1 ----------------------------------------------------------------------------- --- --------------------------------------------------------------------------- ----- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549...

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

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FORM 10-Q

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(XXXX ONE)

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 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)

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BRITISH COLUMBIA, CANADA 00-0000-000
(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)

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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 November
11, 1996 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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2

PART I -- FINANCIAL INFORMATION
ITEM 1 -- CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Condensed consolidated balance sheets -- September 30, 1996 and March
31, 1996.............................................................. 3
Condensed consolidated statements of operations -- three months ended
September 30, 1996 and 1995........................................... 4
Condensed consolidated statements of operations -- six months ended
September 30, 1996 and 1995........................................... 5
Condensed consolidated statements of cash flows -- six months ended
September 30, 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................................................. 12
PART II --
OTHER INFORMATION
Item 1. Legal Proceedings..................................................... 26
Item 6. Exhibits and Reports on Form 8-K...................................... 26
27
Signatures......................................................................

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 in
this section, and in Management's Discussion and Analysis of Financial Condition
and Results of Operations contained in the Company's reports on Form 10-K/A-1
and A-2 for the year ended December 31, 1995 and on Form 10-Q for the three
month periods ended March 31, 1996 and June 30, 1996.

2
3

SANCTUARY XXXXX MULTIMEDIA CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS
AS OF SEPTEMBER 30, 1996 AND MARCH 31, 1996 (UNAUDITED)

SEPTEMBER
30, MARCH 31,
1996 1996
------------ ------------

ASSETS
CURRENT ASSETS:
Cash.......................................................... $ 3,570,979 $ 8,455
Accounts receivable........................................... 842,876 800,701
Inventories................................................... 927,895 1,384,840
Prepaid royalties............................................. 185,243 127,000
Prepaid expenses.............................................. 370,027 294,203
------------ ------------
Total current assets.................................. 5,897,020 2,615,199
PROPERTY AND EQUIPMENT.......................................... 747,895 1,834,266
DEFERRED ROYALTIES & OTHER ASSETS............................... 275,832 144,396
------------ ------------
TOTAL ASSETS.................................................... $ 6,920,747 $ 4,593,861
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Bank debt..................................................... $ 850,000 $ 2,226,781
Notes payable................................................. 1,563,666
Accounts payable.............................................. 1,892,500 3,087,886
Accrued expenses.............................................. 355,154 1,395,359
Royalty obligations........................................... 376,700 611,905
Current portion of capital lease obligations.................. 26,771 28,715
------------ ------------
Total current liabilities............................. 3,501,125 8,914,312
8% CONVERTIBLE DEBENTURES DUE 1999.............................. 5,302,000
LONG-TERM ROYALTY OBLIGATIONS................................... 84,000 534,000
CAPITAL LEASE OBLIGATIONS....................................... 13,781
------------ ------------
Total liabilities..................................... 8,887,125 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 September 30, 1996
and 22,158,580 shares at March 31, 1996.................... 34,736,887 31,763,839
Accumulated deficit........................................... (35,951,394) (35,874,113)
Accumulated translation adjustments........................... (751,871) (757,958)
------------ ------------
Total stockholders' equity (deficit).................. (1,966,378) (4,868,232)
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)............ $ 6,920,747 $ 4,593,861
============ ============

See notes to condensed consolidated financial statements.

3
4

SANCTUARY XXXXX MULTIMEDIA CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 1996 AND 1995 (UNAUDITED)

