus its efforts solely
on developing and publishing children's curriculum-based educational software
products.
A number of factors contributed to the Company's net loss in the three
months ended December 31, 1995. Sales of the Company's products in the December
1995 quarter were significantly below expectations and the Company experienced
significantly higher than expected returns. In light of the continued
competitive pressures in the marketplace, inventory levels in the retail
channel, the introduction of competitive products, downward pricing pressures
and the focusing of the Company's operations and cash resources on products
targeted at the children's education markets in the December 1995 quarter, the
Company accelerated write-offs of certain prepaid and deferred royalties and
made additional provisions for returns, price protection and inventory
obsolescence as follows:
Estimated sales returns and price protection............ $ 5,475,002
Write-offs of unrecoverable prepaid and deferred
royalties............................................. 4,260,532
Provision for inventory obsolescence.................... 1,033,389
Write-offs of licenses and other intangibles............ 235,000
-----------
Total......................................... $11,003,923
===========
For most of the first nine months of calendar 1996, the Company lacked
sufficient operating scale and capital resources to adequately fund sales,
marketing and other operational activities. The Company estimates that lower
than satisfactory sales volume for the nine month period ended December 31, 1996
was at least partially due to the lack of resources needed to market and promote
its titles.
The net loss for the nine months ended December 31, 1996 was $1,615,137
compared to a net loss of $15,801,449 for the nine months ended December 31,
1995. The net loss from operations for the nine months ended December 31, 1996
totaled $2,300,129 compared to a net operating loss of $15,785,926 for the same
period one year ago. Net cash used by operating activities was $4,808,105 for
the nine months ended December 31, 1996 compared to $9,181,557 for the same
period one year ago. The net loss for the three and nine month periods ended
December 31, 1995 was primarily due to charges totaling over $11,000,000 related
to sales returns and markdowns, royalties, inventory obsolescence and other
write-offs (see above).
At February 12, 1997 the Company had $925,000 in cash and bank borrowings
totaling $174,000.
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1996-1997 Management Actions
During 1996 and early 1997, the Company instituted measures to improve
operations and cash flows. Specific items accomplished through February 12, 1997
included the following:
- Appointment of a new Chairman, President and Chief Executive Officer,
Vice President of Marketing, and a Controller.
- Reduction of head count from 148 employees at December 31, 1995 to 32 at
February 12, 1997 and elimination of many part-time, temporary and
contract positions.
- Ceasing publication of new entertainment titles.
- Closure of the Publisher Services Division.
- Sale of substantially all of the fixed assets of the Entertainment
Division. This included the sale of a studio in Victoria, British
Columbia during May 1996 for $1,900,000, of which $500,000 was used to
reduce bank borrowings. The gain on the sale of the studio, included in
other income for the nine month period ended December 31, 1996, totaled
$897,260.
- Reduction by $2,398,000 of the outstanding borrowings under the bank line
of credit from its January 1996 peak level of $2,572,000 to $174,000 at
February 12, 1997.
- A 10% reduction in senior management salaries.
- Termination of all software development projects through outside
developers.
- The hiring of Strategic Marketing Partners to represent the Company's
product line in the retail distribution channel.
- Sale in June 1996 of certain entertainment product rights to one of its
licensors in consideration for a $429,688 reduction in royalty
obligations. Such sale was included as licensing revenue in the nine
month period ended December 31, 1996. The transaction also encompassed
the issuance of 175,000 shares of the Company's common stock in
consideration of an additional $120,000 reduction in royalty obligations.
- Sale of other entertainment product rights (included in licensing
revenue) for $150,000 in the nine month period ended December 31, 1996.
- Closure of the Company's office in Toronto, Ontario in January 1997.
In addition, under the direction of its new management, the Company has now
focused on the development and publishing of its children's curriculum-based
educational software products. From the beginning of the current fiscal year
(April 1, 1996) through February 3, 1997, the Company has completed the
development of seven new or revised products: Major League Math(TM), Franklin
Learns Math(TM), How Do You Spell Adventure?(TM), Orion Burger(TM), NFL(TM)
Math, NFL(TM) Reading and Franklin's Activity Center(TM). The Company currently
sells six of the titles and has sold the publishing rights to Orion Burger(TM)
to a third party publisher.
Liquidity and Capital Resources.
Due to more than $25,000,000 in operating losses incurred during calendar
1995 and 1996, the Company experienced severe liquidity problems through
September 30, 1996.
In September 1996, the Company privately placed for cash $5,302,000 in 8%
convertible debentures due July 31, 1999. A substantial portion of the proceeds
were used to repay bank and trade indebtedness. Interest (which the holders
referred to below have agreed to forego) is payable annually in arrears and is
to be paid only in shares of the Company's common stock valued at a price equal
to the average closing price for the ten trading days prior to the date of
payment. Interest will continue to accrue until the debentures are paid or
converted.
