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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended: AUGUST 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _________ to __________
Commission file number: 0-18066
CHELL GROUP CORPORATION
(Exact name of registrant as specified in its charter)
NEW YORK 11-2805051
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
800 3RD AVE., 21ST FLOOR, NY, NY 10022
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (416) 675-0874
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK, PAR
VALUE US$0.0467
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes No X
----- ------
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Aggregate market value (i.e., last price) of voting stock held by
non-affiliates of the Registrant, as of April 7, 2004 US$275,000 based on the
closing sale price of US$0.02 on April 7, 2004.
Indicate the number of shares outstanding of each of the Registrant's
classes of common stock, as of April 7, 2004 13,795,907 shares of common stock,
par value US$0.0467 per share
DOCUMENTS INCORPORATED BY REFERENCE: NONE
FORWARD LOOKING STATEMENTS
--------------------------
THIS ANNUAL REPORT ON FORM 10-K AND THE DOCUMENTS INCORPORATED HEREIN
CONTAIN "FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995. SUCH FORWARD-LOOKING STATEMENTS
INVOLVE KNOWN AND UNKNOWN RISKS, UNCERTAINTIES AND OTHER FACTORS WHICH MAY CAUSE
THE ACTUAL RESULTS, PERFORMANCE OR ACHIEVEMENTS OF THE COMPANY, OR INDUSTRY
RESULTS, TO BE MATERIALLY DIFFERENT FROM ANY FUTURE RESULTS, PERFORMANCE OR
ACHIEVEMENTS EXPRESSED OR IMPLIED BY SUCH FORWARD-LOOKING STATEMENTS. WHEN USED
IN THIS ANNUAL REPORT, STATEMENTS THAT ARE NOT STATEMENTS OF CURRENT OR
HISTORICAL FACT MAY BE DEEMED TO BE FORWARD-LOOKING STATEMENTS. WITHOUT LIMITING
THE FOREGOING, THE WORDS "PLAN", "INTEND", "MAY," "WILL," "EXPECT," "BELIEVE",
"COULD," "ANTICIPATE," "ESTIMATE," OR "CONTINUE" OR SIMILAR EXPRESSIONS OR OTHER
VARIATIONS OR COMPARABLE TERMINOLOGY ARE INTENDED TO IDENTIFY SUCH
FORWARD-LOOKING STATEMENTS. READERS ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE ON
THESE FORWARD-LOOKING STATEMENTS, WHICH SPEAK ONLY AS OF THE DATE HEREOF. EXCEPT
AS REQUIRED BY LAW, THE COMPANY UNDERTAKES NO OBLIGATION TO UPDATE ANY
FORWARD-LOOKING STATEMENTS, WHETHER AS A RESULT OF NEW INFORMATION, FUTURE
EVENTS OR OTHERWISE.
ANY REFERENCE TO "CHELL", THE COMPANY OR THE REGISTRANT, WE, OUR OR US MEANS
CHELL GROUP CORPORATION, INC. AND ITS SUBSIDIARIES.
TABLE OF CONTENTS
FORM 10-K INDEX
PAGE
PART I
Item 1. Business.......................................................... 1
Item 2. Properties........................................................ 9
Item 3. Legal Proceedings................................................. 10
Item 4. Submission of Matters to a Vote of Security Holders............... 12
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters............................................... 12
Item 6. Selected Financial Data........................................... 13
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations......................................... 14
Item 7A. Quantitative and Qualitative Disclosures About Market Risk........ 25
Item 8. Financial Statements and Supplementary Data....................... 26
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.......................................... 26
Item 9A. Controls and Procedures........................................... 27
PART III
Item 10. Directors and Executive Officers of the Registrant................ 28
Item 11. Executive Compensation............................................ 30
Item 12. Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters................................... 33
Item 13. Certain Relationships and Related Transactions.................... 34
Item 14. Principal Accountant Fees and Services............................ 35
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K... 36
PART I
EXCHANGE RATES
The currency amounts in this Annual Report on Form 10-K, including the
financial statements, are, unless otherwise indicated, expressed in Canadian
dollars ("Cdn$"). This Form 10-K contains translations of certain amounts in
Canadian dollars into United States dollars ("US$") based upon the exchange rate
in effect at the end of the period to which the amount relates, or the exchange
rate on the date specified. For such purposes, the exchange rate means the noon
buying rate in New York City for cable transfers in Canadian dollars as
certified for customs purposes by the Federal Reserve Bank of New York (the
"Noon Buying Rate"). These translations should not be construed as
representations that the Canadian dollar amounts actually represent such U.S.
dollar amounts or that Canadian dollars could be converted into U.S. dollars at
the rate indicated or at any other rate. The Noon Buying Rate at the end of each
of the five years ended August 31, the average of the Noon Buying Rates on the
last day of each month during each of such fiscal years and the high and low
Noon Buying Rate for each of such fiscal years were as follows:
- ---------------------------------------------------------------------------------------------------------------------------
Fiscal Year Ended August 31,
2004(1) 2003 2002 2001 2000 1999 1998
At end of period Cdn$1.3113 Cdn$1.3857 Cdn$1.5588 Cdn$1.5508 Cdn$1.4715 Cdn$1.4965 Cdn$1.5722
Average for period 1.3245 1.4822 1.5724 1.5284 1.4714 1.4949 1.4390
High for period 1.3632 1.5778 1.6003 1.5825 1.4955 1.5135 1.5770
Low for period 1.2960 1.3523 1.5317 1.4685 1.4489 1.4760 1.4100
(1) Through April 6, 2004.
On April 6, 2004 the Noon Buying Rate was Cdn $1.3093.
ITEM 1. BUSINESS.
OVERVIEW
GENERAL
At August 31, 2002, we were engaged in the business of providing systems
integration and interactive entertainment. Our business is conducted in our
wholly-owned operating subsidiaries. At such date, we provided systems
integration services through our Logicorp Data Systems Ltd. and Logicorp
Services Group Ltd. subsidiaries (collectively referred to as "Logicorp") and
eTelligent Solutions Inc. ("eTelligent"); and interactive entertainment services
through our NTN Interactive Network Inc. ("NTN") and GalaVu Entertainment
Network Inc. ("GalaVu") subsidiaries.
We sold GalaVu on April 25, 2003 and effective December 15, 2003 we sold
certain assets and liabilities of NTN. We discontinued the operations in our
merchant capital services subsidiaries comprised of Chell Merchant Capital Group
("CMCG") and Chell.com USA, during February 2001; CMCG was then used to acquire
Logicorp in January 2002.
We were incorporated on May 12, 1986 pursuant to the laws of the State
of New York as TrioSearch, Inc. In June 1988, we changed our name to NTN Canada,
Inc. In March 1998 we changed our name to Networks North Inc. and in September
2000, changed our name to Chell Group Corporation. Our head office and principal
place of business is located at 14 Meteor Drive, Toronto, Ontario, M9W 1A4. Our
registered office is located at c/o Reitler Brown LLC, 800 Third Avenue, 21st
Floor, New York, New York, 10022.
1
Through August 31, 2001, our management employed an aggressive
acquisition and disposition strategy. During the year ended August 31, 2002, our
management employed a strategy of building and maintaining our current
operations.
In October 1996, we acquired all of the outstanding stock of Magic
Lantern Communications Ltd., an Ontario corporation, and its subsidiaries. In
August 1997, we acquired through Magic Lantern certain business assets of Image
Media Ltd. and 802117 Ontario Inc., operating as Pilot Software. Effective March
18, 2002, we sold all of the outstanding stock of Magic Lantern Communications
Ltd. for Cdn$1.85 million in cash.
As of June 1999, we acquired all of the outstanding stock of Interlynx
Multimedia Inc., an Ontario corporation. Effective June 2001, we sold our
interest in Interlynx for $50,000 cash and a $45,000 note.
In September 1999, we acquired substantially all of the property and
assets (excluding accounts receivable) of GalaVu Entertainment Inc., an Ontario
corporation. In April 2003, we sold GalaVu for $170,000 and a note for $325,000.
In September 2000, we acquired certain assets and the following shares
from Chell.com, a corporation the sole stockholder and director of which is
Cameron Chell, our former Chairman of the Board of Directors, President, and
Chief Executive Officer, for an aggregate purchase price of US$27,002,086: (a)
480,000 shares of cDemo which then represented approximately 14.3% of cDemo's
issued and outstanding stock; (b) 875,000 shares of Engyro Inc. which then
represented approximately 34% of Engyro's issued and outstanding stock; and (c)
100% of the issued and outstanding stock of Chell.com (USA) Inc., a Nevada
corporation. See "Certain Relationships and Related Party Transactions."
Effective January 1, 2002, we acquired through CMCG all of the issued
and outstanding shares of 123557 Alberta Ltd. and 591360 Alberta Ltd. which own
1/3 of the shares of Logicorp Data Systems Ltd., and Logicorp Service Group Ltd.
respectively. The remaining 2/3 of the shares of Logicorp Data Systems and
Logicorp Service Group were acquired directly by CMCG.
On March 18, 2002, we sold our educational video and media resources
business, which was conducted through our Magic Lantern subsidiary and its
subsidiaries.
Effective December 15, 2003 we sold certain assets and liabilities of
NTN to NTN Communications, Inc. ("NTN Communications"), an unaffiliated third
party from which NTN licenses portions of its technology. The purchase price
consisted of US$250,000 in cash, US$650,000 in stock of NTN Communications, and
additional cash based on working capital at closing. The purchase price was
offset by approximately US$700,000 owed by NTN to NTN Communications under this
license agreement. We believe that the interactive entertainment industry does
not represent the growth markets that we wish to develop.
Until April 30, 2001, Chell.com USA was an operating company in the
merchant services. Since then and thru August 31, 2002, we have not had any
operations in merchant services.
Engyro and cDemo were investment companies that were invested in under
our merchant services segment. We have no further plans to develop these
companies. We held shares in these companies as investments which were written
down during the fiscal year ended August 31, 2001 to zero.
BUSINESS SEGMENTS
Systems Integration is an area of business in which our subsidiaries
offer systems solutions to companies of various sizes. These solutions can be
through the delivery and installation of computer hardware solutions; through
offering services to companies to aid in their business processes or
infrastructures or through personalized solutions aided for growing technology
with their organization.
Interactive Entertainment is an area of business that we have decided to
divest ourselves of in order to focus our attention on the systems integration
as is seen with the subsequent sales of GalaVu and NTN. This segment was viewed
as an area of business in which we could use our technology to provide
entertainment to the end user. In addition to being a benefit the end users,
this entertainment would allow for the interaction with other users or just for
their own benefit.
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Merchant Services was viewed as an area in which we could provide
financing and operational expertise to growing companies in order to aid them
with their development and growth. This segment has been discontinued by the
closing down of our CMCG subsidiary's operations.
ORGANIZATIONAL STRUCTURE
During the year ended August 31, 2002, we conducted our business through
five material operating subsidiaries or subsidiary groups and three other
companies in which we held investments. The following is a list of these
subsidiaries or groups and investments, a designation of the business segments
in which each then operated, and the percentage of our revenue attributable to
such subsidiary or group of subsidiaries or investment:
- ----------------------------------------------------------------------------------------------------
PERCENTAGE OF REVENUE
FOR THE YEAR ENDED
WHOLLY-OWNED SUBSIDIARIES BUSINESS SEGMENT AUGUST 31, 2002
====================================================================================================
SUBSIDIARIES OR SUBSIDIARY GROUPS ACTUAL PROFORMA(1)
- --------------------------------- ------ ----------
Logicorp Systems Integration 94.9 70.6
eTelligent Systems Integration 5.1 3.7
NTN (sold December 2003) Interactive Entertainment 0.0 13.6
GalaVu (sold April 2003) Interactive Entertainment 0.0 12.1
CMCG Merchant Services 0.0 0.0
INVESTMENT COMPANIES
Engyro, Inc. Other 0.0 0.0
cDemo Inc. Other 0.0 0.0
======================================================================================================
(1) The operations of NTN were sold on December 15, 2003. We sold GalaVu on
April 25, 2003. We discontinued the operations of CMCG in February 2001.
CMCG was then used to acquire Logicorp in January 2002.
We believe that we currently beneficially own less than 5.0% of the
outstanding securities of Engyro and cDemo. As a result of our minority
investment in such entities, future revenues, when and if realized, will not be
included in our total revenues. We have no obligation to provide additional
funding or support to such corporations and believe that such corporations are
immaterial to our business.
LOGICORP
Logicorp is a Western Canadian information technology solution provider,
specializing in network infrastructure, security, Microsoft Business Solutions
and managed services. Our strategy is for our clients to consider us their one
source for product and services, to meet their entire network infrastructure,
security and managed services needs, whether it is at a single or multiple
locations. We believe our strong relationship with manufacturers and suppliers
and our commitment to development and education can be a huge advantage for our
clients. We provide the strategies, solutions, services and products to help our
clients manage the business and technology complexities of the digital economy,
bringing together the world's best technologies and processes to address our
clients' critical business imperatives. Our goal is to help clients solve
complex business issues and achieve results with technology.
IT INFRASTRUCTURE. We offer comprehensive, expert development of clients' IT
environments. Through our supply channels and our team of experts, we can assist
a client in creating an IT infrastructure that will enable them to concentrate
on managing their business and not the technology. Whether through remote
monitoring and management, request management, or on-site systems support we can
help a company maintain smooth operation of its network, regardless of the size
of the network, by assisting in the management of the desktop environment for
end-user communities, implementation and maintenance of desktop infrastructure,
help-desk services, managing local area networks and shared systems and
technology lifecycle management. We also offer a continuum of fully managed,
scalable, hosting services, including assisting clients with the implementation
and hosting of their enterprise packaged applications, storage related
consulting, mainframe management, security and privacy services and web hosting
services.
- ----------
(1) - See Note 13 of consolidated financial statements for disclosures on
business acquisitions.
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o END USER SERVICES. Our services are customized to manage the desktop
environment for end-user communities with distinct user profiles,
devices, applications, work locations or collaboration needs. Offered
through a Web portal with flexible pricing options. End user services
include messaging, digital learning, mobility and mail services.
o FIELD SERVICES. We offer on-site implementation and maintenance of
desktop infrastructure, including hardware and software support,
install/move/add/change services and warranty management.
o HELPDESK SERVICES. We provide users with a single point of contact for
problem and service requests. These services enable direct interaction
between the desktop user and EDS' technical support organizations, which
leverage both human and technical resources.
o INFRASTRUCTURE SERVICES. We manage local area networks and shared
systems to defined levels of performance, including server management,
network management, security management and backup/restore services.
o TECHNOLOGY LIFECYCLE MANAGEMENT. EDS provides a suite of services that
augment, support and increase the value and productivity of end-user
hardware and software. These services include planning and architecture,
procurement, global reporting, model office services (to test designs
before implementation), security management and business
continuity/disaster recovery services.
o SECURITY AND PRIVACY. We deliver consulting, technology, training and
managed solutions to ensure the privacy, integrity and continued
availability of critical information and processes. Our services and
solutions include smart cards and biometrics, perimeter protection of
logical systems, best practices in business continuity, security and
privacy training and outsourced managed security and privacy.