1996 1995
---------- ----------

SALES:
Consumer titles................................................... $ 533,735 $8,838,884
Licensing revenue................................................. 642,237 339,103
Publisher services................................................ 174,078
---------- ----------
Total sales............................................... 1,175,972 9,352,065
---------- ----------
COST OF SALES:
Consumer titles................................................... 244,634 3,719,673
Technology amortization........................................... 183,090
Publisher services................................................ 145,174
---------- ----------
Total cost of sales....................................... 244,634 4,047,937
---------- ----------
GROSS MARGIN........................................................ 931,338 5,304,128
---------- ----------
OPERATING EXPENSES:
Research and development.......................................... 250,298 1,232,925
Marketing and sales............................................... 621,694 2,164,984
Administration.................................................... 490,425 803,080
Depreciation...................................................... 76,512 204,110
---------- ----------
Total operating expenses.................................. 1,438,929 4,405,099
---------- ----------
OPERATING INCOME (LOSS)............................................. (507,591) 899,029
---------- ----------
OTHER INCOME (EXPENSE)
Foreign exchange loss............................................. (280) (7,412)
Interest (expense) income -- net.................................. (32,579) 2,686
Other income...................................................... 120,191 7,059
---------- ----------
Total other income........................................ 87,332 2,333
---------- ----------
NET INCOME (LOSS)................................................... $ (420,259) $ 901,362
========== ==========
PRIMARY NET INCOME (LOSS) PER SHARE................................. $(0.02) $ 0.05
FULLY DILUTED NET INCOME (LOSS) PER SHARE........................... $(0.02) $ 0.04
PRIMARY SHARES USED IN COMPUTATION.................................. 23,241,164 19,171,452
FULLY DILUTED SHARES USED IN COMPUTATION............................ 23,241,164 23,171,452

See notes to condensed consolidated financial statements.

4
5

SANCTUARY XXXXX MULTIMEDIA CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
SIX MONTHS ENDED SEPTEMBER 30, 1996 AND 1995 (UNAUDITED)

1996 1995
---------- -----------

SALES:
Consumer titles.................................................. $1,528,451 $10,162,647
Licensing revenue................................................ 1,567,890 904,235
Publisher services............................................... 344,053
----------- -----------
Total sales.............................................. 3,096,341 11,410,935
----------- -----------
COST OF SALES:
Consumer titles.................................................. 927,734 4,683,695
Technology amortization.......................................... 344,180
Publisher services............................................... 290,348
----------- -----------
Total cost of sales...................................... 927,734 5,318,223
----------- -----------
GROSS MARGIN....................................................... 2,168,607 6,092,712
----------- -----------
OPERATING EXPENSES:
Research and development......................................... 709,362 2,211,245
Marketing and sales.............................................. 1,254,500 3,977,762
Administration................................................... 978,331 1,922,166
Depreciation..................................................... 211,917 325,256
----------- -----------
Total operating expenses................................. 3,154,110 8,436,429
----------- -----------
OPERATING LOSS..................................................... (985,503) (2,343,717)
----------- -----------
OTHER INCOME (EXPENSE)
Foreign exchange (loss) gain..................................... (3,269) 4,068
Interest (expense) income, net................................... (114,747) 11,688
Net gain on sale and disposal of assets.......................... 875,161
Other income (expense)........................................... 151,078 (32,985)
----------- -----------
Total other income (expense)............................. 908,223 (17,229)
----------- -----------
NET LOSS........................................................... $ (77,280) $(2,360,946)
=========== ===========
PRIMARY NET LOSS PER SHARE......................................... $ (0.00) $ (0.13)
PRIMARY SHARES USED IN COMPUTATION................................. 21,268,183 17,755,425

See notes to condensed consolidated financial statements.

5
6

SANCTUARY XXXXX MULTIMEDIA CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED SEPTEMBER 30, 1996 AND 1995 (UNAUDITED)

1996 1995
----------- -----------

CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss........................................................ $ (77,280) $(2,360,946)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization................................... 213,763 615,603
Stock option and warrant compensation........................... 81,981 66,275
Sale of intellectual property rights in consideration for a
reduction in royalty obligations............................. (429,688)
Net gain on sale and disposal of assets......................... (875,161) (203)
Changes in assets and liabilities:
Accounts receivable.......................................... (42,175) (5,384,852)
Inventories.................................................. 456,945 (803,493)
Prepaid royalties, expenses and other........................ (140,400) 1,243,032
Accounts payable and accrued expenses........................ (2,160,091) 1,274,888
----------- -----------
Net cash used by operating activities................... (2,972,106) (5,349,493)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of assets.................................... 1,900,000
Purchase of property and equipment.............................. (30,951) (495,864)
----------- -----------
Net cash provided (used) in investing activities........ 1,869,049 (495,864)
----------- -----------
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..................... 7,991,484
Net payments on bank debt....................................... (1,376,781) (200,000)
Payments on long-term debt...................................... (15,725)
----------- -----------
Net cash provided in financing activities............... 4,659,494 7,791,484
----------- -----------
EFFECT OF EXCHANGE RATE CHANGES ON CASH........................... 6,087
----------- -----------
NET INCREASE IN CASH.............................................. 3,562,524 1,946,127
CASH, BEGINNING OF PERIOD......................................... 8,455 268,552
----------- -----------
CASH, END OF PERIOD............................................... $ 3,570,979 $ 2,214,679
=========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest..................................................... $ 68,587 $ 63,933
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 in exchange for a reduction in
royalty obligations and issuance of common stock............. 550,000
Conversion of account payable into common stock................. 195,000