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The debentures are convertible into shares of the Company's common stock at
the rate of one share for each $.55 of principal (9,640,000 shares) plus accrued
interest. The debentures are automatically convertible on July 31, 1999 or upon
occurrence of either of the following events: (a) the Company's obtaining any
equity financing in an amount not less than $2,000,000 at prices not less than
$1.00 per share or (b) the common stock of the Company having closed trading at
a price of $1.375 or more per share for any 21 trading days in any consecutive
40 day trading period. From April 1, 1997 to July 31, 1999 the debentures are
convertible at the option of the holder. The debentures are subordinate to
senior debt and to the security interest of the Company's bank. The Company may
prepay the debentures at any time without penalty.
The Company originally issued to each purchaser of the debentures a warrant
to purchase one share of common stock for each $2.00 invested or 2,651,000
shares in total. Each warrant may be exercised at a price of $.6875 per share
until September 1999. Pursuant to the warrant issue, the Company incurred a
deferred charge totaling $265,100 with an offsetting increase to paid-in
capital. The deferred charge is being expensed ratably over the life of the
warrants.
In December 1996, the Company agreed in principle, and subject to required
approvals, to exchange $550,000 principal amount of 8% convertible debentures
for shares of Series A Convertible Preferred Stock on terms to be negotiated.
The holders of stock issued upon conversion of debentures or Series A
Preferred Stock or exercise of warrants have certain rights to have these shares
registered.
The Company presently intends to issue to its non-Canadian holders of its
Common Stock and 8% Convertible Debentures due 1999 rights ("Rights") to
subscribe for more than 50,000,000 shares of Common Stock. The preliminary terms
of this Rights offering are more particularly described in a registration
statement filed on Form S-2 with the Securities and Exchange Commission (the
"Commission") and are subject to change. The Company will not offer the Rights
until the registration statement is declared effective by the Commission. The
Company will reserve the right to not conduct the Rights offering even if the
registration statement is declared effective.
The Company also renegotiated its revolving bank line of credit to expire
April 3, 1997 and provide for working capital borrowings not to exceed $750,000.
Borrowings under the line of credit are limited to 65% of eligible trade
accounts receivable. Interest is payable based on the bank's prime rate plus
2.50% (4% if the Company is out of compliance with its borrowing base) and was
10.75% at December 31, 1996.
The credit agreement contains restrictions on the Company's ability to
incur or guarantee indebtedness, enter into mergers or acquisitions, pay
dividends or lease property. The agreement also requires the Company to maintain
minimum levels of profitability and tangible net worth and to maintain certain
defined ratios of cash flow, liquidity and leverage and limit capital
expenditures. Amounts outstanding under the revolving credit agreement are
secured by substantially all of the Company's assets.
As a result of significant losses, the Company was in violation of certain
covenants of its bank line of credit at December 31, 1995 and thereafter. In
addition, the Company had borrowed in excess of the amounts allowed under the
credit agreement. As of August 15, 1996, the credit agreement was amended to
waive all previous covenant violations and to provide the revolving credit
described above.
In connection with two 1996 amendments to the bank credit agreement, the
Company issued the Bank warrants to purchase 400,000 shares (subject to
adjustment to not more than 600,000 shares in certain events) of common stock at
prices from $.50 to $.5625 per share.
For the quarter ended December 31, 1996, the Company did not to comply with
the earnings covenant set forth in the bank agreement. In January 1997 the bank
informed the Company that it would not enforce its default rights under the
agreement at this time and that it has elected not to renew the line of credit
when it matures April 3, 1997.
At February 12, 1997, the Company had cash of $925,000 and bank borrowings
of $174,000. The Company intends to raise funds through a rights offering (see
"Recent Developments" above). The purpose of the rights offering is to raise
necessary working capital for the Company and the Company has filed a
registration statement with the Securities and Exchange Commission. In the event
the rights offering is delayed, the Company believes it has the ability to raise
additional capital on a near term basis from both
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existing shareholders and other sources. In the event of a rights offering
management believes that the Company's existing cash resources, cash flows from
operations and additional proceeds from debt or equity financing or exercise of
outstanding warrants, will enable the Company to repay the bank on April 3, 1997
and meet its financial obligations and conduct its operations through September
30, 1997. There can be no assurance that any intended rights offering will be
conducted or if conducted, be successful. If the rights offering is not
conducted or is unsuccessful, there can be no assurance that the Company will be
able to raise working capital from other sources. Failure to do so will have a
material adverse effect on the Company's financial condition and results of
operations.
NASDAQ Listing.
In July 1996, it was determined that the Company no longer met the
requirements for inclusion on the NASDAQ Small Cap Market because it failed to
meet the continuing inclusion requirements for tangible net worth and minimum
bid price. As of July 1, 1996, the Company's stock ceased trading on the
National Small Cap Market and began trading on the OTC Bulletin Board.