TRANSFORMATION SERVICES. Our transformation services consist of Business Process
Innovation Services and Business Acceleration Services. Our Business Process
Innovation Services help clients achieve their business objectives by
redesigning and transforming their process and performance measurement systems
to effectively support their business strategies. Our Business Acceleration
Services optimize business processes and deliver solutions that enable clients
to quickly realize business value, generate savings and minimize implementation
risk.
APPLICATIONS MANAGEMENT AND DEVELOPMENT SERVICES. Our services help
organizations plan, develop, integrate and manage custom applications, packaged
software and industry-specific solutions. We offer applications management and
development services on an outsourced or out-tasked basis. Services range from
outsourcing of all application development and management to implementation and
management of Logicorp-owned or third-party industry applications. Our services
are supplemented by our industry-specific applications for the communications,
financial, health care and transportation industries, as well as for government
clients.
SERVICES CONSULTING
Services Consulting consist of a variety of innovative and scalable
solutions from enterprise strategy through application design, development and
deployment. Our services encompass the management and deployment of disciplines,
competencies and capabilities within the following areas: Applications Services,
Applied Value Chain Services, Business Process Innovation Services and Business
Acceleration Services.
o APPLICATION DEVELOPMENT AND SUPPORT. We create new applications,
providing full lifecycle support through delivery. We define the
application requirements, analyze application characteristics, implement
to a production environment and monitor performance for a warranted
time.
o APPLICATION SELECTIVE OUTSOURCING. We offer full support for either
specific applications or an entire application portfolio. An expert
Logicorp team assesses the specified applications, plans the transition
and provides ongoing management to improve the client's productivity and
operating efficiency.
o CUSTOMER RELATIONSHIP MANAGEMENT SERVICES. Our services help clients
create collaborative, client-centric organizations. We provide
assessments, design and architecture, and implementation of CRM
solutions to manage the customer experience.
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o ENTERPRISE RESOURCE MANAGEMENT SERVICES. Our services help clients
assess and optimize their core enterprise business processes and
applications globally in both shared and dedicated environments.
Services include solutions engineering, enterprise modeling, real-time
automation, business intelligence and enterprise-software expertise.
o INDUSTRY PRODUCTS. Services include a full range of consulting,
planning, implementation and optimization to support adapting and
deploying industry-specific solutions to meet our clients' needs.
BUSINESS PROCESS INNOVATION SERVICES
Business Process Innovation Services facilitates clients in achieving
their business objectives by redesigning and transforming their people, process
and performance measurement systems to effectively support their business
strategies. We create operational efficiencies and enhancements for our clients
to deliver products and services to their clients as well as throughout our
client's business. Services include the prompt identification of opportunities
for the greatest impact, the development of a business case for change, the
implementation of industry-specific best practices and the development of a
phased change implementation plan. Our competencies are organized into the
following practice areas:
o INTEGRATION SERVICES. By integrating disparate systems, we offer clients
greater access to information, systems and tools within their enterprise
or among other members of their trading community. Our capabilities
include integration assessment, application-to-application and
business-to-business integration, building of portals and dashboards and
workflow integration.
o PORTALS AND DASHBOARDS. Provides clients with immediate, aggregated
information in a personalized view. We focus on implementing secure,
Web-based solutions that provide a single point of access to
information, applications and services. This practice combines functions
from many IT disciplines, including business intelligence, document
management and Intranet site development.
o COLLABORATION SERVICES. Enables clients to share and coordinate data
with employees, customers, suppliers and partners, build digital
communities and exchange information within applications, among
enterprises and across business relationships. We optimize collaboration
and improve related business processes through the deployment of leading
messaging and collaboration technologies.
o MOBILE APPLICATIONS. Enables clients to extend information sharing to an
increasingly remote work force. Our offerings include Mobile Workplace,
an integrated service platform providing mobile employees real-time
interactive access to workplace applications, and Mobile e-mail and
Collaboration, extending e-mail access to mobile employees.
o WEB CONTENT MANAGEMENT. We design and deploy innovative Web content
management solutions to help clients manage digital contents to deliver
a personalized Web experience, enable collaboration and promote re-use.
o WEB APPLICATION DEVELOPMENT. Allows clients to significantly reduce IT
costs and create more responsive and effective organizations by
seamlessly connecting information, people, systems and devices. We offer
a range of services using Microsoft (R) and Java (R) 2 Enterprise
Edition (J2EE) platforms as well as the advantages of certified
developers, proven architectural frameworks and best practice software
development methodologies.
o MICROSOFT ENTERPRISE SERVICES. We build and deliver innovative solutions
that leverage Microsoft platforms, products and tools, with emphasis on
developer tools, server software, client software and end user
applications.
eTELLIGENT SOLUTIONS INC.
eTelligent is a western Canadian team of business system consultants
specializing the in implementation and integration e-business, CRM (customer
relationship management) and financial services solutions from Microsoft Great
Plains. It is comprised of professional accountants, information technology
specialists and support staff, who provide implementation, training and support
services. eTelligent Solutions has offices in Edmonton and
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Calgary, Alberta. It has offered successful business solutions to a variety of
business organizations for over ten years, and it currently represents and
supports over 70 Microsoft Great Plains customers throughout Alberta. All of its
employees are certified through the Microsoft Great Plains University.
NTN
NTN Interactive Network. Our NTN Interactive Network subsidiary is
engaged in the marketing and distribution of the NTN Entertainment Network
services throughout Canada. These activities are being conducted through an
exclusive license covering Canada granted to NTN Sports Inc., (predecessor to
our NTN Interactive Network subsidiary) by NTN Communications, Inc. of Carlsbad,
California, an unaffiliated corporation from which NTN licenses a portion of its
technology ("NTN-US"). The license grants our NTN Interactive Network subsidiary
the right to market the products and programs of NTN Communications, Inc.
throughout Canada for a 25-year term ending December 31, 2015. NTN-US does not
have an equity position in us or in our NTN Interactive Network subsidiary.
Effective on December 15, 2003, we sold certain assets and liabilities
of NTN to NTN-US. In exchange for this business and assets, NTN-US has agreed to
pay US$1.5 million (Cdn$2.03 million), consisting of (i) US$650,000
(approximately Cdn$853,000) of unregistered common stock (approximately 238,000
shares) of NTN-US (NTN:AMEX) valued on the closing market price on the date of
sale and (ii) US$250,000 (approximately Cdn$328,000) in cash at closing, less
certain fees due from NTN to NTN-US, such amounts payable in three equal monthly
payments.
THE NTN ENTERTAINMENT NETWORK
The NTN Entertainment Network is owned and operated by NTN-US and uses
existing technology to broadcast two-way interactive live events to subscriber
locations. The network provides digital data transmissions, which enable
equipment and software at subscriber locations to display text and graphics
programming and to interpret responses from network viewers. All programming is
produced at and transmitted from the NTN-US broadcast center in Carlsbad,
California. More than 3,600 restaurants, lounges, hotels, and other hospitality
sites across North America have subscribed to these services and installed
systems capable of receiving network broadcasts. These subscriber systems
receive satellite transmissions containing updates to the network interactive
programs, such that thousands of patrons at subscriber locations can interact
with the same programs simultaneously. Our NTN subsidiary markets the network
throughout Canada to the hospitality industry, installs the systems, and
provides technical and marketing support to network sites. Over 400 group
subscribers are located in Canada. Designed to be hardware independent, the
network may be transmitted through a variety of techniques including, direct
satellite, cable, gateway service, FM sideband, Internet, TV vertical blanking
interval, and telephone. We currently use direct satellite as the method of
transmission.
NETWORK PROGRAMMING.
The two-way interactive programming currently featured over the network
includes a variety of interactive sports and trivia games permitting viewer
interaction and participation for 16 hours each day. All present network
programming is structured to provide time for national, regional and local
advertisements, as well as for local inserts, which permit each subscriber to
display announcements of promotional prices or other events at its business
location.
NTN PLAY-ALONG GAMES.
NTN Play-Along Games are played in conjunction with live, televised
events. The primary NTN Play-Along Game is QB1, a game of football strategy.
NTN PREMIUM TRIVIA GAMES.
NTN Premium Trivia Games are promotion-oriented weekly game shows that
usually require an hour of participation. Prizes are awarded to the top
finishers. Games among all participating subscriber locations include the
following: Showdown, a general knowledge game; Sports Trivia Challenge, a game
focused on sports, and Spotlight, a game that quizzes players about the world of
show business and celebrities; Playback, a music news, trivia, song title and
musical topics game; and Sports IQ, a weekly sports trivia game. Half-hour
interactive trivia
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games comprise the majority of the Network's programming. Countdown and Wipeout
are trivia games designed for fast competitive play among participants at each
subscriber location.
INTERACTIVE EVENTS. Interactive Events is a customizable, hosted
interactive trivia, polling or question event brought to the customer. An event
can be created with a customer's logos, graphics and content and will be hosted
by a real host to aid in increasing the enjoyment of the event.
NTN INTERACTIVE NETWORK MARKET. Our NTN subsidiary positions the network
to prospects and clients as a means of attracting patrons (to play the games),
retaining their patronage (as they return to play again), and increasing the
length of time patrons stay in their establishment. As the number of repeat
customers and their length of stay increases, the hospitality establishment has
an increased opportunity to sell additional food and beverage.
Our NTN subsidiary's sales force targets the strongest hospitality
outlets in Canada, including a number of chain accounts. Attractive rental
packages are in place to support our NTN subsidiary's sales efforts. Our NTN
subsidiary promotes the network as one of the best and technically advanced
forms of on-premises advertising to this market, offering long-term repetitive
exposure to a captive, attentive, and enthusiastic audience.
Each end user receives the subscriber system, including the equipment
and the proprietary software, from our NTN subsidiary. In most instances, the
customer rents the equipment from our NTN subsidiary. Our NTN subsidiary, in
turn, purchases equipment from several suppliers. Following installation, each
end user pays a monthly fee to our NTN subsidiary for the network services.
GALAVU ENTERTAINMENT NETWORK INC.
Our GalaVu subsidiary (sold April 2003) is a technology-based
entertainment provider of interactive in-room entertainment systems to hotels.
At August 31, 2002, our GalaVu subsidiary was installed in over 200 Canadian
hotels, primarily small and mid sized. GalaVu's interactive system is based on
proprietary technology and provides a wide range of affordable, in-room
entertainment packages. Marketed to guests under the "Round-the-Clock
Entertainment" brand, GalaVu's suite of products include Hollywood movies on
demand, premium television programming, and other information and entertainment
services designed to enhance the stay of hotel guests while generating revenue
for our GalaVu subsidiary and its hotel partners.
Pursuant to a Share Purchase Agreement dated April 25, 2003, we sold to
DVOD Networks Inc., an Ontario corporation ("DVOD"), all of the issued and
outstanding shares of capital stock of GalaVu for $1.00. Concurrently, we
assigned to DVOD or caused our subsidiaries to assign to DVOD, for $2.00
promissory notes and other receivables of GalaVu in the aggregate amount of
$1,672,608. In addition, 488605 Ontario Limited, a non-affiliated Canadian
corporation ("488605") and an individual assigned a $375,000 note payable by
GalaVu in return for $170,000. This amount was paid by DVOD to us and a new
$325,000 note was issued to one of our subsidiaries.
CHELL MERCHANT CAPITAL GROUP
CMCG was set up as a separate subsidiary to be in the business of
researching, identifying and acquiring technology companies. CMCG's focus was to
identify upcoming technology trends and create the effective infrastructure
required to build out and support these trends.
ENGYRO
Engyro is the surviving legal entity resulting from the merger of R Home
Funding Co. Ltd., a Nevada corporation and its wholly owned Delaware subsidiary,
Engyro, Inc. Its headquarters are located in Shelton, Connecticut. Engyro was a
financial transaction engine designed to support the high demands created by
rapid growth in the application service Provider industry. We own less than 5.0%
of the stock of Engyro and the remaining equity of the company is owned by
private venture capitalists and Engyro's management. The direction and purpose
of the company may now be very different from its original intent. We have
written down our investment to zero as our ownership is less than 5%.
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cDEMO
cDemo is a start up company that was incorporated in the State of
Delaware in February 2000. We own less than 5.0% of the stock of cDemo and the
remainder of the company's stock is distributed as follows: private venture
capitalists; cDemo's management and employees, none of whom are affiliated with
us. Allan Chell, the brother of Cameron Chell, our former Chairman of the Board
of Directors, President and Chief Executive Officer, is a Director and principal
shareholder of cDemo and it's Vice-President of Strategic Development.
cDemo plans to position itself as a trusted and unbiased electronic
assessment tool and service. To perform a standardized electronic assessment and
listing, cDemo has researched and developed an assessment methodology that is
capable of "commoditizing" products, and displaying them in a format that is
easy to both read and view. cDemo's unique consortium of technology partners are
producing a technological system that we believe will be capable of tailoring
the cDemo electronic assessment to industry and partner requirements. The
assessment software will be loaded into a rugged, handheld tablet. cDemo plans
to use this tablet device to collect and transmit an electronic demonstration
based on an Internet connection to the cDemo backend database.
GROWTH STRATEGY
Our growth strategy primarily focuses on increasing the profitability of
our operating companies through process development and technological advances
to aid an organization in operating efficiencies, as well as acquiring assets of
or interests in new companies such that we can increase our market share and our
profitability or acquire unique technologies that our companies can sell and
promote to our existing and potential new clients.
COMPETITION
The market for each of our business segments at August 31, 2002 is
rapidly evolving and highly competitive. Although we believe that each of our
business segments is comprised of a large number of actual and potential
competitors and that, other than our interactive entertainment business segment,
the business segments in which we operate diverse segments of the interactive
entertainment and venture capital services markets will provide opportunities
for more than one supplier of products and services similar to ours, it is
possible that a single supplier may dominate one or more market segments.
Competitors include a wide variety of companies and organizations, including
venture capitalists, interactive entertainment providers, Internet software,
content, service and technology companies, telecommunication companies, cable
companies and equipment/technology suppliers.
Our NTN Interactive Network subsidiary operates in the interactive
entertainment services industry. In 1996, we became aware of a new entertainment
system, Sports Active, attempting to enter the hospitality market. Sports Active
offers only two programs, a football game and a trivia game. While it is
visually entertaining, it requires audio and we believe this is a significant
drawback in the restaurant environment in which it is being marketed. We have
not found this to be a significant competitive entry.
With the entrance of motion picture, cable and TV companies, competition
in the interactive entertainment and multimedia industries will likely intensify
in the future.