See notes to condensed consolidated financial statements.

6
7

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
SIX MONTHS ENDED SEPTEMBER 30, 1996 AND 1995

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 childrens' 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 to March 31 from December 31. The change was effected April
1, 1996. Accordingly, the accompanying condensed consolidated financial
statements include the three and six month periods ended September 30, 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 and
the three month periods ended March 31 and June 30, 1996 included in Form 8-K as
filed on October 31, 1996. Results of operations for interim periods are not
necessarily indicative of results for the full year.

2. HISTORICAL OPERATING LOSSES AND CERTAIN MANAGEMENT ACTIONS

Net loss for the six month period ended September 30, 1996 was ($77,280)
compared to a net loss of ($2,360,946) for the six months ended September 30,
1995. The net loss from operations for the six month period ended September 30,
1996 totalled ($985,503) compared to a net operating loss of ($2,343,717) for
the same period one year ago. Net cash used by operating activities was
($2,972,106) for the six month period ended September 30, 1996 compared to
($5,349,493) for the same period one year ago. At September 30, 1996 the Company
had $3,570,979 in cash and bank borrowings totalling $850,000.

1996 Management Actions

During 1996, the Company instituted measures to improve operations and cash
flows to continue its operations. Specific items accomplished through November
11, 1996 included the following:

- Appointment of a new President and Chief Executive Officer, Vice President of
Marketing, and a Controller, and promotion of the Vice President of the
Education Division to Senior Vice President.

- Reduction of head count from 148 employees at December 31, 1995 to 35 at
November 11, 1996 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 six month
period ended September 30, 1996, totaled $897,260.

7
8

NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)

- Reduction by $2,038,000 of the outstanding borrowings under the bank line of
credit from its January 1996 peak level of $2,572,000 to $534,000 at November
11, 1996.

- 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 six month period ended
September 30, 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 six month period ended September 30, 1996.

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 12.25% at
September 30, 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 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.

At November 11, 1996 the Company was in compliance with the terms of its
bank credit agreement.

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. 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.

8
9

NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)

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. 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.

The holders of stock issued upon conversion of debentures or exercise of
warrants have certain rights to have these shares registered.

* * * *

At November 11, 1996, the Company had cash of $2,200,000 and bank
borrowings of $534,000. Management believes that the Company's existing cash
resources, cash flows from operations and additional proceeds, if necessary,
from debt or equity financing (including the exercise of warrants) will enable
the Company to comply with its bank covenants through April 3, 1997 and meet its
financial obligations and conduct its operations through September 30, 1997.

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:

SEPTEMBER 30, MARCH 31,
1996 1996
------------- -----------

Accounts receivable -- trade.............................. $ 2,125,293 $ 4,814,104
Less allowances for:
Doubtful accounts....................................... (221,138) (207,352)
Sales returns and allowances............................ (1,061,279) (3,806,051)
----------- -----------
Accounts receivable -- net................................ $ 842,876 $ 800,701
=========== ===========

4. INVENTORIES

Inventories consisted of:

SEPTEMBER 30, MARCH 31,
1996 1996
------------- -----------

Finished goods............................................ $ 1,091,912 $ 1,967,558
Raw materials............................................. 573,595 866,957
---------- ----------
1,665,507 2,834,515
Less allowance for obsolete, slow-moving and
non-salable inventory................................... (737,612) (1,449,675)
---------- ----------
Inventories-net........................................... $ 927,895 $ 1,384,840
========== ==========

5. COMMON STOCK OPTIONS AND WARRANTS

At November 11, 1996 there were outstanding options to purchase 2,019,750
shares of common stock at $.50 to $5.75 per share and warrants to purchase
4,771,000 shares of common stock at $0.50 to $0.6875 per share.