RESULTS OF OPERATIONS -- THREE MONTH PERIODS ENDED DECEMBER 31, 1996 AND 1995
Net Loss. The net loss for the quarter ended December 31 ,1996 was
$1,537,857 compared to a net loss of $13,440,503 in the quarter ended December
31, 1995. The net loss in the December 1996 quarter was primarily due to lower
than expected revenues and included the following:
-- bad debt losses totaling $138,985 partly related to bankruptcy filings
by two of the Company's significant customers.
-- interest expense totaling $106,040 related to the September 1996
convertible debenture issuance. This is a non-cash cash charge payable
only in common stock of the Company.
-- charges relating to the closure of the Company's office in Toronto,
Ontario and other shutdown expenses of approximately $123,000 including
$47,997 on the disposal of the Toronto assets.
With the Company completing a financing in September 1996, the three month
period ended December 1996 represented first full quarter in calendar 1996 in
which the Company was able to allocate resources to restart the marketing of its
products. During the quarter the Company allocated over $400,000 to sales and
marketing programs.
Sales. Total net sales were $1,201,782 in the quarter ended December 31,
1996 compared to negative $(1,934,953) in the quarter ended December 31, 1995.
Net sales for consumer titles were $808,882 in the quarter ended December 31,
1996 compared to negative $(2,362,010) in the quarter ended December 31, 1995.
The Company and the multimedia industry experienced the effects of an
increasingly competitive marketplace during the 1995 quarter that resulted in
lower than expected sales, higher than expected returns, and downward pricing
pressures. The negative sales of consumer titles for the 1995 quarter were
primarily attributable to the $5,475,002 in reserves the Company provided for
estimated returns and price protection. Excluding the provision for returns and
price protection, sales of consumer titles decreased to $1,063,133 in the
quarter ended December 31, 1996 from $3,112,992 in the quarter ended December
31, 1995. Beginning in 1996, the Company decided to discontinue the manufacture
and promotion of entertainment titles and focus its efforts solely on developing
and publishing children's curriculum-based educational software products. Thus,
sales of consumer titles in the December 1996 quarter reflect a narrower product
mix compared to the December 1995 quarter which included the sale of
entertainment products.
QUARTERLY CONSUMER TITLE SALES
-------------------------------------
DECEMBER 31, 1996 DECEMBER 31, 1995
----------------- -----------------
Gross sales.................................. $ 1,063,133 $ 3,112,992
Provision for returns and Markdowns........ (254,251) (5,475,002)
---------- -----------
Net sales.................................. $ 808,882 $(2,362,010)
========== ===========
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Licensing revenues decreased 2.9% to $392,900 in the quarter ended December
31, 1996 from $404,557 in the quarter ended December 31, 1995.
In January, 1996, the Company decided to close its office in Dallas, Texas
and discontinue its publisher services operation. There were no sales related to
these operations in the quarter ended December 31, 1996.
Cost of Sales/Gross Margins. Total cost of sales was $311,875 for the
quarter ended December 31, 1996 compared to $6,530,431 in the quarter ended
December 31, 1995. The December 1995 quarter includes significant charges
totaling $5,831,263 which include the write-off of $4,260,532 in unrecoverable
royalty advances, $1,033,389 of inventory obsolescence, $96,783 in technology
amortization (which was fully expensed in 1995), $205,449 in publisher services
costs and $235,000 in write-offs of licenses and trademarks. Gross margins were
74% of sales in the quarter ended December 31, 1996. Because of the significant
write-off discussed above, gross margins were negative (438%) in the quarter
ended December 31, 1995.
Research and Development Costs. Research and development costs decreased
68% to $404,461 in the quarter ended December 31, 1996 from $1,276,386 in the
quarter ended December 31, 1995. This decrease is primarily due to a reduction
in personnel and facility costs associated with the sale of the Company's
Victoria studio in May 1996 and the overall reduction of the Company's work
force.
Marketing and Sales. Marketing and sales expenditures decreased 60% to
$980,305 in the quarter ended December 31, 1996 from $2,429,858 in the quarter
ended December 31, 1995. This decrease was due to reduced personnel and facility
expenses due to the elimination of its entertainment products and the related
reduction of the Company's work force. In the quarter ended December 1995, the
Company invested substantial sums to promote its entertainment titles Buried In
Time and Ripleys:Xxxxxx of Master Lu.
Administrative Costs. Administrative expenses decreased 22% to $743,255 in
the quarter ended December 31, 1996 from $955,067 in the quarter ended December
31, 1995 due to the reduction in the Company's work force. As a percentage of
sales, administrative costs increased primarily due to expenses for bad debts
and legal and professional fees.