GalaVu's competition includes other interactive in-room entertainment
providers. With the development of new satellite technologies, and the
increasing speed of network connections, GalaVu expects the competition to
develop new services. These new services may include digital programming on
demand, enhanced hotel concierge services, billing presentment and settlement,
and others. GalaVu expects that new technologies will lead to intensifying
competition in the future.
INTELLECTUAL PROPERTY
Our success is dependent upon software and other intellectual property
from third parties. Notwithstanding the foregoing, no one license is material to
our business prospects, financial condition or results of operations. We must
conduct our operations without infringing on the proprietary rights of third
parties. We also rely upon non-patented trade secrets and the know-how and
expertise of our employees. To protect our licensed technology and other
intellectual property, we rely primarily on a combination of the protections
provided by applicable contract, copyright, trademark, and trade secret laws as
well as on confidentiality procedures and licensing arrangements. Although we
believe that we have taken appropriate steps to protect our non-patented
proprietary rights, including requiring that our employees and third parties who
are granted access to our licensed technology enter into
8
confidentiality agreements with us, there can be no assurance that these
measures will be sufficient to protect our rights against third parties. Others
may independently develop or otherwise acquire non-patented technologies or
products similar or superior to ours.
We license from third parties certain software and Internet tools that
we include in our services and products. If any of these licenses were
terminated, we could be required to seek licenses for similar software and
Internet tools from other third parties or develop these tools internally. We
may not be able to obtain such licenses or develop such tools in a timely
fashion, on acceptable terms, or at all. Companies participating in the software
and Internet technology industries are frequently involved in disputes relating
to intellectual property. We may in the future be required to defend our
intellectual property rights against infringement, duplication, discovery, and
misappropriation by third parties or to defend against third-party claims of
infringement. Likewise, disputes may arise in the future with respect to
ownership of technology developed by employees who were previously employed by
other companies. Any such litigation or disputes could result in substantial
costs to, and a diversion of effort by, us. An adverse determination could
subject us to significant liabilities to third parties, require us to seek
licenses from, or pay royalties to, third parties, or require us to develop
appropriate alternative technology. Some or all of these licenses may not be
available to us on acceptable terms or at all, and we may be unable to develop
alternate technology at an acceptable price or at all. Any of these events could
have a material adverse effect on our business, prospects, financial condition,
and results of operations.
EMPLOYEES
As of March 31, 2004, we employed 65 employees in the four operating
subsidiaries, consisting of 3 executives, 3 general managers, 29 salespersons,
and 3 in marketing, 5 individuals involved in administration, 5 individuals
involved in finance and accounting, 17 individuals involved in information
services. We believe that our staff is adequate for our anticipated needs.
EMPLOYEE COMPENSATION
For the years ended August 31, 2002, 2001, and 2000, among our current
and former executive officers and directors, Don Pagnutti, our then President
had annual compensation exceeding $100,000. No long-term compensation was
awarded or paid to these individuals in such years.
As of August 31, 2002, we did not have any formal written employment
agreements with any of our directors, executives or other employees and we had
not issued any stock options or stock appreciation rights to any executive
officers (or any other persons).] We may grant stock options or stock
appreciation rights to these or other executive officers or other persons in the
future at the discretion of our Board of Directors.
ITEM 2. PROPERTIES.
On October 12, 2002, we sold an office building owned by 3484751 Canada
Ltd. located at 775 Pacific Road, Oakville Ontario to an unrelated 3rd party for
approximately $560,000. The sale of the building resulted in a loss of
approximately $250,000.
During the fiscal year ended August 31, 2002, we owned an approximately
25,000 square foot parcel of land, located at 14 Meteor Drive in Toronto,
Ontario, on which stands a 12,500 square foot, one story building. On December
19, 2003, we sold this land and building to an unrelated third party for
approximately $730,000 and recorded a gain on the sale of approximately
$100,000.
During the fiscal year ended August 31, 2002, we owned an approximately
29,000 square foot parcel of land, located at 10 Meteor Drive, Toronto, Ontario,
on which stands a 14,000 square foot, two story building. We sold this land and
building to an unrelated party on March 7, 2004 for approximately $710,000. The
sale resulted in an approximate gain of $70,000.
The properties located at 10 & 14 Meteor Drive in Toronto, Ontario and
775 Pacific Road in Oakville had been financed through a mortgage, with the Bank
of Montreal, dated April 24, 2002. The principal balance outstanding regarding
these two properties, as at August 31, 2002 was Cdn$1,166,667. The property at
14 Meteor was sold December 19, 2003 and our former subsidiary NTN and ourselves
are occupying the property at 10 Meteor. NTN has signed a 2-month lease for the
premises.
9
During the fiscal year ended August 31, 2002, GalaVu leased 8,619 square
feet of office space in a building located at 3790 - 3820 Victoria Park Avenue,
North York, Ontario, which lease expires on October 31, 2002 (CND$77,729
annually).
During the fiscal year ended August 31, 2002, Chell Merchant Capital
Group leased 12,043 square feet of office space in Suites 301, 500 and 700 in a
building located at 630 - 8th Avenue S.W. Calgary, Alberta, T2P 1G6. The
combined annual rent of the three suites was Cdn$202,087. We subleased this
space to unaffiliated third parties upon the discontinuation of the operations
of this subsidiary for Cdn$150,000 per annum.
Commencing on December 15, 2002, we started utilizing interim space in
Toronto, Ontario at nominal cost.
Logicorp leases approximately 17,502 square feet in Edmonton, 11,800
square feet in Calgary and approximately 4,500 square feet in Vancouver for
approximately annual rent of $220,350, $115,640 and $62,300 respectively. The
leases expire as follows: Edmonton - December 2006, Calgary - July 31, 2012, and
Vancouver - March 31, 2007.
We believe that our facilities and those of our subsidiaries are
adequate for their present requirements.
ITEM 3. LEGAL PROCEEDINGS.
In the ordinary course of business we may be subject to litigation from
time to time. Set forth below is a description of material pending litigation to
which we are a party.
NTN LITIGATION
On June 18, 1992, Interactive Network Inc. (Interactive) commenced a
lawsuit against us, NTN Communications and our NTN subsidiary in the Federal
Court of Canada, Trial Division, Montreal, Quebec, under the titled INTERACTIVE
NETWORK, INC. v. NTN COMMUNICATIONS, INC., NTN SPORTS, INC. AND NTN CANADA, INC.
This action alleges that Interactive granted NTN Communications the right to use
the Interactive Patent, which right Communications then improperly licensed to
our NTN subsidiary and us. Interactive alleges that the license agreement
between NTN Communications and our NTN subsidiary and us infringes upon the
Interactive Patent. The action seeks a declaration of the validity of the
Interactive Patent, an injunction restraining us from further infringement, and
either damages (in an unspecified amount) or an accounting of profits derived
from certain games used in Canada. Except for the aforementioned pleadings, no
proceedings or discovery have been undertaken in this action.
We believe that the licenses granted to us by NTN Communications are
valid and that the patent infringement claims underlying this action will
ultimately be proven to be unfounded. We intend to vigorously defend our
position and to prosecute the Interactive position in the action; however, there
can be no assurance that any or all of these actions will be decided in favor of
us. We believe, based in part upon the advice of outside, independent counsel,
that the costs of defending and prosecuting these actions will not have a
material adverse effect upon our financial position.
In its Quarterly Report on Form 10-Q, for the quarter ended September
30, 1996, NTN Communications stated that "[w]ith the courts [SIC] assistance,
[Communications] and [Interactive] have been able to reach a resolution of all
pending disputes in the United States and have agreed to private arbitration
regarding any future licensing, copyright or infringement issues which may arise
between the parties." The disputes referred to in the NTN Communications Form
10-Q involved litigation in the United States involving allegations similar to
the allegations underlying the actions between Interactive and us. In the NTN
Communication Form 10-Q, NTN Communications also noted that "no substantive
action has been taken in the furtherance of" the Company Action or Interactive
Action.
CANADA CUSTOMS AND REVENUE AGENCY LITIGATION
Canada Customs and Revenue Agency is currently in discussions with us
regarding a potential liability with respect to withholding tax on certain
amounts paid to Communications. An assessment in the amount of approximately
$550,000 has been made to date by Canada Customs and Revenue Agency and we have
filed a notice of objection. We believe that we have valid defenses with respect
to these matters and accordingly, no amount has
10
been recorded in the Company's financial statements. In the event that such
matters are settled in favor of Canada Customs and Revenue Agency, the amounts
could be material and would be recorded in the period in which they become
determinable.
LOGICORP DATA SYSTEMS LITIGATION
On January 27, 2003, a former President of Logicorp Data Systems filed a
wrongful dismissal claim against Logicorp Data Systems and us. A round of
examinations for discovery has been held and preparation of the affidavit of
records is underway. Further discoveries were held during the week of September
8, 2003. Our counsel has determined that it is too early in the process to
evaluate the merits of the case. We have not accrued any liabilities related to
this claim as of August 31, 2002. We have filed a counter-suit stating that the
former President was fraudulent in his representation to the Company.
In June 2001, a former employee filed a wrongful dismissal claim against
LDS. Subsequently the employee offered to settle for which LDS rejected. No
further action has taken place since October 2001 and accordingly, LDS believes
it will prevail and has not accrued liabilities on the accompanying financial
statements related to this claim.
8% CONVERTIBLE NOTES
On December 1, 2001, the Company offered to certain investors 8%
convertible notes up to a maximum amount of US$ 8,000,000 in a private
placement. The Company received approximately Cnd$6,587,622 through this
offering. Under the terms of this offering, the notes are convertible into
shares of common stock at a price of the greater of (1) 50% of the average
closing bid prices for the ten trading days prior to conversion or (2) US$0.50.
These notes were due August 9, 2002. On April 9, 2002 all of the holders of the
notes signed commitments to voluntarily convert the notes based on the
conversion price per the terms of the agreement, which was determined to be
US$0.95 per share. This conversion was subject to shareholder approval. The
conversion of these notes would have resulted in the issuance of approximately
4,389,000 shares representing approximately 20% of the total common shares
outstanding after the issuance, and diluting the current common stockholders. As
of August 31, 2002, none of these shares has been issued and the outstanding
amount of the convertible notes was classified as liabilities. As of December 2,
2002, the Company, Joseph Gunnar & Co., LLC ("JGUN"), the placement agent in
this offering, and the holders of these notes entered into a settlement
agreement providing that the conversion price for these notes shall equal 85% of
the two day weighted average trading price of the common stock for the five
trading days preceding effective date of the registration statement under the
Securities Act of 1933, as amended, relating to the resale of the shares of
common stock issuable upon such conversion, provided, that such conversion price
cannot be greater than $0.75 or less than $0.40. Effective January 7, 2003, the
Company, JGUN, Cameron Chell and the holders of the notes agreed that if this
registration statement is not declared effective on or prior to September 1,
2003, the noteholders could "put" their shares of common stock to Mr. Chell at a
price of $0.475 per share during the period of December 1 - 14, 2003. At April
30, 2004, such registration statement has not been filed. By letter dated
December 4, 2003, the noteholders agreed to permit the Company until February
28, 2004 to file all required filing and periodic reports under the Securities
Exchange Act of 1934, as amended, and to amend the period during which they may
"put" their shares issuable upon such conversion to Mr. Chell from December
1--14, 2003, to March 1 - 14, 2004, in exchange for the extension of the "put"
period and the reduction of the conversion price to $0.25 per share, provided,
that, if such deadline was not satisfied by the Company such agreement and
reduction of the conversion price would be null and void. By letter, dated
February 26, 2004, this deadline and the "put" period were amended to be April
30, 2004 and May 1 - 14, 2004, respectively. By letter, dated April 29, 2004,
the Company requested that such deadline and "put" period be further amended to
be May 30, 2004 and June 1 - 14, 2004, respectively. In the event that the notes
should be converted into shares of common stock at the conversion price of $0.25
per share, the aggregate number of shares of common stock issued upon such
conversion would be approximately 16,640,000, representing approximately 54% of
the common stock outstanding giving effect to such conversion. One noteholder
has indicated to the Company that it believes that it has a cause of action
against the Company with respect to the foregoing and its rights under such
notes, and has threatened to bring such action against the Company. In the event
that the Company should be found to be in default of the notes or the related
agreements, the Company may be required to repay the notes in the event that a
settlement is not reached with the noteholders. In such event, the Company does
not believe that it currently has the necessary capital available to repay the
notes and would be required to seek additional sources of capital or seek
protection from creditors. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Liquidity and Capital
Resources".
11
Neither our property nor ourselves are a party or subject to any other
material pending legal proceedings, other than ordinary routine litigation
incidental to our business.
To our knowledge no other proceedings of a material nature have been or
are contemplated against us.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
PART II
ITEM 5. MARKET PRICE FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS.
Our common stock, par value $.0467 per share (the "Common Stock"), was
delisted from the over-the-counter market and was quoted on the NASDAQ Small Cap
Market ("NASDAQ"), under the symbol "CHEL". It is now traded on the NASDAQ pink
sheets under the symbol "CHEL.PK". Set forth below is the range of high and low
bid prices (US$) for shares of Common Stock for each full quarterly period
within our three most recent fiscal years and our quarter of the current year.
The information reflects inter-dealer prices, without retail mark-ups, markdowns
or commissions and may not necessarily represent actual transactions.
-----------------------------------------------------------------
HIGH LOW
------- ------
(US$) (US$)
=================================================================
2000 FISCAL YEAR
First Quarter 2.500 1.500
Second Quarter 3.625 1.375
Third Quarter 7.875 2.250
Fourth Quarter 11.438 3.000
2001 FISCAL YEAR
First Quarter 7.219 3.000
Second Quarter 4.813 1.813
Third Quarter 2.313 0.938
Fourth Quarter 1.600 0.870
2002 FISCAL YEAR
First Quarter 1.310 0.510
Second Quarter 1.990 0.520
Third Quarter 2.250 1.190
Fourth Quarter 1.40 0.109
2003 FISCAL YEAR
First Quarter 0.909 0.109
Second Quarter 0.209 0.019
Third Quarter 0.409 0.109
Fourth Quarter 0.499 0.001
2004 FISCAL YEAR
First Quarter 0.259 0.001
Second Quarter 0.109 0.01
-----------------------------------------------------------------
On April 7, 2004, the closing price of the Common Shares on NASDAQ pink
sheets was US$0.02.
As of April 7, 2004, we had 13,795,907 shares of common stock
outstanding.
As of the close of business on April 7, 2004, there were approximately
228 holders of record of our Common Stock. We believe that there are
approximately 1,100 beneficial holders of Common Stock. We are
12
informed and believe that as of December 10, 2003, Cede & Co. held 3,406,326
shares of our common stock as nominee for Depository Trust Company, 55 Water
Street, New York, New York 10004. It is our understanding that Cede & Co. and
Depository Trust Company both disclaim any beneficial ownership therein and that
such shares are held for the account of numerous other persons.