9
10

NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)

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 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
$0.01 per share originally paid for the Performance Shares then issuable and the
market price of its common stock at that time. Such a pro rata or full expense
recognition will occur prior to the pro rata or full release from escrow of the
Performance Shares. If and when such expense recognition criteria are achieved,
based on the closing price of the Company's common stock on the Vancouver Stock
exchange at November 11, 1996, of approximately US$.20 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 $800,000.
Any compensation expense recognized related to the Performance Shares will be a
noncash charge against income 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 November 11, 1996,
no Performance Shares have been earned or released.

10
11

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 8-K dated October 30,
1996 and Management's Discussion and Analysis of Financial Condition and Results
of Operations contained in the Company's Annual Report on Form 10-K/A-1 and A-2
for the fiscal year ended December 31, 1995, and Forms 10-Q for the three month
periods ended March 31 and June 30, 1996 as filed with the Securities and
Exchange Commission.

Overview and Recent Developments.

In 1996, the Company changed its fiscal year to end March 31.

During 1996, the Company instituted measures to improve operations and cash
flows to continue its operations. Specific items accomplished through November
11, 1996 included the following:

- Appointment of a new President and Chief Executive Officer, Vice President of
Marketing, and a Controller, and promotion of the Vice President of the
Education Division to Senior Vice President.

- Reduction of head count from 148 employees at December 31, 1995 to 35 at
November 11, 1996 and elimination of many part-time, temporary and contract
positions.

- Ceasing publication of new entertainment titles.

- Closure of the Publisher Services Division.

- Reduction by $2,038,000 of the outstanding borrowings under the bank line of
credit from its January 1996 peak level of $2,572,000 to $534,000 at November
11, 1996.

- 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 of other entertainment product rights (included in licensing revenue) for
$150,000 in the six month period ended September 30, 1996.

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. The Company develops these products primarily in
its San Mateo, California studio. Since the beginning of the current fiscal year
through November 11, 1996, the Company has completed the development of six new
products: Major League Math(TM), Franklin Learns Math(TM), How Do You Spell
Adventure?(TM), Orion Burger(TM), NFL(TM) Math and NFL(TM) Reading. The Company
currently sells five of the titles and has sold the publishing rights to Orion
Burger(TM) to a third party publisher.

11
12

Liquidity and Capital Resources.

Due to more than $23,600,000 in operating losses incurred during the
eighteen months ended June 30, 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 applied to repay banks 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 holders of stock issued upon conversion of debentures or exercise of
warrants have certain rights to have these shares registered.

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
12.25% at September 30, 1996.

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.

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.

12
13

RESULTS OF OPERATIONS -- THREE MONTHS ENDED SEPTEMBER 30, 1996 AND 1995

Net Loss. The net loss for the quarter ended September 30 ,1996 was
$(420,259) compared to net income of $901,362 in the quarter ended September 30,
1995. The net loss in the September 1996 quarter was primarily due to lower
sales as compared to the September 1995 quarter. The September 1995 quarter
includes significant sales of two of the Company's entertainment titles, Buried
in Time and Ripleys:Xxxxxx of Master Lu into the retail distribution channel.
Due to the poor sell through of these entertainment titles, and the severe
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 on developing education software titles.

Sales. Sales decreased 87% to $1,175,972 in the quarter ended September
30, 1996 from $9,352,065 in the quarter ended September 30, 1995. Most of the
decrease resulted from the Company's elimination of its entertainment products
business in early 1996. In the quarter ended September 30, 1995, the Company
generated a large sales volume from the release of two entertainment titles,
Buried In Time and Ripleys:Xxxxxx of Master Lu. In the quarter ended September
30, 1996, the Company generated a low volume of sales for its education consumer
titles. For most of the first nine months of calendar 1996, the Company lacked
sufficient capital resources to adequately fund sales, marketing and other
operational activities. The Company estimates that the low volume of sales was
at least partially due to the lack of resources needed to market and promote its
products.