As of February 12, 1997, the Company had 32 full time employees in San
Mateo, California. These employees were employed in the following functions:
Product Development -- Children's Educational Products.......... 6
Marketing, Sales, Customer Service and Technical Support........ 17
Administrative.................................................. 9
--
Total................................................. 32
==
RESULTS OF OPERATIONS -- NINE MONTH PERIODS ENDED DECEMBER 31, 1996 AND 1995
Net Loss. The net loss for the nine month period ended December 31 ,1996
was $1,615,137 compared to a net loss of $15,801,449 in the nine month period
ended December 31, 1995. The net loss in the December 1996 period was primarily
due to weak sales. The Company also experienced significant bad debt expenses
associated with the bankruptcy of two of the Company's customers and legal and
professional expenses related to the Company's reorganization. The net loss for
the nine months ended December 31, 1996 was due to charges totaling over
$11,000,000 related to sales returns and markdowns, royalties, inventory
obsolescence and other write-offs (see above). The nine month period ended
December 1995 included significant sales of two of the Company's entertainment
titles Buried in Time and Ripleys:Xxxxxx of Master Lu into the retail
distribution channel. In 1996, due to the poor sell through of these
entertainment titles, and the severe losses and cash constraints experienced by
the Company, management decided to discontinue the manufacture and promotion of
entertainment titles and focus its efforts on developing and publishing
children's curriculum-based educational software products.
Net Sales. Sales decreased 55% to $4,298,123 for the nine month period
ended December 31, 1996 from $9,475,982 in the nine month period ended December
31, 1995 primarily due to the elimination of the entertainment products
business. For most of the first nine months of calendar 1996, the Company lacked
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sufficient operating scale and capital resources to adequately fund sales,
marketing and other operational activities. The Company estimates that the
reduction in its volume of sales was at least partially due to the lack of
resources needed to market and promote its products.
Licensing revenues increased 50% to $1,960,790 in the nine month period
ended December 31, 1996 from $1,308,792 in the nine month period ended December
31, 1995. The increase was primarily due to the sale of publishing rights to
certain entertainment titles and increased royalties from international sales.
In January, 1996, the Company decided to close its office in Dallas, Texas
and discontinue its publisher services operation. There were no sales related to
these operations in the nine months ended December 31, 1996.
Cost of Sales/Gross Margins. Total cost of sales was $3,058,515 for the
nine months ended December 31, 1996 compared to $11,848,654 in the nine months
ended December 31, 1995. The nine month period ended December 1995 includes
significant charges totaling $5,528,921 which include the write-off of
$4,260,532 in unrecoverable royalty advances, $1,033,389 of inventory
obsolescence, and $235,000 in write-offs of licenses and trademarks. The nine
month period ended December 1995 also included $451,997 in technology
amortization (which was fully expensed in 1995) and $484,763 in publisher
services costs. Gross margins were 71% of sales in the nine months ended
December 31, 1996. Because of the significant write-off discussed above, gross
margins were negative (25%) in the nine months ended December 31, 1995.
Research and Development Costs. Research and development costs decreased
68% to $1,113,824 in the nine month period ended December 31, 1996 from
$3,487,629 in the same period last year. This decrease is primarily due to a
reduction in personnel and facility costs associated with the sale of the
Company's Victoria studio in May 1996 and the overall reduction of the Company's
work force.
Marketing and Sales. Marketing and sales expenditures decreased 66% to
$2,234,805 in the nine month period ended December 31, 1996 from $6,525,990 in
the same period last year. This decrease was due primarily to the Company's lack
of resources to fund advertising and promotion activities until the latter part
of September 1996. In addition, the Company has reduced personnel expenses due
to the elimination of its entertainment products and sale of the studio in
Victoria, Canada. During the nine month period ended December 1995, the Company
invested substantial sums to promote the release of its entertainment titles
Buried In Time and Ripleys:Xxxxxx of Master Lu. As a percentage of sales, sales
and marketing costs were 52% in the nine month period ended December 31, 1996
compared to 69% for the same period last year.
Administrative Costs. Administrative expenses decreased 38% to $1,721,586
in the nine month period ended December 31, 1996 from $2,758,873 in the nine
month period ended December 31, 1995, primarily due to the reduction in the
Company's work force. As a percentage of sales, administrative costs were 40% in
the nine month period ended December 31, 1996 versus 29% in the same period last
year. This increase is primarily due to substantially reduced sales from the
elimination of the Company's entertainment products and to increased bad debt
expense and legal and professional fees.
Other. During the quarter ended September 30, 1996 the Company negotiated
settlements with certain trade creditors to reduce payments owed to them on past
due obligations. Savings generated from the settlements approximating $115,000
are included in other income in the nine months ended December 31, 1996.
ADDITIONAL RISK FACTORS
There are numerous additional risks associated with the Company's on-going
operations, including without limitation the following:
Continued Losses; Fluctuations in Operating Results; Seasonality. The
Company has not been profitable on an annual basis in the last three years. The
Company has experienced, and expects to continue to experience, significant
fluctuations in operating results due to a variety of factors, including the
size and rate of growth of the consumer software market, market acceptance of
the Company's products and those of its competitors, development and promotional
expenses relating to the introduction of new products or new
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versions of existing products, projected and actual changes in computing
platforms, the timing and success of product introductions, product returns,
changes in pricing policies by the Company and its competitors, difficulty in
securing retail shelf space for the Company's products, the accuracy of
retailers' forecasts of consumer demand, the timing of orders from major
customers, order cancellations and delays in shipment. In response to
competitive pressures, the Company may take certain pricing or marketing actions
that could materially adversely affect the Company's business, operating results
and financial condition. The Company may be required to pay fees in advance or
to guarantee royalties, which may be substantial, or to obtain licenses to
intellectual properties from third parties before such properties have been
introduced or achieved market acceptance. A significant portion of the Company's
operating expenses are relatively fixed, and planned expenditures are based in
part on sales forecasts. If net sales do not meet the Company's expectations,
the Company's business, operating results and financial condition could be
materially adversely affected.