Since its inception in 1986, we have not paid any cash dividends on our
Common Stock. However, we have, in the past, declared certain stock dividends
and stock splits. We intend to retain earnings, if any, to finance operations
and, therefore, do not expect to declare or pay any cash dividends on the Common
Stock in the foreseeable future.
ITEM 6. SELECTED FINANCIAL DATA.
The following table sets forth a summary of selected financial
information regarding the Company and its subsidiaries, consolidated, for each
of the five fiscal years ended August 31, 2002.
STATEMENT OF OPERATIONS DATA (CANADIAN DOLLARS):
--------------------------------------------------------------------------------------------------------------------
YEAR ENDED AUGUST 31,
2002 2001 2000 1999 1998
----------- --------- --------- ---------- -----------
Cdn$ Cdn$ Cdn$ Cdn$ Cdn$
Restated(1)
====================================================================================================================
Operating revenues 34,207,924 16,595 13,703 61,804 117,561
Cost of sales 31,319,987 -- -- -- --
Gross profit 2,887,937 16,595 13,703 61,804 117,561
Net income (loss) (30,751,537) (11,747,639) (2,323,621) (971,497) 618,065
Net income (loss) per share,
basic and diluted (3.11) (1.40) (0.81) (0.36) 0.24
Weighted average number of
shares outstanding, basic
and diluted 9,879,836 8,393,589 2,873,042 2,635,050 2,550,805
====================================================================================================================
BALANCE SHEET DATA (CANADIAN DOLLARS):
--------------------------------------------------------------------------------------------------------------------
AUGUST 31,
2002 2001 2000 1999 1998
----------- --------- --------- ---------- -----------
RESTATED(1)
====================================================================================================================
Total assets 9,246,755 9,537,219 10,631,974 12,072,282 12,952,836
Long-term obligations 2,914,656 2,417,388 1,206,479 1,243,151 1,857,245
Shareholders' (deficit) equity (16,988,536) 3,408,066 9,383,419 10,792,767 11,033,178
====================================================================================================================
(1) - See Note 17 to consolidated financial statements
13
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
THIS MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS AND OTHER PORTIONS OF THIS REPORT CONTAIN FORWARD-LOOKING
INFORMATION THAT INVOLVE RISKS AND UNCERTAINTIES. THE COMPANY'S ACTUAL RESULTS
COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED BY THE FORWARD-LOOKING
INFORMATION. FACTORS THAT MAY CAUSE SUCH DIFFERENCES INCLUDE, BUT ARE NOT
LIMITED TO, AVAILABILITY AND COST OF FINANCIAL RESOURCES, PRODUCT DEMAND, MARKET
ACCEPTANCE AND OTHER FACTORS. THIS MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS SHOULD BE READ IN CONJUNCTION WITH
THE COMPANY'S FINANCIAL STATEMENTS AND THE RELATED NOTES INCLUDED ELSEWHERE IN
THIS REPORT.
INTRODUCTION
CORPORATE BACKGROUND
We are engaged in the business of providing interactive entertainment
services, electronic/on-line products and services, systems integration
services, corporate services and merchant capital services. Our core businesses
are interactive entertainment services provided by our NTN Interactive Network
and GalaVu Entertainment Network Inc. subsidiaries and the systems integration
services provided by our Logicorp Data Systems Ltd. subsidiary.
As of August 31, 2002, we had a working capital deficit of $17,960,854
and an accumulated deficit of $43,909,481. We generated revenues of $34,207,924
for the 2002 Fiscal Year and incurred a net loss of $30,751,537. In addition,
during the 2002 Fiscal Year, net cash used in operating activities was
$9,019,544.
We are in a transitional stage of operations and, as a result, the
relationships between revenue, cost of revenue, and operating expenses reflected
in the financial information included in this annual file do not represent
future expected financial relationships. Much of the cost of revenue and
operating expenses reflected in our consolidated financial statements are costs
based on costs associated with raising funds, retirement of debt and a
write-down of goodwill. Accordingly, we believe that, at our current stage of
operations period-to-period comparisons of results of operations are not
meaningful.
PLAN OF OPERATIONS
Our business strategy is to focus on our core operating companies in order
to make the profitable, to divest ourselves of non-core operating and to wind up
all other non-operating companies, as well as to find new opportunities in order
to increase our value and profitability. Our core operations are the systems
integration segment companies. Additionally, we intend to become current with
all of our filings and we will begin to petition for market status.
We expect our general and administrative costs to increase in future
periods due to our operating as a public company whereby we will incur added
costs for filing fees, increased professional services and insurance costs.
The following is our selected statement of operations data by business
segment for the years ended August 31, 2002, 2001, and 2000.
14
================================================================================
2002 2001 2000
$ $ $
Restated Restated
================================================================================
REVENUE
Systems Integration 34,205,614 -- --
Corporate 2,310 16,595 13,703
- --------------------------------------------------------------------------------
34,207,924 16,595 13,703
- --------------------------------------------------------------------------------
OPERATING PROFIT (LOSS)
Systems Integration (1,162,568) -- --
Merchant Service -- (5,076,619) --
Corporate (15,089,159) (3,115,758) (1,321,542)
- --------------------------------------------------------------------------------
(16,251,727) (8,192,377) (1,321,542)
- --------------------------------------------------------------------------------
NET LOSS
Systems Integration (12,173,848) -- --
Merchant Service -- (6,524,427) --
Corporate (16,561,949) (3,115,758) (1,367,902)
Discontinued Operations (2,015,740) (2,107,454) (955,719)
- --------------------------------------------------------------------------------
(30,751,537) (11,747,639) (2,323,621)
- --------------------------------------------------------------------------------
TOTAL ASSETS
Systems Integration 6,435,982 -- --
Merchant Service -- 1,589,465 --
Education -- 128,986 1,088,157
Corporate 2,810,773 3,170,689 1,818,027
Discontinued Operations -- 4,648,078 7,725,789
- --------------------------------------------------------------------------------
9,246,755 9,537,218 10,631,973
- --------------------------------------------------------------------------------
CAPITAL EXPENDITURES
Systems Integration 127,737 -- --
Corporate 7,355 46,978 --
- --------------------------------------------------------------------------------
135,092 46,978 --
- --------------------------------------------------------------------------------
DEPRECIATION & AMORTIZATION
Systems Integration 425,692 -- --
Merchant Service -- 431,967 --
Corporate 601,550 162,836 47,055
- --------------------------------------------------------------------------------
1,027,242 594,803 47,055
- --------------------------------------------------------------------------------
INTEREST EXPENSE
Systems Integration 182,209 -- --
Corporate 10,077,990 1,146,708 46,360
- --------------------------------------------------------------------------------
10,260,199 1,146,708 46,360
- --------------------------------------------------------------------------------
RESULTS OF OPERATIONS
YEAR ENDED AUGUST 31, 2002 COMPARED TO YEAR ENDED AUGUST 31, 2001
REVENUES. Revenues from product sales for the 2002 Fiscal Year were
$32,468,400. As Logicorp was purchased in the 2002 Fiscal Year there is no
comparison for our fiscal year ended August 31, 2001 (the "2001 Fiscal Year").
Revenues from service sales for the 2002 Fiscal Year were $1,739,524. As
Logicorp was purchased in the 2002 Fiscal Year there is no comparison.
Other revenues were nil, compared to $16,595 for the 2001 Fiscal Year.
Other revenue composed of income derived from securities held. Since there are
no longer such investments, there was a decrease.
As a result of the foregoing, our total revenues in the aggregate were
$34,207,924, compared to $16,595 for the 2001 Fiscal Year, an increase of
$34,191,329. The increase is due to the purchase of the Logicorp entities.
COST OF REVENUES. Cost of revenues from product sales for the 2002
Fiscal Year was $30,725,499. As Logicorp was purchased in the 2002 Fiscal Year
there is no comparison for our 2001 Fiscal Year.
Cost of revenues from service sales for the 2002 Fiscal Year were
$594,488. As Logicorp was purchased in the 2002 Fiscal Year there is no
comparison.
As a result of the foregoing, our total cost of revenues for continuing
operations was $31,319,987, compared to $nil for the 2001 Fiscal Year, an
increase of $31,319,987 or 100%.
GROSS PROFIT. Gross profit was $2,887,937 for the 2002 Fiscal Year
compared to $16,595 for the 2001 Fiscal Year. As Logicorp was purchased in the
2002 Fiscal Year there is no comparison for our 2001 Fiscal Year.
15
EXPENSES. Selling, general and administrative expenses for the 2002
Fiscal Year were $7,622,873, compared to $7,258,609 for the 2001 Fiscal Year, an
increase of $364,264 or 5.0%. Of this, there was increased legal and accounting
fees of $1,324,433 offset by decreasing operating costs of CMCG. These increased
due to the acquisition and the financing raises.
Depreciation and amortization for the 2002 Fiscal Year were $1,027,242,
compared to $594,803 for the 2001 Fiscal Year, an increase of $432,439 or 72.7%.
This increase is the result of $425,692 of additional depreciation resulting
from the addition of Logicorp and eTelligent. As a percentage of our total
revenues, such costs decreased to 3.0% for the 2002 Fiscal Year.
Loss from the impairment of goodwill for the 2002 Fiscal Year was
$10,489,549 compared to nil for the 2001 Fiscal Year. The costs arose from the
revaluation of our subsidiaries in the Logicorp Group of Companies. As a
percentage of the Company's total revenues, such costs were 30.7% for the 2002
Fiscal Year.
Loss from operations for the 2002 Fiscal Year was $16,251,727 compared
to $8,192,377 for the 2001 Fiscal Year, an increase of $8,059,350 or 98.4%. This
increase was caused primarily by the impairment of goodwill of $10,489,549.
Loss on extinguishment of debt was $521,120 for the 2002 Fiscal Year
with no comparison for the 2001 Fiscal Year. A beneficial conversion and
interest expense was calculated as of the date of the agreement to convert the
notes to common shares, as the difference between the conversion price and the
fair value of the common stock into which the notes are convertible. The Company
recognized a loss on extinguishment of debt and corresponding additional paid in
capital and the balance of this debt has been retired.
Interest expense for the 2002 Fiscal Year were $10,123,183, compared to
$1,146,708 for the 2001 Fiscal Year, an increase of $8,976,475 or 782.6%. The
increase was the result of the interest costs of beneficial conversion features
($6,283,881), interest costs associated with the financing raises ($1,909,011),
the amortization of the discount on debt ($589,981), increased debt levels and
the addition of Logicorp ($193,602). As a percentage of our total revenues, such
costs increased to 29.5% for the 2002 Fiscal Year.
Loss on write-down of investments for the 2002 Fiscal Year were
$1,838,140 compared to nil for the 2001 Fiscal Year. The costs arose from
writing off the investment in Wareforce and the deposit on
Applicationstation.com. As a percentage of the Company's total revenues, such
costs were 5.4% for the 2002 Fiscal Year.
The financing costs, write-down on investments and the loss on sale of
subsidiaries are one-time in nature and we don't view them as occurring until
similar transactions happen.
NET INCOME/LOSS. As a result of all of the above, the Company's net loss
for the 2002 Fiscal Year was $30,751,537 (which includes 2,015,740 of losses
from discontinued operations) compared to net loss of $11,747,639 (which
includes 2,107,454 of losses from discontinued operations) for the 2001 Fiscal
Year, a change of $19,003,898.
DISCONTINUED OPERATIONS. The Company sold Galavu and Interactive
subsequent to August 31, 2002 (See Note 4 of financial statements for further
discussion). Accordingly, the Company is following the guidance in APB 30,
"Reporting the Results of Operations-Reporting the Effects of Disposal of a
Segment of a Business, and Extraordinary, Unusual, and Infrequently Occurring
Events and Transactions," and EITF 95-18 "Accounting and Reporting for a
Discontinued Business Segment When the Measurement Date Occurs After the Balance
Sheet Date but Before the Issuance of Financial Statements". The operations of
Galavu and Interactive, along with Magic, are presented as discontinued
operations for all periods presented.
YEAR ENDED AUGUST 31, 2001 COMPARED TO YEAR ENDED AUGUST 31, 2000
REVENUES.
Other revenues were $16,595, compared to $13,703 for the 2000 Fiscal
Year, an increase of $2,892 or 21.1%.
16
As a result of the foregoing, our total revenues in the aggregate were
$16,595, compared to $13,703 for the 2000 Fiscal Year, an increase of $2,892 or
21.1%.
COST OF REVENUES. Cost of revenues were nil for network services for the
2001 and 2000 Fiscal Years.
GROSS PROFITS. Gross profits were $16,595 for the 2001 Fiscal Year
compared to $13,703 for the 2000 Fiscal Year, an increase of $2,892 or 21.1%.
EXPENSES. Selling, general and administrative expenses for the 2001
Fiscal Year were $7,258,609, compared to $1,288,190 for the 2000 Fiscal Year, an
increase of $5,970,419 or 463.5%. The increase was caused by the addition of the
Chell Merchant Capital Group and Chell.com (USA). Chell Merchant Capital Group's
and Chell.com (USA)'s selling, general and administration expenses for the 2001
Fiscal Year were $5,452,378 and $121,715 respectively (There are no comparative
figures for the 2000 Fiscal Year). There were increased consulting, legal and
accounting fees of $298,556, $819,215 and $302,739 respectively. These increased
due to the acquisition and the increased reporting requirements for the
Quarterly reviews. There were also increased operating costs due to the addition
of the two new companies, such as: communications ($202,531), rent and utilities
($117,649), travel ($992,595), office supplies ($100,023). Also there was
increased advertising and promotion ($418,557) and investor and public relations
($492,846) associated with the two new companies. In addition there was an
increase in salaries and benefits of $1,762,128. These staffing levels have been
reduced and these costs should not be incurred in the next fiscal year. As a
whole, Chell Merchant Capital Group and Chell.com (USA) attributed for the
increase in selling, general and administrative expenses, however these costs
have been dramatically decreased and should not occur with our current company
structure in the next fiscal year.
Write-off of leaseholds was $355,560 for the 2001 Fiscal Year. Chell
Merchant Capital Group experienced the one-time write-offs.
Interest and bank charges for the 2001 Fiscal Year were $1,146,708,
compared to $46,360 for the 2000 Fiscal Year, an increase of $1,100,348 or
2,373.5%. The increase was the result of the increased debt levels associated
with the promissory note and convertible debenture. As a percentage of our total
revenues, such costs increased to 6910.0% for the 2001 Fiscal Year from 338.3%
for the 2000 Fiscal Year.