Licensing revenues increased 89% to $642,237 in the quarter ended September
30, 1996 from $339,103 in the quarter ended September 30, 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 quarter ended September 30, 1996.

Gross Margins. Gross margins increased to 79% of total sales in the
quarter ended September 30, 1996 from 57% in the quarter ended September 30,
1995. This increase is partially due to the increase in licensing revenues,
which carry no costs of sale, the elimination of the publisher services
division, and the decrease in technology amortization which was fully expensed
in 1995. This increase in margin was slightly offset by an increase in cost of
sales on consumer titles to 46% in the quarter ended September 30, 1996 from 42%
in the quarter ended September 30, 1995. Although the September 1995 quarter
contained higher royalty and freight costs relating to the release of Buried In
Time and Ripleys:Xxxxxx of Master Lu, the September 1996 quarter includes
increased provisions for returns and price-protection.

Research and Development Costs. Research and development costs decreased
80% to $250,298 in the quarter ended September 30, 1996 from $1,232,925 in the
quarter ended September 30, 1995. This decrease is primarily due to a reduction
in personnel and facility costs associated with the sale of the Company's
Victoria studio and the overall reduction of the Company's work force. As a
percentage of sales, research and development costs were 21% in the quarter
ended September 30, 1996 compared to 13% in the same quarter last year. The
increase is primarily due to substantially reduced sales resulting from the
elimination of the Company's entertainment products.

Marketing and Sales. Marketing and sales expenditures decreased 71% to
$621,694 in the quarter ended September 30, 1996 from $2,164,984 in the quarter
ended September 30, 1995. This decrease was due primarily to the Company's lack
of resources to fund advertising and promotion activities until the latter part
of the quarter. In addition, the Company has reduced personnel expenses due to
the elimination of its entertainment products. In the quarter ended September
1995, the Company invested substantial sums to promote the release of its then
premiere entertainment titles Buried In Time and Ripleys:Xxxxxx of Master Lu. As
a percentage of sales, sales and marketing costs were 53% in the quarter ended
September 30, 1996 compared to 23% in the same quarter last year. The increase
is primarily due to substantially reduced sales resulting from the elimination
of the Company's entertainment products.

Administrative Costs. Administrative expenses decreased 39% to $490,425 in
the quarter ended September 30, 1996 from $803,080 in the quarter ended
September 30, 1995, primarily due to the reduction in

13
14

the Company's work force. As a percentage of sales, administrative costs were
42% in the quarter ended September 30, 1996 compared to 9% in the same quarter
last year. This increase is primarily due to substantially reduced sales
resulting from the elimination of the Company's entertainment products and to
increased bad debt expense and consulting and professional fees.

As of November 11, 1996, the Company had 35 full time employees and
operated facilities in Xxx Xxxxx, Xxxxxxxxxx xxx Xxxxxxx, Xxxxxx. These
employees were employed in the following functions:

Product Development -- Children's Educational Products.......................... 12
Marketing, Sales, Customer Service & Technical Support.......................... 14
General and Administrative...................................................... 9
--
Total................................................................. 35
==

In November 1996, management decided to close the Company's Toronto office
effective January 31, 1997 and relocate the activities conducted there to its
San Mateo headquarters. The closure will force the layoff of 4 full-time product
development employees.

RESULTS OF OPERATIONS -- SIX MONTH PERIODS ENDED SEPTEMBER 30, 1996 AND 1995

Net Loss. The net loss for the six month period ended September 30, 1996
was $(77,280) compared to a net loss of $(2,360,946) in the six month period
ended September 30, 1995. The net loss in the September 1996 period was due to
reduced sales compared to the September 1995 period. The six month period ended
September 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 education software
titles.