Possible write-offs from Product Returns, Price Protection; Bad Debts;
Collections. In accordance with industry practice, the Company recognizes
revenue from the sale of its products (net of an allowance for product returns
and price protection) upon shipment to its distributors and retailers. The
Company had a reserve balance for price protection and returns as of December
31, 1996, of $1,049,688. Product returns or price protection concessions that
exceed the Company's reserves could materially adversely affect the Company's
business, operating results and financial condition and could increase the
magnitude of quarterly fluctuations in the Company's operating and financial
results. In addition, the Company has experienced in the past, and continues to
experience, significant delays in the collection of its accounts receivable.
Further, if the Company's assessment of the creditworthiness of its customers
receiving products on credit proves incorrect, the Company could be required to
significantly increase the reserves previously established.
Impact of Reorganization of Operations. The Company may take additional
steps to reorganize or consolidate its operations. These steps may include,
among other things, the sale of certain assets of the Company. In an effort to
reduce its expense structure, the Company reorganized its operations during the
first half of calendar 1996, reduced its work force by more than 66% and revised
its product development plans for 1996. These changes or other future actions to
reorganize and reduce expenses could result in the delayed introduction of new
products which could have a material adverse effect on the Company's financial
condition and results of operations.
Dependence on Key Personnel; Retention of Employees. The Company's success
depends in large part on the continued service of its key creative, technical,
marketing, sales and management personnel and its ability to continue to
attract, motivate and retain highly qualified employees. Because of the
multifaceted nature of interactive media, key personnel often require a unique
combination of creative and technical talents. Such personnel are in short
supply, and the competition for their services is intense. The process of
recruiting key creative, technical and management personnel with the requisite
combination of skills and other attributes necessary to execute the Company's
strategy is often lengthy. The Company has entered into at-will employment
agreements with its management and certain other personnel, who may generally
terminate their employment at any time. The loss of the services of key
personnel or the Company's failure to attract additional qualified employees
could have a material adverse effect on the Company's results of operations and
research and development efforts. In particular, the Company has recently
reorganized its operations and has undergone a reduction in force among its
employees. Such reduction in force, combined with the Company's disappointing
operating performance, the price of the Company's stock, and the availability of
substantial alternative employment opportunities for talented employees of the
Company, may result in key employees and managers leaving the Company, which
could materially adversely impact the Company's ability to develop and sell its
products. The Company does not have key person insurance covering any of its
personnel.
Dependence on New Product Development; Product Delays. The success of the
Company depends on the continual and timely introduction of successful new
products. In general, consumer preferences for software products are difficult
to predict and are often short-lived. The retail life of software programs has
become shorter, and may now last only 9 to 12 months (or even less for
unsuccessful products), while the Company typically requires 6 to 9 months or
longer for the development of a new educational CD-ROM title. The short life
span of a product combined with a lengthy development cycle makes it especially
difficult to predict whether a product will be a success by the time it comes to
market. There can be no assurance that
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new products introduced by the Company will achieve any significant market
acceptance or that, if such acceptance occurs, it will be sustained for any
significant period. If the Company does not correctly anticipate and respond to
demand for its products in a timely manner, the Company's business, operating
results and financial condition will be materially adversely affected.
A significant delay in the introduction of, or the presence of a defect in,
one or more products could have a material adverse affect on the Company's
business, operating results and financial condition, particularly in view of the
seasonality of the Company's business. Further, delays in a product introduction
near the end of a fiscal quarter may materially adversely affect operating
results for that quarter, as initial shipments of a product may move from one
quarter to the next and may represent a substantial percentage of annual
shipments of a product. The timing and success of software development is
unpredictable due to the technological complexity of software products, inherent
uncertainty in anticipating technological developments, the need for coordinated
efforts of numerous creative and technical personnel and difficulties in
identifying and eliminating errors prior to product release. In the past, the
Company has experienced delays in the introduction of certain new products.
There can be no assurance that new products will be introduced on schedule or at
all or that they will achieve market acceptance or generate significant
revenues.