Depreciation and amortization for the 2001 Fiscal Year were $594,803,
compared to $47,055 for the 2000 Fiscal Year, an increase of $547,748 or
1,164.1%. This increase is the result of depreciation on the capital asset
additions in 2001, and the addition of our Chell Merchant Capital Group
subsidiary ($431,697). As a percentage of our total revenues, such costs
increased to 3,584.2% for the 2001 Fiscal Year from 343.4% for the 2000 Fiscal
Year.
NET INCOME/LOSS. As a result of all of the above, the Company's net loss
for the 2001 Fiscal Year was $11,747,639 (which includes 2,107,454 of losses
from discontinued operations) compared to net loss of $2,323,621 (which includes
955,719 of losses from discontinued operations) for the 2000 Fiscal Year, a
change of $9,424,018.
LIQUIDITY AND CAPITAL RESOURCES
Our principal sources of liquidity have been cash provided by
operations, sale of subsidiaries, capital raises, issuance of short-term notes
payable and credit terms from suppliers and subcontractors. Our principal uses
of cash have been for operations and working capital. We anticipate these uses
will continue to be our principal uses of cash in the future.
At the 2002 Fiscal Year end, we had the requisite working capital to
fund our ongoing business operations based upon the losses that had been
incurred during the previous two fiscal years. In addition, our business plan
for 2003 contemplates obtaining additional working capital through refinancings
or restructurings of our existing loan agreements, and the possible sale of some
of our existing subsidiaries. Our management is of the opinion that they will be
able to obtain enough working capital and that together with funds provided by
operations, there will be sufficient working capital for the Company's
requirements.
We may require additional financing in order to implement our business
plan. We currently anticipate capital expenditures of at least $250,000 during
the next 12 months for the replacement of older capital assets. If the
anticipated cash generated by our operations are insufficient to fund
requirements and losses, we will need to obtain additional funds through third
party financing in the form of equity, debt or bank financing. There can be no
17
assurance that we will be able to obtain the necessary additional capital on a
timely basis or on acceptable terms, if at all. If additional capital is not
raised, our business, prospects, financial condition, and results of operations
would be materially and adversely affected. As a result of a financing involving
equity, the holders of our common stock may experience substantial dilution. In
addition, as our results may be negatively impacted and thus delayed as a result
of political and economic factors beyond our control, our capital requirements
may increase.
The following factors, among others, could cause actual results to
differ from those indicated in the above forward-looking statements: pricing
pressures in the industry; the loss of any of our major customers; a continued
downturn in the economy in general or in the interactive entertainment sector; a
further decrease in demand for our products or continued weak demand for these
products; our ability to attract new customers; our ability to reduce costs; an
increase in competition in the market for interactive entertainment; and the
ability of some of our new customers to obtain financing. These factors or
additional risks and uncertainties not known to us or that we currently deem
immaterial may impair business operations and may cause our actual results to
differ materially from any forward-looking statement.
Although we believe the expectations reflected in the forward-looking
statements are reasonable, we cannot guarantee future results, levels of
activity, performance or achievements. We are under no duty to update any of the
forward-looking statements after the date of this report to conform them to
actual results or to make changes in our expectations.
We have listed below the details of all the debt and borrowings the
Company has.
In March 2001, LDS replaced the entered into a line of credit agreement
with HSBC Bank of Canada. Bank advances are payable on demand. The loan
agreement covers (i) a demand revolving operating loan up to $3,000,000; (ii)
equipment loan up to $300,000; (iii) demand Evergreen capital loan/lease
facility up to $300,000; (iv) loan on forward exchange contracts up to $500,000.
The operating loan carries an interest rate of 0.82% over the prime rate while
the equipment and Evergreen Capital loans carry an interest rate equal to, at
the option of the Company, (a) 1.05% over the prime rate at the end of each
month; or (b) a fixed rate agreed by both the Bank and the Company. Under the
terms of the agreement, the Company can borrow, under the operating loan and 31%
of the forward exchange contracts outstanding, up to an aggregate of (i) 70% of
acceptable accounts receivable (ii) 50% of the lesser of cost or current market
value of its inventory not to exceed $750,000. Borrowings under the line are
subject to certain financial covenants and restrictions on additional
indebtedness and other related items. As of August 31, 2002, the Company is in
violation of maximum debt to net worth and minimum working capital covenants.
The loans are secured by the assets of the Company under a general security
agreement, and are guaranteed by the Logicorp Service Group Ltd., through a
security agreement and are also personally guaranteed by the former shareholders
of LDS.
LDS aggress to pay $212,290 payable to HP with respect to the settlement
of claims. The loan is payable in monthly installments of $4,423 due on the
first day of every month, commencing on May 1, 2003 through April 2007 carrying
an interest rate of 0%. Amortization of imputed interest is immaterial to the
accompanying consolidated financial statements.
In November 2001, the Bank of Montreal made available to the Company, a
Demand loan, non-revolving and/or Fixed Rate Term Loan in the amount of
$1,250,000. The loan was for payment of the Matched Fund Term Loan held in the
prior year by The Royal Bank of Canada for properties at 10 Meteor Drive and 775
Pacific Road. Borrowings are repayable by blended monthly principal payments of
$10,417 and interest based on 10-year term which matures in December 2011.
Interest is currently calculated at Prime Rate plus 1.25%. The Company may
convert the Demand loan, non-revolving advances in part or in total to a Fixed
Rate Term Loan advances, and may be converted back to Demand loan, non-revolving
at maturity of terms. Fixed Rate Term Loan rates are to be determined based on
applicable rates at time of draw and the available terms are from 1 to 5 years.
On December 1, 2001, the Company offered to certain investors 8%
convertible notes up to a maximum amount of US$ 8,000,000 in a private
placement. The Company received approximately Cnd$6,587,622 through this
offering. Under the terms of this offering, the notes are convertible into
shares of common stock at a price of the greater of (1) 50% of the average
closing bid prices for the ten trading days prior to conversion or (2) US$0.50.
These notes were due August 9, 2002. On April 9, 2002 all of the holders of the
notes signed commitments to voluntarily convert the notes based on the
conversion price per the terms of the agreement, which was determined to be
US$0.95 per share. This conversion was subject to shareholder approval. The
conversion of these notes would
18
have resulted in the issuance of approximately 4,389,000 shares representing
approximately 20% of the total common shares outstanding after the issuance, and
diluting the current common stockholders. As of August 31, 2002, none of these
shares has been issued and the outstanding amount of the convertible notes was
classified as liabilities. As of December 2, 2002, the Company, Joseph Gunnar &
Co., LLC ("JGUN"), the placement agent in this offering, and the holders of
these notes entered into a settlement agreement providing that the conversion
price for these notes shall equal 85% of the two day weighted average trading
price of the common stock for the five trading days preceding effective date of
the registration statement under the Securities Act of 1933, as amended,
relating to the resale of the shares of common stock issuable upon such
conversion, provided, that such conversion price cannot be greater than $0.75 or
less than $0.40. Effective January 7, 2003, the Company, JGUN, Cameron Chell and
the holders of the notes agreed that if this registration statement is not
declared effective on or prior to September 1, 2003, the noteholders could "put"
their shares of common stock to Mr. Chell at a price of $0.475 per share during
the period of December 1 - 14, 2003. At April 30, 2004, such registration
statement has not been filed. By letter dated December 4, 2003, the noteholders
agreed to permit the Company until February 28, 2004 to file all required filing
and periodic reports under the Securities Exchange Act of 1934, as amended, and
to amend the period during which they may "put" their shares issuable upon such
conversion to Mr. Chell from December 1--14, 2003, to March 1 - 14, 2004, in
exchange for the extension of the "put" period and the reduction of the
conversion price to $0.25 per share, provided, that, if such deadline was not
satisfied by the Company such agreement and reduction of the conversion price
would be null and void. By letter, dated February 26, 2004, this deadline and
the "put" period were amended to be April 30, 2004 and May 1 - 14, 2004,
respectively. By letter, dated April 29, 2004, the Company requested that such
deadline and "put" period be further amended to be May 30, 2004 and June 1 - 14,
2004, respectively. The Company believes that, as these notes have been held by
the noteholders for an excess of two years, and none of such noteholders are or
have been affiliates of the Company during the preceding 90 days, the notes may
be converted tat any time and the shares of common stock issuable upon such
conversion could be resold pursuant to Rule 144(k), and, provided that the
Company files all filings and periodic reports under the Securities Exchange Act
prior to May 31, 2004, these notes shall be mandatorily converted into shares of
common stock. In the event that the notes should be converted into shares of
common stock at the conversion price of $0.25 per share, the aggregate number of
shares of common stock issued upon such conversion would be approximately
16,640,000, representing approximately 54% of the common stock outstanding
giving effect to such conversion. One noteholder has indicated to the Company
that it believes that it has a cause of action against the Company with respect
to the foregoing and its rights under such notes, and has threatened to bring
such action against the Company. In the event that the Company should be found
to be in default of the notes or the related agreements, the Company may be
required to repay the notes in the event that a settlement is not reached with
the noteholders. In such event the Company does not believe that it currently
has the necessary capital available to repay the notes and would be required to
seek additional sources of capital or seek protection from creditors. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources".
In addition, since this debt is convertible into equity at the option of
the note holder at beneficial conversion rates, an embedded beneficial
conversion feature was recorded as a debt discount and will be amortized using
the effective interest rate method over the life of the debt in accordance with
EITF 00-27. Total cost of beneficial conversion feature of Cnd$6,177,647 is
recorded as a discount of the convertible debt which is fully amortized during
the year ended August 31, 2002.
During the year ended August 31, 2003, B.O.T.B., a company controlled by
Cameron Chell, advanced Logicorp Data Systems $820,000, and during the period of
September 1, 2003 through April 30, 2004, advanced Logicorp Data Systems
$567,399. The advances are due on demand and do not carry a stated interest
rate. Due to their long-term nature, the Company has imputed interest on the
advances at a rate of 9% per annum. As of April 30, 2004, the aggregate amount
of such advances was $1,387,399.
On January 15, 2001, the Company received US$1,500,000 (approximately
Cnd$2,280,000) in return for a promissory note payable to Naveen Channana. The
note bears interest at 2% per month and US$1,000,000 of the principal and
accrued interest was due and payable on December 5, 2001. Effective May 6, 2002,
the remaining principal and interest expense was converted to 725,952 common
shares. A beneficial conversion and interested expense was calculated as of the
date of the agreement to convert the notes to common shares, as the difference
between the conversion price and the fair value of the common stock into which
the notes are convertible. The Company recognized a loss on extinguishment of
debt and corresponding additional paid in capital in the amount of approximately
$521,000. During the year ended August 31, 2002, the Company recorded interest
of $522,564, made cash payments of $1,520,000 and settled the remaining balance
of $1,282,564 with 725,952 shares of the Company's common stock.
19
On October 3, 2000, the Company closed the sale of a US$3,000,000
(approximately Cnd$4,740,000) Convertible 10% Debenture to the VC Advantage
Limited Partnership ("VCALP"). As at August 31, 2001, US$1,700,000
(approximately Cnd$2,635,000) has been advanced. This unsecured convertible
debenture is due three years from issue. The Convertible Debenture bears
interest at 10% per annum, payable upon conversion, redemption or maturity. The
unpaid principal of the debenture bears interest from the date that it is
actually advanced until paid. Interest is payable in cash or stock at our
option. The Convertible Debenture is convertible into common stock, at US$3.00
per share, in amounts specified by the VCALP. The maximum number of common
shares VCALP will receive is one million. On the close date, the Company also
issued 50,000 warrants to purchase 50,000 common shares at US$3.00 per share to
VCALP. The warrants have a term of four years. The fair value of these warrants
totaling approximately $220,000 was computed using the Black-Scholes model under
the following assumptions: (1) expected life of 1 1/2 years; (2) volatility of
80%, (3) risk free interest of 5.87% and (4) dividend of 0%. This convertible
debt matured in 2003. The Company can elect to pay the outstanding loan balance
in shares of common stock at a fixed conversion price of US$3. In addition,
since this debt is convertible into equity at the option of the note holder at
beneficial conversion rates, an embedded beneficial conversion feature was
recorded as a debt discount and will be amortized using the effective interest
rate method over the life of the debt in accordance with EITF 00-27. Total cost
of beneficial conversion feature of $1,728,134 and the relative fair value of
the warrants of $220,000 are recorded as a discount of the lines of credit. For
the quarter ended November 30, 2003, the amortization of the discount is
immaterial to the accompanying financial statements. During the year ended
August 31, 2001, the Company amortized $563,367 as interest expense. As of
August 31, 2001, the outstanding balance of this debt net of unamortized
discount totaled $1,250,233.
On November 30, 2000 the convertible debenture was assigned by VCALP to
CALP II Limited Partnership.
During the 2002 Third Fiscal Quarter, the convertible debenture held by
CALP II Limited Partnership ("CALP II") on behalf of Canadian Advantage Limited
Partnership ("CALP") and Advantage (Bermuda) Fund Ltd. ("ABFL") was exchanged
for a note payable to CALP in the amount of US$1,365,100 and a note payable to
ABFL in the amount of US$504,900. These notes provide for payment of principal
and interest at the rate of 10% per annum on August 31, 2006. The notes are
secured by a general security agreement against the assets of the Company in
priority to all other claims subject to the existing security of the Bank of
Montreal and the CIBC. The terms of the debt were changed and thus resulted in a
decrease in the discount by the amount of $408,155.
Effective April 15, 2002, the Company entered into an agreement with
CALP to convert the principal amount of the note plus accrued interest into
Common Stock at the rate of US$0.80 pursuant to which CALP received 1,314,000
shares of the Company. CALP will receive an additional 442,145 shares upon the
approval of the Company's shareholders.
Effective April 15, 2002, the Company also entered into an agreement
with ABFL to convert the principal amount of the note plus accrued interest into
Common Stock at the rate of US$0.80 pursuant to which ABFL received 486,000
shares of the Company. ABFL will receive an additional 163,533 shares upon the
approval of the Company's shareholders.
Certain terms of the convertible debt has been changed including the
fixed conversion price reduced from $3 to $0.80. The Company recorded additional
discount of $677,216 and amortized $787,294. As of August 31, 2002, outstanding
balance of this debt net of unamortized discount totaled $1,360,311.
The conversion of the debt has been approved and the debt will be
converted from debt to equity upon the filling of the registration statement and
issuance of the shares.
The retirement compensation trusts were set up pursuant to section
248(1) of the Income Tax Act of Canada to provide retirement income to the three
individuals who owned Logicorp. Pursuant to the original and amended purchase
agreements of Logicorp, the Company will make monthly payments including
interest in various amounts. The loan carries an interest rate of prime plus
4.75%.
The Term loans are comprised of the following:
20
[a] Loan bearing interest at Prime plus 1.25% per annum, repayable
in monthly principal installments of $6,643 together with interest. Loan is due
July 31, 2005. Outstanding balance of this loan totaled $38,050 as of August 31,
2002.