For most of the first nine months of calendar 1996, the Company lacked
sufficient capital resources to adequately fund sales, marketing and other
operational activities. The Company estimates that the low sales volume during
the six month period ended September 30, 1996 was at least partially due to the
lack of resources needed to market and promote its titles. However, the
permanent reductions in headcount and operating overhead somewhat offset the
negative impact on the operating loss of these financial constraints.

Net Sales. Sales decreased 73% to $3,096,341 for the six month period
ended September 30, 1996 from $11,410,935 in the six month period ended
September 30, 1995 primarily due to the elimination of the entertainment
products business. In the quarter ended September 30, 1996, the Company
experienced a low volume of sales for its education consumer titles. For most of
the first nine months of calendar 1996, the Company lacked sufficient capital
resources to adequately fund sales, marketing and other operational activities.
The Company estimates that the low volume of sales was at least partially due to
the lack of resources needed to market and promote its products.

Licensing revenues increased 73% to $1,567,890 in the six month period
ended September 30, 1996 from $904,235 in the six month period ended September
30, 1995. The increase was primarily due to the sale of publishing rights to
certain entertainment titles and increased royalties from international sales.

Gross Margins. Gross margins increased to 70% of total sales in the six
month period ended September 30, 1996 from 53% in the six month period ended
September 30, 1995. This increase is due to the increase in licensing revenues,
which carry no costs of sale and the decrease in technology amortization which
was fully expensed in 1995. Cost of sales on consumer titles increased to 61% in
the six month period ended September 30, 1996 from 46% in the same period last
year due to increased provisions for product returns and price-protection in the
September 1996 period.

Research and Development Costs. Research and development costs decreased
68% to $709,362 in the six month period ended September 30, 1996 from $2,211,245
in the same period last year. This decrease is

14
15

primarily due to a reduction in personnel and facility costs associated with the
sale of the Company's Victoria studio and the overall reduction of the Company's
work force.

Marketing and Sales. Marketing and sales expenditures decreased 69% to
$1,254,500 in the six month period ended September 30, 1996 from $3,977,762 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. 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 six month period ended September 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 41% in the six month period ended September 30, 1996
compared to 35% for the same period last year. The increase is primarily due to
substantially reduced sales resulting from the elimination of the Company's
entertainment products.

Administrative Costs. Administrative expenses decreased 50% to $978,331 in
the six month period ended September 30, 1996 from $1,922,166 in the six month
period ended September 30, 1995, due to the reduction in the Company's work
force. As a percentage of sales, administrative costs were 32% in the six month
period ended September 30, 1996 versus 17% in the same period last year. This
increase is primarily due to substantially reduced sales resulting from the
elimination of the Company's entertainment products and to increased bad debt
expense and consulting 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 totalling $115,000 is
included in other income for the quarter.

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 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. The Company recognizes revenue in accordance with industry
practice (net of an allowance for product returns and price protection) from the
sale of its products upon shipment to its distributors and retailers. The
Company had a reserve balance for price protection and returns as of September
30, 1996, of $1,061,279. 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

15
16

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 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

16
17

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 only for DOS
and Windows 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.

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. 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

17
18

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 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 management at their then estimated
fair market value of $.03 per share.

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19

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 November 11, 1996, no Performance Shares have
been earned or released.

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 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
November 11, 1996, the Company had outstanding options to purchase 2,019,750
shares of Common Stock, warrants to purchase 4,771,000 shares of Common Stock
and debentures convertible into 9,640,000 shares of Common Stock. Furthermore,
the Company has reserved approximately 443,000 additional shares of Common Stock
for future issuance pursuant to the Company's 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.

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20

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 had
been accrued at September 30, 1996.

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

(b) Reports on Form 8-K:
October 30, 1996 (Items 5 and 7 -- Other events and exhibits).