Competition. The software industry is intensely competitive, and market
acceptance for any of the Company's products may be adversely affected by the
introduction by the Company's competitors of similar products with greater
consumer demand. The Company competes against a large number of other companies
of varying sizes and resources. Most of the Company's competitors have
substantially greater financial, technical and marketing resources, as well as
greater name recognition and better access to consumers. Existing competitors
may continue to broaden their product lines and potential competitors, including
large computer or software manufacturers, entertainment companies, diversified
media companies, and book publishers, may enter or increase their focus on the
CD-ROM school and home education markets, resulting in increased competition for
the Company. Retailers of the Company's products typically have a limited amount
of shelf space and promotional resources, and there is intense competition among
consumer software producers for high quality and adequate levels of shelf space
and promotional support from retailers. To the extent that the number of
consumer software products and computer platforms increases, this competition
for shelf space may intensify. Due to increased competition for limited shelf
space, retailers and distributors are increasingly in a better position to
negotiate favorable terms of sale, including price discounts and product return
policies. Retailers often require software publishers to pay fees in exchange
for preferred shelf space. There can be no assurance that retailers will
continue to purchase the Company's products or provide the Company's products
with adequate levels of shelf space. Increased competition could result in loss
of shelf space for, and reduction in sell-through of, the Company's products at
retail stores and significant price competition, any of which could materially
adversely affect the Company's business, operating results and financial
condition. In addition, other types of retail outlets and methods of product
distribution, such as on-line services, may become important in the future, and
it may be important for the Company to gain access to these channels of
distribution. There can be no assurance that the Company will gain such access
or that the Company's access will be on terms favorable to the Company.
Changing Product Platforms and Formats. The Company's software products
are intended to be used on machines built by other manufacturers. The operating
systems of machines currently being manufactured are characterized by several
competing and incompatible formats or "platforms," and new platforms will
probably be introduced in the future. The Company must continually anticipate
the emergence of, and adapt its products to, popular platforms for consumer
software. When the Company chooses a platform for its products, it must commit
substantial development time and investment in advance of shipments of products
on that platform. If the Company invests in a platform that does not achieve
significant market penetration, the Company's planned revenues from those
products will be adversely affected and it may not recover its development
investment. If the Company does not choose to develop for a platform that
achieves significant market success, the Company's revenues may also be
adversely affected. The Company is currently developing products for PC and
Macintosh computers. The Company has terminated virtually all current
development for other platforms such as the Sony PlayStation and Sega Saturn.
There can be no assurance that the Company has chosen to support the platforms
that ultimately will be successful.
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Changes in Technology and Industry Standards. The consumer software
industry is undergoing rapid changes, including evolving industry standards,
frequent new product introductions and changes in consumer requirements and
preferences. The introduction of new technologies, including operating systems
and media formats, can render the Company's existing products obsolete or
unmarketable. Recent operating setbacks at Apple may adversely affect future
sales of Macintosh Computers. The development cycle for products utilizing new
operating systems, microprocessors or formats may be significantly longer than
the Company's current development cycle for products on existing operating
systems, microprocessors and formats and may require the Company to invest
resources in products that may not become profitable. There can be no assurance
that the current demand for the Company's products will continue or that the mix
of the Company's future product offerings will keep pace with technological
changes or satisfy evolving consumer preferences or that the Company will be
successful in developing and marketing products for any future operating system
or format.
Limited Protection of Intellectual Property and Proprietary Rights; Risk of
Litigation. The Company regards its software as proprietary and relies
primarily on a combination of trademark, copyright and trade secret laws, and
employee and third-party nondisclosure agreements and other methods to protect
its proprietary rights. However, the Company does not have signed license
agreements with its end-users and does not include in its products any mechanism
to prevent or inhibit unauthorized copying. Unauthorized parties may copy the
Company's products or reverse engineer or otherwise obtain and use information
that the Company regards as proprietary. If a significant amount of unauthorized
copying of the Company's products were to occur, the Company's business,
operating results and financial condition could be materially adversely
affected. Further, the laws of certain countries in which the Company's products
are or may be distributed do not protect applicable intellectual property rights
to the same extent as the laws of the United States. In addition, the Company
holds no patents, and, although the Company has developed and continues to
develop certain proprietary software tools, the copyrights to which are owned by
the Company, most of the technology used to develop the Company's products is
not proprietary. There can be no assurance that the Company's competitors will
not independently utilize existing technologies to develop products that are
substantially equivalent or superior to the Company's. Also, as the number of
software products in the industry increases and the functionality of these
products further overlaps, software developers and publishers may increasingly
become subject to infringement claims. There can be no assurance that third
parties will not assert infringement claims against the Company in the future
with respect to current or future products.
As is common in the industry, from time to time the Company receives
notices from third parties claiming infringement of intellectual property or
other rights of such parties. The Company investigates these claims and responds
as it deems appropriate. There has been substantial litigation regarding
copyright, trademark and other intellectual property rights involving computer
software companies in general. The Company may also face suits as a result of
employment matters, publicity rights, governmental or regulatory investigations,
or due to claims of breach of the Company's obligations under various agreements
to publish or develop products, or for goods or services provided to the
Company. Adverse determinations in such claims or litigation could have a
material adverse effect on the Company's business, operating results and
financial condition. The Company may find it necessary or desirable in the
future to obtain licenses relating to one or more of its products or relating to
current or future technologies. There can be no assurance that the Company will
be able to obtain these licenses or other rights on commercially reasonable
terms or at all.