[b] Small Business Equipment Loans bearing interest at Prime plus
2.25% per annum. Outstanding balance of this loan totaled $11,227 as of August
31, 2002.
Approximate future annual principal payments for long-term debt, exclusive of
the above bank indebtedness, are as follows:
---------------------------------------------------
Years ended August 31,
2003 $ 450,739
2004 2,378,634
2005 656,266
2006 254,755
2007 125,000
Thereafter 583,335
---------------------------------------------------
4,448,729
===================================================
In May 2002, the Company did a private financing raise in the amount of
US$290,000 ($443,189). Since the shares have not been issued the raise has been
placed as a note payable. Upon the issuance of the Company's shares, the note
will be converted from debt to equity.
At August 31, 2002, the Company had a working capital deficit of
$17,960,854, an increase of $14,672,711 from working capital of $3,288,143 at
August 31, 2001.
A comparison of balance sheet accounts does not provide any relevant
information since all prior operating companies are not listed as discontinued
operations. In addition, there is no historical comparison for our current
operating companies as they were acquired within the 2002 Fiscal Year.
For the 2002 Fiscal Year, we had a net cash outflow of $25,902, a cash
outflow of $978,153 for the 2001 Fiscal Year and $906,809 cash outflow for the
2000 Fiscal Year. The decrease in net cash flow for the 2002 Fiscal Year was
primarily due to cash used in operating activities.
Cash used in operating activities for the 2002 Fiscal Year was
$6,031,515. The major factor contributing to the cash used in operations for the
2002 Fiscal Year is the net loss with non-cash expenses added back of
$10,684,237 and a decrease in accounts payable and accrued liabilities of
$2,619,458; cash provided by operations were: decrease in accounts receivable,
trade of $3,002,443, and a decrease in assets from discontinued operations of
$2,794,223. The major factors contributing to the cash used in operations for
the 2001 Fiscal Year include: net loss with non-cash expenses added back of
$9,006,617; cash provided by operations, a decrease in assets from discontinued
operations of $3,254,147, and an increase in accounts payable and other
liabilities of $1,361,950. Cash used in operating activities for the 2000 Fiscal
Year was $1,153,743. The major factor contributing to the cash used in
operations during the 2000 Fiscal Year was net loss with non-cash expenses added
back of $2,708,476; cash provided by operations was a decrease in discontinued
operations of $771,835.
Cash provided by investing activities in the 2002 Fiscal Year was
$207,690. This amount resulted from the purchase of property and equipment of
$135,092, the acquisition of the Logicorp group of companies and eTelligent
Solutions of $1,500,000 and $240,000 respectively, offset by the proceeds from
disposal of property and equipment of $232,782 and the proceeds from the sale of
Magic Lantern of $1,850,000. Cash used in investing activities in the 2001
Fiscal Year was $1,686,688. This amount resulted from the purchase of capital
assets totaling $46,978 and the deposit on purchase of Applicationstation.com of
$1,689,710. Cash used in investing activities in the 2000 Fiscal Year was nil.
Cash provided by financing in the 2002 Fiscal Year were $5,797,923, the
increase in primarily made up of the $6,587,622 convertible promissory note
offset by payments of debt of $1,577,839. Cash provided by financing in the 2001
Fiscal Year were $4,880,321. The increase is primarily due to the sale of the
convertible debenture and
21
the bridge financing. Cash provided by financing in the 2001 Fiscal Year was
$246,934 resulting primarily from the $281,134 proceeds of exercised employee
stock options.
We purchased the Logicorp group of companies and eTelligent Solutions in
Fiscal 2002, both of which are in the Systems Integration segment. We have no
obligation to fund these operations, as they are self-sufficient operations.
INFLATION
The rate of inflation has had little impact on our operations or
financial position during the years ended August 31, 2002, August 31, 2001 and
August 31, 2000 and inflation is not expected to have a significant impact on
our operations or financial position during the 2003 Fiscal Year.
We pay a number of our suppliers, including our licensor and principal
supplier, NTN Communications, Inc., in US dollars. Therefore, fluctuations in
the value of the Canadian dollar against the US dollar will have an impact on
our gross profit as well as our net income. If the value of the Canadian dollar
falls against the US dollar, our cost of revenues will increase thereby reducing
our gross profit and net income. Conversely, if the value of the Canadian dollar
rises against the US dollar, our gross profit and net income will increase.
CRITICAL ACCOUNTING POLICIES
As discussed in our financial statements, the preparation of financial
statements in conformity with accounting principles generally accepted in the
U.S. requires management to make estimates and assumptions about future events
that affect the amounts reported in the financial statements and accompanying
notes. Since future events and their effects cannot be determined with absolute
certainty, the determination of estimates requires the exercise of judgment.
Actual results could differ from those estimates, and such differences may be
material to the financial statements. The most significant accounting estimates
inherent in the preparation of our financial statements include estimates as to
the appropriate carrying value of certain assets and liabilities which are not
readily apparent from other sources, primarily accounts receivable, inventory,
property and equipment, intangible assets, deferred revenue, rebates and coop
fund and warranty costs. Management bases its estimates on historical experience
and on various assumptions which are believed to be reasonable under the
circumstances. We reevaluate these significant factors as facts and
circumstances change. Historically, actual results have not differed
significantly from our estimates.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In July 2001, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 141 "BUSINESS COMBINATIONS." SFAS No. 141 supersedes Accounting
Principles Board ("APB") No. 16 and requires that any business combinations
initiated after June 30, 2001, be accounted for as a purchase, therefore,
eliminating the pooling-of-interest method defined in APB No. 16. The statement
was effective for any business combination initiated after June 30, 2001, and
must have been applied to all business combinations accounted for by the
purchase method for which the date of acquisition was July 1, 2001, or later.
The adoption of this statement did not have a material impact to our financial
position or results of operations.
In July 2001, the FASB issued SFAS No. 142, "GOODWILL AND OTHER
INTANGIBLE ASSETS", which requires the use of a non-amortization approach to
account for purchased goodwill and certain intangibles. This statement is
effective for fiscal years beginning after December 15, 2001. We adopted this
statement on September 1, 2001. Under the non-amortization approach, goodwill
and certain intangibles will not be amortized into results of operations, but
instead will be reviewed for impairment, written down and charged to results of
operations only in periods in which the recorded value of goodwill and certain
intangibles is more than its fair value. The adoption of this statement did not
have a material impact to our financial position or results of operations.
In October 2001, the FASB issued SFAS No. 143, "ACCOUNTING FOR ASSET
RETIREMENT OBLIGATIONS", which requires companies to record the fair value of a
liability for asset retirement obligations in the period in which they are
incurred. The statement applies to a company's legal obligations associated with
the retirement of a tangible long-lived asset that results from the acquisition,
construction, and development or through the normal operation of a long-lived
asset. When a liability is initially recorded, the company would capitalize the
cost, thereby increasing the carrying amount of the related asset. The
capitalized asset retirement cost is depreciated over the life of the
22
respective asset while the liability is accreted to its present value. Upon
settlement of the liability, the obligation is settled at its recorded amount or
the company incurs a gain or loss. The statement is effective for fiscal years
beginning after June 30, 2002. We do not expect the adoption of this statement
to have a material impact on our financial position or results of operations.
In August 2001, the FASB issued SFAS No. 144, "ACCOUNTING FOR THE
IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF".
SFAS No. 144 addresses financial accounting and reporting for the impairment or
disposal of long-lived assets. SFAS No. 144 requires that long-lived assets be
reviewed for impairment whenever events or changes in circumstances indicate
that its carrying amount may not be recoverable and is measured by a comparison
of the carrying amount of an asset to undiscounted future net cash flows
expected to be generated by the asset. If the carrying amount of an asset
exceeds its estimated future undiscounted cash flows, an impairment charge is
recognized for the amount by which the carrying amount of the asset exceeds the
fair value of the asset. SFAS No. 144 requires companies to separately report
discontinued operations and extends that reporting to a component of an entity
that either has been disposed of (by sales, abandonment or in a distribution to
owners) or is classified as held for sale. Assets to be disposed of are reported
at the lower of the carrying amount or fair value less costs to sell. We adopted
SFAS No. 144 on September 1, 2002. The effects of the adoption will be reflected
in the consolidated financial statements for the year ended August 31, 2003. For
the year ended August 31, 2002, the Company has followed the disclosure
requirements of APB 30 and EITF 95-18.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." SFAS-145 eliminates the current requirement that gains and losses
on extinguishments of debt must be classified as extraordinary items in the
income statement. Instead, SFAS-145 requires that gains and losses on
extinguishments of debt be evaluated against the criteria in Accounting
Principles Board (APB) Opinion 30, "Reporting the Results of Operations --
Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary,
Unusual and Infrequently Occurring Events and Transactions," to determine
whether or not it should be classified as an extraordinary item. If
classification as an extraordinary item is not appropriate, the gain or loss
would be included as part of income from operations. The Company adopted SFAS
No. 145 on September 1, 2001 and reported the loss of extinguishment of debt of
$521,120 as loss from operations.
In June 2002, the FASB issued Statement No. 146, "ACCOUNTING FOR COSTS
ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES". This Statement addresses financial
accounting and reporting for costs associated with exit or disposal activities
and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, "LIABILITY
RECOGNITION FOR CERTAIN EMPLOYEE TERMINATION BENEFITS AND OTHER COSTS TO EXIT AN
ACTIVITY (INCLUDING CERTAIN COSTS INCURRED IN A RESTRUCTURING)". The provisions
of this Statement are effective for exit or disposal activities that are
initiated after December 31, 2002, with early application encouraged. We do not
expect the adoption to have a material impact on our financial position or
results of operations.
In December 2002, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards (SFAS) No. 148, "ACCOUNTING
FOR STOCK-BASED COMPENSATION - TRANSITION AND DISCLOSURE". SFAS 148 amends FASB
Statement No. 123, "ACCOUNTING FOR STOCK-BASED COMPENSATION", providing
alternative methods of transition for a voluntary change to the fair value based
method of accounting for stock-based employee compensation. SFAS 148 also amends
the disclosure provisions of SFAS 123 and Accounting Principles Board (APB)
Opinion No. 28, "INTERIM FINANCIAL REPORTING", to require prominent disclosures
in both annual and interim financial statements about the method of accounting
for stock-based employee compensation and the effect of the method used on
reported results. Amendments to SFAS 123 related to the transition and annual
disclosures are effective for fiscal year's ending after December 15, 2002.
Amendments to disclosure requirements of APB Opinion 28 are effective for
interim periods beginning after December 15, 2002. We do not expect the adoption
of SFAS 148 will have a material impact on our financial position, results of
operations or cash flows.
In November 2002, FASB issued FASB Interpretation (FIN) No. 45,
"GUARANTOR'S ACCOUNTING AND DISCLOSURE REQUIREMENTS FOR GUARANTEES, INCLUDING
INDIRECT GUARANTEES OF INDEBTEDNESS OF OTHERS". FIN 45 requires that the
guarantor recognize, at the inception of certain guarantees, a liability for the
fair value of the obligation undertaken in issuing such guarantee. FIN 45 also
requires additional disclosure requirements about the guarantor's obligations
under certain guarantees that it has issued. The initial recognition and
measurement provisions of this interpretation are applicable on a prospective
basis to guarantees issued or modified after December 31, 2002 and the
disclosure requirements are effective for financial statement periods ending
after
23
December 15, 2002. The Company adopted FIN No. 45 on September 1, 2002 and did
not expect the adoption of FIN 45 to have a material impact on the Company's
financial position, results of operations or cash flows.
In January 2003, FASB issued Interpretation No. 46, "CONSOLIDATION OF
VARIABLE INTEREST ENTITIES". FIN 46 changed the criteria by which one company
includes another entity in its consolidated financial statements. Previously,
the criteria were based on control through voting interest. FIN 46 requires a
variable interest entity to be consolidated by a company if that company is
subject to a majority of the risk of loss from the variable interest entity's
activities or entitled to receive a majority of the entity's residual returns or
both. A company that consolidates a variable interest entity is called the
primary beneficiary of that entity. The consolidation requirements of FIN 46
apply immediately to variable interest entities created after January 31, 2003.
The consolidation requirements apply to older entities in the first fiscal year
or interim period beginning after June 15, 2003. Certain of the disclosure
requirements apply in all financial statements issued after January 31, 2003,
regardless of when the variable interest entity was established. During October
2003, the FASB deferred the effective date for applying the provisions of FIN 46
until the end of the first interim or annual period ending after December 31,
2003, if the variable interest was created prior to February 1, 2003 and the
public entity has not issued financial statements reporting such variable
interest entity in accordance with FIN 46. On December 24, 2003, the FASB issued
FASB Interpretation No. 46 (Revised December 2003), CONSOLIDATION OF VARIABLE
INTEREST ENTITIES, (FIN-46R), primarily to clarify the required accounting for
interests in variable interest entities. FIN-46R replaces FIN-46 that was issued
in January 2003. FIN-46R exempts certain entities from its requirements and
provides for special effective dates for entities that have fully or partially
applied FIN-46 as of December 24, 2003. In certain situations, entities have the
option of applying or continuing to apply FIN-46 for a short period of time
before applying FIN-46R. While FIN-46R modifies or clarifies various provisions
of FIN-46, it also incorporates many FASB Staff Positions previously issued by
the FASB. Management is currently assessing the impact, if any, FIN 46 may have
on us; however, our management does not anticipate the adoption to have a
material impact to the Company's financial position or results of operations.
In April 2003, FASB issued SFAS No. 149, "AMENDMENT OF STATEMENT 133 ON
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES. This Statement amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts
(collectively referred to as derivatives) and for hedging activities under SFAS
No. 133, "ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES" and is
effective for contracts entered into or modified after June 30, 2003. This
Statement amends Statement 133 for decisions made (i) as part of the Derivatives
Implementation Group process that effectively required amendments to Statement
133, (ii) in connection with other FASB projects dealing with financial
instruments, and (3) in connection with implementation issues raised in relation
to the application of the definition of a derivative, in particular, the meaning
of an initial net investment that is smaller than would be required for other
types of contracts that would be expected to have a similar response to changes
in market factors, the meaning of underlying, and the characteristics of a
derivative that contains financing components. We do not anticipate that the
adoption of this pronouncement will have a material effect on the financial
statements.