20
21

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:
------------------------------------
Xxxxxxxxx X. Xxxxxx
President and
Chief Executive Officer

By:
------------------------------------
Xxxxx Xxxxxxx
Controller
Principal Financial and
Accounting Officer

Dated: November 13, 1996

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22

SIGNATURES

SANCTUARY XXXXX MULTIMEDIA CORPORATION

By: /s/ XXXXXXXXX X. XXXXXX
------------------------------------
Xxxxxxxxx X. Xxxxxx
President and
Chief Executive Officer

By: /s/ XXXXX XXXXXXX
------------------------------------
Xxxxx Xxxxxxx
Controller
Principal Financial and
Accounting Officer

Dated: November 13, 1996

22
23

EXHIBIT LIST

EXHIBIT ITEM
------- ---------------------------------------------------------------------------------

27.1 Financial Data Schedule
11.1 Computation of Net Income (Loss) Per Common Share

23
24
[ARTICLE] 5

[PERIOD-TYPE] 6-MOS
[FISCAL-YEAR-END] MAR-31-1997
[PERIOD-START] JUL-01-1996
[PERIOD-END] SEP-30-1996
[CASH] 3,570,979
[SECURITIES] 0
[RECEIVABLES] 2,125,293
[ALLOWANCES] 1,282,417
[INVENTORY] 927,895
[CURRENT-ASSETS] 5,897,020
[PP&E] 747,895
[DEPRECIATION] 76,512
[TOTAL-ASSETS] 6,920,747
[CURRENT-LIABILITIES] 3,501,125
[BONDS] 0
[PREFERRED-MANDATORY] 0
[PREFERRED] 0
[COMMON] 34,736,887
[OTHER-SE] (751,871)
[TOTAL-LIABILITY-AND-EQUITY] 6,920,747
[SALES] 0
[TOTAL-REVENUES] 1,175,972
[CGS] 244,634
[TOTAL-COSTS] 244,634
[OTHER-EXPENSES] 1,438,929
[LOSS-PROVISION] 132,000
[INTEREST-EXPENSE] 32,579
[INCOME-PRETAX] (420,259)
[INCOME-TAX] 0
[INCOME-CONTINUING] (420,259)
[DISCONTINUED] 0
[EXTRAORDINARY] 0
[CHANGES] 0
[NET-INCOME] (420,259)
[EPS-PRIMARY] (.02)
[EPS-DILUTED] (.02)

EXHIBIT 11.1

COMPUTATION OF NET INCOME (LOSS) PER COMMON SHARE

THREE MONTHS ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- --------------------------
1996 1995 1996 1995
---------- ---------- ---------- -----------

NET INCOME (LOSS)........................ $ (420,259) $ 901,362 $ (77,280) $(2,360,946)
=========== =========== =========== ===========
PRIMARY SHARES OUTSTANDING:
Common Shares............................ 27,241,164 21,746,262 25,268,183 20,796,651
Performance shares held in escrow........ (4,000,000) (4,000,000) (4,000,000) (4,000,000)
Common stock equivalents (including stock
options and warrants).................. 1,425,190 958,774
----------- ----------- ----------- -----------
Total.......................... 23,241,164 19,171,452 21,268,183 17,755,425
=========== =========== =========== ===========
PRIMARY NET LOSS PER SHARE............... $ (0.02) $ 0.05 $ (0.00) $ (0.13)
=========== =========== =========== ===========
FULLY DILUTED NET LOSS PER SHARE(1)
NET LOSS................................. $ (420,259) $ 901,362 $ (77,280) $(2,360,946)
=========== =========== =========== ===========
FULLY DILUTED SHARES OUTSTANDING:
Common Shares............................ 27,241,164 21,746,262 25,268,183 20,796,651
Convertible Debt......................... 1,271,209 632,131
Common stock equivalents (including stock
options and warrants).................. 27,090 1,425,190 533,596 1,110,843
----------- ----------- ----------- -----------
Total.......................... 28,539,463 23,171,452 26,433,910 21,907,494
=========== =========== =========== ===========
FULLY DILUTED NET LOSS
PER SHARE.............................. $ (0.01) $ 0.04 $ (0.00) $ (0.11)
=========== =========== =========== ===========

---------------
(a) Fully Diluted Net Loss Per Common Share has been presented in accordance
with Regulation S-K Item 601(b)(11) even though the amount of fully diluted
loss per share is not required to be presented in the statement of
operations under the provisions of APB Opinion No. 15 because of the
anti-dilutive effects of including common stock equivalents.

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