Relationship with Vendors. Failure to pay vendors on a timely basis may
result in loss of the availability of the services of such vendors, which could
hamper the Company's ability to manufacture and ship products, and may
ultimately result in the Company being sued for collection of such amounts as
may be owed to such vendors. If the Company is unable to produce its products to
fill orders, the Company's operating results and financial condition could be
materially adversely affected. In the event that suits by vendors are filed
against the Company, the Company may be required to incur unanticipated legal
expenses or find it necessary to seek protection under the applicable bankruptcy
statutes of Canada and/or the United States.
Market for Common Stock; Stock Price Volatility. The Common Stock has been
quoted on the Vancouver Stock Exchange since December 1991, and was quoted on
the NASDAQ Stock Market from September 8, 1993 until July 2, 1996, when it began
trading the OTC Bulletin Board. Based upon historical trends in the market for
other software company stocks, the Company anticipates that the trading price of
its
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Common Stock may be subject to wide fluctuations in response to quarterly
variations in operating results, changes in actual earnings or in earnings
estimates by analysts, announcements of technological developments by the
Company or its competitors, general market conditions or other events largely
outside the Company's control. In addition, the stock market has experienced,
from time to time, extreme price and volume fluctuations which have particularly
affected the market prices of high technology stocks. These fluctuations have
often been disproportionate or unrelated to the operating performance of these
companies. These broad market fluctuations, general economic conditions or other
factors outside the Company's control, as well as the Company's results of
operations and financial condition, may adversely affect the market price of the
Company's stock.
Performance Shares and Related Compensation Expense. In October 1991, in
connection with the sale of 1,800,000 common shares to the Company's founders
and principal stockholders, the Company issued 4,000,000 common "performance"
shares (the "Performance Shares") at CDN $0.01 per share to certain of these
individuals. These Performance Shares were issued pursuant to Local Policy #3-07
of the British Columbia Securities Commission ("BCSC") and Policy 19 of the
Vancouver Stock Exchange, which provide the guidelines for the issuance of
performance shares. In July 1996, a total of 1,200,000 of these shares were sold
and transferred to certain members of current and former management at their
then estimated fair market value of $.03 per share.
The Performance Shares are held in escrow to be released as the Company
achieves positive operating cash flow on an annual basis as defined by the BCSC
("BCSC Operating Cash Flow"). The holders of Performance Shares will be entitled
to a pro rata release from escrow on the basis of one share for every CDN $0.653
of annual positive BCSC Operating Cash Flow, subject to approval by the BCSC and
the Vancouver Stock Exchange. Performance Shares are permitted to be released
from escrow on an annual basis, and all of the Performance Shares will be
released once CDN $2,612,000 of annual positive BCSC Operating Cash Flow has
been generated by the Company.
At the time when BCSC Operating Cash Flow justifying release of the
Performance Shares, or a pro rata portion thereof, is probable, the Company will
record as compensation expense an amount equal to the difference between the CDN
$0.01 per share originally paid for the Performance Shares then issuable and the
market price of its common stock at that time. Such a pro rata or full expense
recognition will occur prior to the pro rata or full release from escrow of the
Performance Shares. If and when such expense recognition criteria becomes
probable, based on the closing price of the Company's common stock on the
Vancouver Stock exchange at February 12, 1997 of approximately US$.17 per share
(for example purposes only), the aggregate compensation expense that would be
recognized as a result of earning of all the performance shares would be
approximately $640,000. Any compensation expense recognized related to the
Performance Shares will be a noncash charge and will have no net impact on total
stockholders' equity (deficit).
The Company may pursue an early release of all or a large portion of the
Performance Shares. Such an early release from escrow would reduce a source of
continuing uncertainty surrounding the Company's consolidated financial
statements, but could also result in compensation expense in the quarter in
which the release is made.
If and when the Performance Shares are earned, the number of shares used to
calculate primary net income (loss) per share will increase by the number of
Performance Shares earned. Through February 12, 1997 no Performance Shares have
been earned or released.
The Company is negotiating in principle with holders of these performance
shares to exchange these shares for common stock or warrants or a combination of
both. The transaction is subject to approval by the Vancouver Stock Exchange.
Shares Eligible for Future Sale; Possible Adverse Effect on Future Market
Price. Sale of substantial amounts of shares in the public market or the
prospect of such sales or the sales or issuance of convertible securities or
warrants could adversely affect the market price of the Company's Common Stock.