In May 2003, FASB issued SFAS No. 150, "ACCOUNTING FOR CERTAIN FINANCIAL
INSTRUMENTS WITH CHARACTERISTICS OF BOTH LIABILITIES AND EQUITY". This Statement
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity, and
is effective for financial instruments entered into or modified after May 31,
2003, and otherwise is effective at the beginning of the first interim period
beginning after June 15, 2003. SFAS 150 requires that an issuer classify a
financial instrument that is within its scope as a liability (or an asset in
some circumstances). Many of those instruments were previously classified as
equity. Some of the provisions of this Statement are consistent with the current
definition of liabilities in FASB Concepts Statement No. 6, "ELEMENTS OF
FINANCIAL STATEMENTS". The remaining provisions of this Statement are consistent
with FASB's proposal to revise that definition to encompass certain obligations
that a reporting entity can or must settle by issuing its own equity shares,
depending on the nature of the relationship established between the holder and
the issuer. While FASB still plans to revise that definition through an
amendment to Concepts Statement 6, FASB decided to defer issuing that amendment
until it has concluded its deliberations on the next phase of this project. That
next phase will deal with certain compound financial instruments including
puttable shares, convertible bonds, and dual-indexed financial instruments. We
do not anticipate that the adoption of this pronouncement will have a material
effect on the financial statements.
In December 2003, the FASB issued a revised SFAS No. 132, "Employers'
Disclosures about Pensions and Other Postretirement Benefits" which replaces the
previously issued Statement. The revised Statement increases the existing
disclosures for defined benefit pension plans and other defined benefit
postretirement plans. However, it
24
does not change the measurement or recognition of those plans as required under
SFAS No. 87, "Employers' Accounting for Pensions," SFAS No. 88, "Employers'
Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and
for Termination Benefits," and SFAS No. 106, "Employers' Accounting for
Postretirement Benefits Other Than Pensions." Specifically, the revised
Statement requires companies to provide additional disclosures about pension
plan assets, benefit obligations, cash flows, and benefit costs of defined
benefit pension plans and other defined benefit postretirement plans. Also,
companies are required to provide a breakdown of plan assets by category, such
as debt, equity and real estate, and to provide certain expected rates of return
and target allocation percentages for these asset categories. The adoption of
this pronouncement is not expected to have a material impact to the Company's
financial statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risks from changes in foreign currency exchange
rates and interest rates. We and our wholly-owned subsidiaries are located in
Canada and its functional currency is the Canadian dollar.
INTEREST RATE RISKS.
We also had various loans outstanding at August 31, 2002 (approximately
$11,500,000), which bear interest at a fixed rate. A hypothetical 10% adverse
change in the interest rate on this debt would negatively affect net income and
cash flow by approximately $115,000.
The Company did not use any derivative financial instruments to manage this
exposure.
FOREIGN EXCHANGE RATE RISKS.
We are subject to foreign currency exchange rate fluctuations in the
Canadian dollar value of foreign currency-denominated transactions. Based on our
average annual net currency positions in fiscal 2002 and 2001, a 10% adverse
change in average annual foreign currency exchange rates would not have been
material to our consolidated financial statements for the years ended August 31,
2002 or 2001.
25
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Set forth below is a list of the consolidated financial statements of
the Company being furnished in this Annual Report on Form 10-K pursuant to the
instructions to Item 8 to Form 10-K and their respective locations herein.
FINANCIAL STATEMENT LOCATION
Report of Independent Auditors
Current.......................................................... F - 1
Predecessor...................................................... F - 2
Consolidated Balance Sheets........................................... F - 3
Consolidated Statements of Operations................................. F - 4
Consolidated Statements of Shareholders' Equity (Deficit)............. F - 5
Consolidated Statements of Cash Flows................................. F - 6
Notes to Consolidated Financial Statements............................ F - 7
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES.
On July 3, 2003, the Company's Board of Directors terminated the
engagement of Lazar, Levine & Felix, LLP, as its auditors. The reports issued by
Lazar, Levine & Felix LLP on the financial statements for the past two fiscal
years of the Company did not contain an adverse opinion nor a disclaimer of
opinion, and were not qualified or modified as to audit scope or accounting
principles.
There were no disagreements with Lazar, Levine & Felix LLP on any matter
of accounting principles or practices, financial statement disclosure, or
auditing scope or procedure, which disagreements, if not resolved to the
satisfaction of Lazar, Levine & Felix LLP, would have caused Lazar, Levine &
Felix LLP to make reference thereto in their report on the financial statements
for such years or such interim periods.
The Company has requested that Lazar, Levine & Felix LLP furnish it with
a letter addressed to the Commission stating whether or not it agrees with the
above statements. A copy of such letter dated, July 21, 2003, is filed as
Exhibit 2 to Form 8-K filed on October 18, 2003.
On August 11, 2003, the Company's Board of Directors ratified the
engagement of Stonefield Josephson, Inc. as its auditors. The decision to retain
this accountant was approved by the Board of Directors. The Company authorized
Lazar, Levine & Felix, LLP to fully respond to any and all inquiries of
Stonefield Josephson, Inc. concerning Lazar, Levine & Felix, LLP termination.
Prior to our engagement of Stonefield Josephson, Inc. the Company
requested that Stonefield Josephson, Inc. assist with auditing the financial
statements for Logicorp, a subsidiary group of the Registrant's, for the twelve
months ended February 28, 2000, four months ended June 30, 2000, twelve months
ended June 30, 2001, and six months ended December 30, 2001. Other than as
described above, during our two most recent fiscal years prior to the date of
engagement, and the subsequent interim period prior to engaging this accountant,
neither the Company (nor someone on the Company's behalf) consulted the newly
engaged accountant regarding any matter.
The Company has allowed Stonefield Josephson, Inc. to review its Form
8-K before it is filed with the Commission. Stonefield Josephson, Inc. has not
furnished the Company with a clarification, or disagreement with the information
set forth herein.
On October 12, 2000, Ernst & Young LLP ("E&Y"), the independent
accountants who were engaged as the principal accountants to audit our financial
statements resigned as our certifying accountants. E&Y's report on our financial
statements as at August 31, 1999 and for the two years then ended contained no
adverse opinion or disclaimer of opinion, and were not qualified or modified as
to uncertainty, audit scope or accounting principles. During the fiscal year
ended August 31, 1999 and during the subsequent interim period preceding E&Y's
resignation we had no disagreement with E&Y on any matter of accounting
principles or practices, financial statement disclosure, or auditing scope or
procedure. The facts and circumstances that relate to E&Y's resignation, as far
as we know them, are as follows:
26
E&Y served as our certifying accountants since 1995. E&Y orally informed
us that pursuant to E&Y's internal rules, E&Y would resign as our certifying
accountants since it was unwilling and therefore unable to rely upon the
representations of Mr. Cameron Chell, our President and Chief Executive Officer,
due to the existence of a Settlement Agreement dated November 6, 1998, between
Cameron Chell, and the Alberta Stock Exchange. On April 3, 2000, our board of
directors appointed Mr. Chell as a director and elected him as our Chair; on
April 3, 2000, Chell.com. Ltd., an Alberta corporation wholly-owned by Mr.
Chell, purchased approximately 16% of our issued and outstanding common stock;
and on April 7, 2000, we advised E&Y of the existence of the Settlement
Agreement. Pursuant to this Settlement Agreement with the Alberta Stock
Exchange, Mr. Chell acknowledged the existence of certain facts that occurred
during 1996 and 1997 while Mr. Chell was a registered representative in Alberta,
Canada, licensed by the Alberta Securities Commission, and he agreed to certain
restrictions imposed by the Alberta Stock Exchange and to pay a Cdn$25,000 civil
fine. Specifically, Mr. Chell acknowledged that he had breached certain duties
of supervision, disclosure, and compliance of the Alberta Stock Exchange in
connection with various offers and sales of securities. Those restrictions
included Mr. Chell's loss of Alberta Stock Exchange approval for a five-year
period and enhanced supervision for a three-year period.
E&Y's unwillingness to rely upon Mr. Cameron Chell's representations
were based upon the existence of the Settlement Agreement with the Alberta Stock
Exchange and not based upon any representations made by Cameron Chell.
On November 1, 2000, our Board of Directors ratified the engagement of
Lazar, Levine & Felix, LLP as our auditors for the year ending August 31, 2000.
We have authorized E&Y to fully respond to any and all inquiries of Lazar,
Levine & Felix, LLP concerning E&Y's resignation.
ITEM 9A. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer
and Chief Financial Officer, evaluated the effectiveness of our disclosure
controls and procedures as of the end of the period covered by this report.
Based on that evaluation, our Chief Executive Officer and Chief Financial
Officer concluded that our disclosure controls and procedures as of the end of
the period covered by this report were designed and functioning effectively to
provide reasonable assurance that the information required to be disclosed by us
in reports filed under the Securities Exchange Act of 1934, as amended (the
"Exchange Act"), is recorded, processed, summarized and reported within the time
periods specified in the SEC's rules and forms. We believe that a controls
system, no matter how well designed and operated, cannot provide absolute
assurance that the objectives of the controls system are met, and no evaluation
of controls can provide absolute assurance that all control issues and instances
of fraud, if any, within a company have been detected.
(b) Change in Internal Control over Financial Reporting
No change in our internal control over financial reporting occurred
during our most recent fiscal quarter that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.
27
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
CURRENT COMPOSITION
-----------------------------------------------------------------------------------------------
NAME AGE PRINCIPAL POSITIONS WITH THE COMPANY DIRECTOR
SINCE
===============================================================================================
David Bolink 34 Director; Acting Chief Executive Officer 2004
Neil Brown 31 Secretary, Corporate Controller N/A
AS AT AUGUST 31, 2002
-----------------------------------------------------------------------------------------------
NAME AGE PRINCIPAL POSITIONS WITH THE COMPANY DIRECTOR
SINCE
===============================================================================================
Adrian P. Towning 59 Director, Chairman of the Board 2000
Don Pagnutti 53 Directory 2000
Robert Stone 60 Director 2000
Shelly Singhal 36 Director 2001
Michael Rice 37 Director 2001
Stephen McDermott 38 Chief Executive Officer, President N/A
Mark Truman 49 Secretary, Chief Financial Officer N/A
All of our Directors and Executive Officers were re-elected at our
Annual Shareholders' Meeting held on February 28, 2001 and will hold office
until the next succeeding Annual Meeting of Shareholders or until their
successors are duly elected and qualified. There were no resignations of
directors due to differences.
DAVID BOLINK was a Managing Director of Chell Merchant Capital Group
from September 2000 to January 19, 2001 and served as Chell.com. Ltd.'s first
President from December 1999 to July 2000. Mr. Bolink served as Director of
Business Management of FutureLink Distribution Corp., an application service
provider and a provider of server-based computing services, from May 1998 to
December 1999. Mr. Bolink also served as Business Manager of Edmonton Society
for Christian Education from May 1996 to May 1998. From February 1989 to May
1996, Mr. Bolink served as Asset Manager of Wilson Holdings, a property and
financial management company.
NEIL BROWN has been promoted to the position of Director of Operations
and Corporate Controller and the Company's Corporate Secretary, effective June
15, 2003. Neil has served as Assistant Controller of Chell Group and its
predecessor Networks North Inc., since 1999. Previously, Neil served as Canadian
Controller of Games Workshop Canada, a retail, wholesale and mail order company.
RESIGNED BOARD MEMBERS
STEPHEN MCDERMOTT joined Chell Group as Director of Corporate Finance in
February 2002 and was promoted to Chief Executive Officer of the Company in June
2002 until his resignation April 28, 2004. From January 1998 through February
2002, Mr. McDermott served as managing director of Stamford Capital partners
LLC, an investment banking firm. Mr. McDermott has over 13 years of investment
banking and private equity sales experience in the technology, healthcare and
biotech industries. He has also served in corporate finance and institutional
retail sales positions with life sciences focused investment banks Paramount
Capital and D. Blech & Company as well as with Gruntal & Co., and Paine Webber.
ADRIAN TOWNING is a private, independent investor in several companies
involved in the communications industry. As a result of his investments, he has
served as a director of some of these companies, including Medical
Communications Corporation, which we refer to as MCC, from 1994 to July 1996. On
May 14, 1996, MCC filed a petition under Chapter 7 of the United States
Bankruptcy Code and the Bankruptcy Court appointed a Trustee of MCC on July 11,
1996. On July 16, 1996, MCC was dissolved. From 1983 to 1989, he established and
managed Anglo-Massachusetts Investments Incorporated, with offices in Boston and
London, which was involved in providing financial advice to Europeans.
28
DON PAGNUTTI was appointed our Vice President, Finance on September 19,
2000 until his resignation October 31, 2002. Mr. Pagnutti has retained his
position as one of our directors. Mr. Pagnutti had been our Chief Financial
Officer since September 1998, and was our Executive Vice President and Chief
Operating Officer from September 1997 to September 2000. From 1996 to 1997, he
worked for Sullivan Entertainment Inc., as Executive Vice President and Chief
Financial Officer. From 1980 to 1996, he worked for Telemedia Communications
Ltd., a large Canadian media company as Vice President, Radio. Mr. Pagnutti is a
Chartered Accountant and has a Masters Degree in Business Administration and a
Bachelor of Commerce Degree from the University of Toronto.
ROBERT STONE served in various capacities with Cominco Ltd., a company
listed on the Toronto Stock Exchange, and the American Stock Exchange, being the
Vice-President, Finance and Chief Financial Officer of that company from 1980
until 1997. From 1969 until 1973 Mr. Stone was the Director of Finance of Great
Northern Capital Corporation. From 1964 until 1969 Mr. Stone worked with
Clarkson Gordon, Chartered Accountants.
SHELLY SINGHAL from June 2001 to date, has served as Managing Director
for SBI USA LLC and its current and former affiliates, and served as President
of vFinance Capital from December 2001 to December, 2002. From November of 2000
until May of 2001 he was Managing Director of Technology Investment Banking for
BlueStone Capital Securities, Inc. From July of 1995 until August of 2000 Mr.
Singhal was Managing Director of Corporate Finance at Roth Capital Partners
where he was head of the E-Commerce Group and Manager of the Roth Capital
Partners Bridge Fund.
MICHAEL J. RICE is President of Prudential Securities. Mr. Rice joined
Prudential Securities in October 1997, assuming responsibility for strategic
development of the firm's retail arm. Until then, he had been a Vice President
and Branch Manager at Smith Barney. Mr. Rice serves on the Board of New York
City's Rhinelander School for deaf children and is Prudential Securities'
Corporate Champion for the INROADS Program, which is dedicated to developing
high-potential minority youths. He was also recently honored by IRISH AMERICAN
magazine as a member of "The Wall Street Top 50". He holds an undergraduate
degree from Georgetown University and an MBA from the Wharton School of
Business.
MARK TRUMAN, until his resignation in January 2003, has been promoted to
the position of Chief Financial Officer effective November 1, 2002. Mark has
served as Corporate Controller of Chell Group and its predecessor Networks North
Inc., since 1994 and since 1997 has served as the Company's Corporate Secretary.
Previously, Mark served as Canadian Controller and Audit Manager for Arthur
Andersen and as a financial consultant to the health care publishing industry.