Other than the 4,000,000 Performance Shares issued to the Company's founders and
management (which are currently held in an escrow account and are subject to
release upon satisfaction of specified conditions as discussed
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above) substantially all of the Company's issued and outstanding shares are
freely tradable, subject to, in certain circumstances, compliance with Rule 144
or Rule 701 or the effectiveness of a resale registration statement. In
addition, as of February 12, 1997, the Company had outstanding options to
purchase 1,567,750 shares of Common Stock, warrants to purchase 4,931,000 shares
of Common Stock and debentures convertible into 9,640,000 shares of Common
Stock. Furthermore, the Company has reserved approximately 2,432,250 additional
shares of Common Stock for future issuance pursuant to the Company's 1995 Stock
Option Plan.
No Dividends. The Company has not paid any cash dividends since inception
and does not anticipate paying cash dividends in the foreseeable future. The
Company's bank credit agreement prohibits the payment of cash dividends without
the prior written consent of the lender.
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In 1996, Sanctuary Xxxxx was sued by Starpak, Inc. in the state courts of
Colorado. This action was settled and dismissed with prejudice in November 1996.
The Company's payment to Starpak in connection with the settlement was accrued
in September 1996.
ITEM 2. CHANGES IN SECURITIES
At the Company's annual general meeting held on November 12, 1996, the
Company's shareholders approved a resolution authorizing a new class of
preferred stock and authorized the Company's Board of Directors to set the
preferences, limitations and rights of such class of preferred. In connection
with the possible conversion of the Company's outstanding 8% convertible
debentures, the Company intends to create a class of Series A Preferred Stock
which will have preferential rights to dividends and a liquidation preference
relative to the Common Stock.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS
An annual general meeting of the Company was held on November 12, 1996. The
Company furnished its security holders proxy soliciting material which was filed
with the Securities and Exchange Commission. During the meeting, the following
matters were voted upon and passed on motion duly made and seconded on vote of
the shareholders as indicated:
1. To fix the number of Directors for the ensuing year ensuing year:
BROKER
FOR: AGAINST: WITHHELD: ABSTAINED NON VOTES
----------- --------- ---------- ---------- ----------
22,172,255 125,420 0 49,501 0
2. To elect three Directors of the Company to hold office until the 1997
Annual Meeting of Shareholders or until their successors have been duly
elected and qualified:
BROKER
FOR: AGAINST: WITHHELD: ABSTAINED NON VOTES
----------- --------- --------- ---------- ----------
N. Xxxx Xxxxxxxx....... 22,218,631 0 1,500 127,045 0
Xxxxx X. Xxxxxxx....... 22,219,931 0 200 127,045 0
Xxxxxxxxx X. Xxxxxx.... 22,212,113 0 8,018 127,045 0
3. To approve the appointment of Deloitte & Touche LLP, certified public
accountants, as independent auditors of the Company for its fiscal year
ending March 31, 1997 and to authorize the Board of Directors to fix the
remuneration to be paid to the auditors.
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BROKER
FOR: AGAINST: WITHHELD: ABSTAINED NON VOTES
----------- --------- ---------- ---------- ----------
22,246,406 0 69,470 31,300 0
4. To approve amendments of the Company's 1995 Stock Option Plan to (a)
increase the number of shares of Common Stock reserved for issuance
thereunder by 2,030,000 shares from 1,970,000 shares to 4,000,000 shares
and (b) to change the formula for granting options to Directors.
BROKER
FOR: AGAINST: WITHHELD: ABSTAINED NON VOTES
----------- --------- ---------- ---------- ----------
11,793,335 2,922,693 0 153,251 7,477,897
5. To approve, as a special resolution, the consolidation of the Company's
share capital on the basis of one (1) new share for each three (3)
existing shares and to approve an increase to the Company's authorized
capital.
BROKER
FOR: AGAINST: WITHHELD: ABSTAINED NON VOTES
----------- --------- ---------- ---------- ----------
21,682,460 566,766 0 97,950 0
6. To approve, as a special resolution, an amendment to the Company's
Articles of Incorporation authorizing a class of preferred stock with
preferences, limitations and relative rights as determined by the Board
of Directors
BROKER
FOR: AGAINST: WITHHELD: ABSTAINED NON VOTES
----------- --------- ---------- ---------- ----------
11,433,084 3,314,395 0 121,800 7,477,897
There were 22,353,408, shares present or represented by proxy at the
meeting.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
EXHIBIT
NUMBER DESCRIPTION
------ ------------------------------------------------------------------------------------
11 Computation of Net Income (Loss) Per Common Share
27 Financial Data Schedule
Third Amendment to Loan Agreement between Sanctuary Xxxxx Multimedia, Inc. and a
99.1 bank, dated August 15, 1996.
(b) Reports on Form 8-K:
Filed October 30, 1996 (Items 5 and 7 -- Other events and exhibits)
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
SANCTUARY XXXXX MULTIMEDIA CORPORATION
By: /s/ XXXXXXXXX X. XXXXXX
------------------------------------
Xxxxxxxxx X. Xxxxxx, Chairman,
President
and Chief Executive Officer
By: /s/ XXXXX XXXXXXX
------------------------------------
Xxxxx Xxxxxxx
Controller
Dated: February 14, 1997
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