COMPLIANCE WITH SECTION 16(a) OF THE SECURITIES EXCHANGE ACT OF 1934
Section 16(a) of the Exchange Act requires our directors and executive
officers, and persons who own more than ten percent (10%) of our outstanding
Common Stock, to file with the SEC initial reports of ownership and report
changes in ownership of Common Stock. Such persons are required by SEC
regulations to furnish the Company with copies of all such reports they file. To
our knowledge, based solely on a review of the copies of reports furnished to us
and written or oral representations that no other reports were required for such
persons, all Section 16(a) filing requirements applicable to our officers,
directors and greater than ten percent (10%) beneficial owners have been
complied with respect to the fiscal years ended August 31, 2002 and August 31,
2001.
29
ITEM 11. EXECUTIVE COMPENSATION.
SUMMARY COMPENSATION TABLE
The following table sets forth information concerning the compensation
paid or accrued by us during the three years ended August 31, 2002 to the
individuals who served as our Chief Executive Officer, Chief Financial Officer
and Chief Technology Strategist, (collectively, the "Named Executive Officers"),
who received total annual salary and bonuses in excess of US$100,000
(Cdn$157,240) during the 2002 Fiscal Year.
LONG-TERM
ANNUAL COMPENSATION COMPENSATION
---------------------------------------- -------------------
OTHER ANNUAL SECURITIES UNDER ALL OTHER
NAME AND PRINCIPAL POSITION SALARY(1) BONUS COMPENSATION(1) OPTIONS/GRANTED COMPENSATION
YEAR (CDN$) (CDN$) ($) (#) ($)
- ---------------------------------------- ---------------------------------------- ------------------------------------
Stephen McDermott (2) 2002 -- -- -- -- --
Chief Executive Officer
Donald Pagnutti (3) 2002 160,000 -- -- 250,000 --
President, and Chief Financial 2001 160,000 -- -- -- --
Chief Financial Officer 2000 156,249 -- -- 22,500 --
Cameron Chell 2002 -- -- -- -- --
Chief Executive Officer (4) 2001 -- -- -- -- --
- ---------------------------------------- ---------------------------------------- ------------------------------------
NOTES:
(1) Perks and other personal benefits received in 2000, 2001 and
2002 did not exceed the lesser of US$50,000 and 10% of the total
annual salary and bonuses for any of the Named Executive
Officers.
(2) Mr. McDermott was appointed Chief Executive Officer effective
June 27, 2002. His salary commenced August 16, 2002 and was less
than US$100,000. Mr. McDermott resigned as Chief Executive
Officer effective April 28, 2004.
(3) Mr. Pagnutti resigned as President and Chief Financial Officer
effective October 31, 2002. (4) Mr. Chell resigned as Chief
Executive Officer effective June 27, 2002.
During the three year period ended August 31, 2002, we did not grant any
restricted stock awards or stock appreciation rights. Additionally, all of our
group life, health, hospitalization, medical reimbursement or relocation plans,
if any, do not discriminate in scope, terms or operation, in favor of the Named
Executive Officers and are generally available to all salaried employees.
Further, no Named Executive Officer received, in any of the periods specified in
the Summary Compensation Table, perks and other personal benefits, securities or
property in an aggregate amount in excess of the lesser of $50,000 or 10% of the
total salary and bonus reported for the Named Executive Officer in the fiscal
year in which such benefits were received, and no single type of perquisite or
other personal benefits exceeded 25% of the total perquisites and other benefits
reported for the Named Executive Officer in the applicable fiscal year.
OPTION GRANTS TABLE
The following table sets forth (a) the number of shares underlying
options granted to each Named Executive Officer during the 2002 Fiscal Year, (b)
the percentage the grant represents of the total number of options granted to
all our employees during the 2002 Fiscal Year, (c) the per share exercise price
of each option, (d) the expiration date of each option, and (e) the potential
realized value of each option based on: (i) the assumption of a five (5%)
percent annualized compounded appreciation of the market price of the Common
Stock from the date of the grant of the subject option to the end of the option
term, and (ii) the assumption of a ten (10%) percent annualized compounded
appreciation of the market price of the Common Stock from the date of the grant
of the subject option to the end of the option term.
30
Potential Realizable Value
at Assumed Rates of Stock
Price Appreciation for
Option Term
Name Number of Percentage of Exercise Expiration Date 5% 10%
Shares Total Options Price
underlying Granted to
Options Employees in
Granted Fiscal Year
----------- --------------- -------- --------------- ------- -------
Stephen McDermott (1) Nil Nil Nil Nil Nil Nil
Chief Executive Officer
Donald Pagnutti (2) 250,000 17.04 $1.00 November 30, $12,500 $25,000
President and Chief 2011
Financial Officer
Cameron Chell (3) Nil Nil Nil Nil Nil Nil
Chief Executive Officer
NOTES:
(1) Mr. McDermott resigned as Chief Executive Officer effective
April 28, 2004.
(2) Mr. Pagnutti resigned as President and Chief Financial Officer
effective October 31, 2002.
(3) Mr. Chell resigned as Chief Executive Officer effective June 27,
2002.
OPTIONS EXERCISED AND REMAINING OUTSTANDING
Set forth in the table below is information, with respect to each of the
Named Executive Officers, as to the (a) number of shares acquired during the
2002 Fiscal Year upon each exercise of options granted to such individuals, (b)
the aggregate value realized upon each such exercise (i.e., the difference
between the market value of the shares at exercise and their exercise price),
(iii) the total number of unexercised options held on August 31, 2001,
separately identified between those exercisable and those not exercisable, and
(iv) the aggregate value of in-the-money, unexercised options held on August 31,
2002, separately identified between those exercisable and those not exercisable.
SECURITIES AGGREGATE
ACQUIRED ON VALUE UNEXERCISED OPTIONS AT VALUE OF UNEXERCISED IN THE MONEY
EXERCISE REALIZED AUGUST 31, 2002 OPTIONS AT AUGUST 31, 2002
(#) ($) (#) ($)
----------- ---------- --------------------------- ----------------------------------
EXERCISABLE UNEXERCISABLE EXERCISABLE(1) UNEXERCISABLE(1)
----------- ------------- -------------- ----------------
Stephen McDermott Nil Nil Nil Nil Nil Nil
Mark Truman Nil Nil 45,000 15,000 Nil Nil
Donald Pagnutti Nil Nil 187,500 62,500 Nil Nil
Cameron Chell Nil Nil Nil Nil Nil Nil
NOTE:
(1) The value of the unexercised "in-the-money" options has been
determined by subtracting the exercise price of the options from
the closing Common Share price of US$0.379 on August 30, 2002,
and multiplying by the number of Common Shares that may be
acquired upon the exercise of the options. The current exercise
price of the options is higher than the closing Common Share
price of US$0.379, therefore the Value of the options is nil.
31
COMPENSATION OF DIRECTORS
Prior to September 8, 2000, each non-employee director was eligible to
receive $500 for each meeting of the Board of Directors or committee thereof
which such director attended, along with the reimbursement of reasonable
expenses incurred on our behalf. In addition, each non-employee director was
eligible to receive 1,500 stock options annually.
As of December 11, 2000, the Board of Directors formally adopted a
standard arrangement pursuant to which only our outside directors are
compensated for their services in their capacity as directors. This compensation
arrangement is retroactive to September 19, 2000 (the date of the closing of the
Agreement of Purchase and Sale between Networks North Inc., Networks North
Acquisition Corp., Chell.com Ltd. and Cameron Chell).
OUTSIDE DIRECTOR COMPENSATION
- --------------------------------------------------------------------------------
Options Cash (US$)
- --------------------------------------------------------------------------------
Directorship Acceptance Options
(one time grant with a 3 year vesting schedule) 45,000
Annual Retainer-Chairman 20,000 10,000
Annual Retainer-Director 6,000
Annual Retainer-Committee Member
(over and above directorship retainer) 3,000
Annual Retainer-Committee Chair
(over and above directorship retainer
and committee retainer) 2,000
Board Meeting Attendance Fee 750/mtg.
Committee Attendance Fee 500/mtg
EMPLOYMENT CONTRACTS WITH NAMED EXECUTIVE OFFICERS
Effective August 16, 2002, we entered into an employment agreement with
Stephen McDermott, pursuant to which Mr. McDermott will serve as our President
and Chief Executive Officer for a period of one year. The contracted salary is
US$120,000(Cdn$183,288). Mr. McDermott resigned as Chief Executive Officer and
President effective April 28, 2004. Mr. McDermott also resigned his position
with the Board of Directors.
Effective November 1, 2002, we entered into an employment agreement with
Mark Truman, pursuant to which Mr. Truman will serve as our Chief Financial
Officer. Subsequent to this agreement, Mark Truman terminated his employment
with the Company for personal reasons.
In November 1999, we renewed Donald Pagnutti's employment agreement
originally dated August 15, 1997, pursuant to which Mr. Pagnutti serves as our
Executive Vice President, Chief Financial Officer and Chief Operating Officer.
On September 19, 2000, Mr. Pagnutti's title was changed to Vice President,
Finance and Chief Financial Officer. Effective June 27, 2002 Mr. Pagnutti's
title was changed to President and Chief Financial Officer. Mr. Pagnutti did not
to renew the current contract and has entered into a one-year agreement as a
consultant to the Company, effective November 1, 2002. We have terminated this
agreement. Mr. Pagnutti resigned his position with the Board of Directors.
On September 19, 2000, we entered into an employment agreement with
Cameron Chell, pursuant to which Mr. Chell served as our President and Chief
Executive Officer. The agreement provided for an initial base compensation of
$360,000, together with automobile expenses of $8,400. In addition to the fixed
remuneration, we were to provide Mr. Chell with the services of an Executive
Assistant on an ongoing basis and an Accountant for a reasonable period of time
to allow for the completion of outstanding accounting work related to existing
companies in which Mr. Chell is involved. It was the understanding of the
parties that this agreement was to be replaced by a definitive employment
agreement before October 10, 2000; however, such agreement has not been entered
into at this time. Since the signing of this agreement, Mr. Chell has eliminated
both his salary and automobile allowance in an effort to reduce our cash
requirements. Mr. Chell resigned as our President and Chief Executive Officer
effective June 27, 2002.
We do not have any other employment agreements in effect with any other
executive employee.
32
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Our Audit and Compensation Committees at August 31, 2002 consisted of
Robert Stone, Shelly Singhal and Adrian P. Towning. Messrs. Stone, Singhal and
Towning are not our officers or employees, and have not served in such
capacities in the past. None of our executive officers served as a director or
member of the compensation committee (or group performing similar functions) of
another entity, one of whose executive officers served on the Audit and
Compensation Committee or as a director of the Company.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
Set forth in the table below is information concerning the ownership, as
of the close of business on April 30, 2004, of the common stock by each person
who is known to us to be the beneficial owner of more than five (5%) percent of
the common stock, our directors and named executive officers, and all directors
and executive officers as a group. The percentage beneficial ownership as
calculated below does not include the effects of the potential conversion of the
8% convertible notes. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Liquidity and Capital Resources".
AMOUNT & NATURE PERCENTAGE
OF BENEFICIAL OF
NAME AND ADDRESS (1) OWNERSHIP CLASS(2)
- -------------------- --------------- ----------
Chell.com Ltd. (3) 498,354 3.5%
114, 1215 -- 13th Street S.E.
Calgary, Alberta T2G 3J4
Cameron Chell (4) 1,225,000 8.6%
Canadian Advantage Limited Partnership (5) 451,868 3.2%
c/o Thomson Kernaghan & Co. Limited
120 Adelaide Street West, Suite 1800
Toronto Ontario M5H 1T1
CEDE & CO 3,406,326 23.8%
Michael J. Rice 1,700,000 11.9%
Naveen Chanana 748,452 5.2%
ISCA Financial Services 637,636 4.5%
Jayvee & CO 4,201,487 29.4%
Stephen McDermott (President and
Chief Executive Officer) (6) 3,000,000 17.8%
All directors and executive officers
as a group 2 persons 0 0.0%
(1) Unless otherwise stated, the address of the directors and executive
officers of the corporation is c/o Chell Group Corporation c/o Reitler Brown,
800 Third Avenue, 21st floor, NY,NY 10022.
(2) Unless otherwise indicated, we believe that all persons named in the
table have sole voting and investment power with respect to all shares of common
stock beneficially owned by them. A person is deemed to be the beneficial
33
owner of securities that may be acquired by such person within 60 days from the
date on which beneficial ownership is to be determined, upon the exercise of
options, warrants or convertible securities. Each beneficial owner's percentage
ownership is determined by assuming that options, warrants and convertible
securities that are held by such person (but not those held by any other person)
and which are exercisable within such 60-day period, have been exercised.
(3) Cameron Chell is the sole director and shareholder of Chell.com Ltd.
(4) Cameron Chell and Jayee & Co. have a pending dispute as to the
beneficial ownership of up to an additional 3.5 million shares currently held by
Jayvee & Co. While Mr. Chell currently disclaims beneficial ownership of these
shares, in the event that this dispute should be resolved in Mr. Chell's favor,
Mr. Chell would beneficially own an aggregate of 4,725,000 shares of common
stock, representing 33.1% of the outstanding common stock at April 30, 2004.
(5) Includes 36,500 shares issuable upon the exercise of Warrants and
442,145 shares of our common stock to be issued upon shareholder approval
scheduled for October 30, 2002.
(6) Consists of warrants granted in fiscal 2003 to acquire an aggregate of
3,000,000 shares of Common Stock at the exercise price of $0.05 per share. The
warrants expire in 2013. Mr. McDermott resigned all positions with us effective
April 28, 2004.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Set forth below is a description of certain transactions between us and
our directors, executive officers, beneficial owners of five percent or more of
the outstanding Common Stock, or members of the immediate family of any of the
foregoing persons, as well as certain business relationships between the us and
our directors, which occurred or existed during the 2002 Fiscal Year and
subsequent thereto. Our management believes that the transactions described in
this section were made on terms no less favorable than those that could have
been obtained from third parties.
The Company entered into a License Agreement with, Cameron Chell, and
Chell Merchant Capital Group dated August 31, 2000 pursuant to which Mr. Chell
granted the Company and Chell Merchant Capital Group the right to use the
trademarks "Chell.com", "Chell Merchant Capital Group" and "Chell Group
Corporation" in exchange for the fee of $1.00 per year.
The Company entered into a Securities Purchase Agreement with VC
Advantage Fund ("VC") on October 3, 2000, pursuant to which VC may lend up to an
aggregate of US$3,000,000 to the Company. VC received a Convertible Debenture,
which is convertible into the Company's Common Stock, at a conversion price of
$3.00 per share. As of November 30, 2000, VC had assigned its rights in this
Agreement to Canadian Advantage Limited Partnership ("CALP II") and a total of
US$1,700,000 has been advanced to the Company. The US$1,700,000 advance is
convertible into 566,667 Common shares. Cameron Chell is a Director and
shareholder of VC Advantage Limited, the general partner of VC. Pursuant to the
assignment of this agreement to CALP II, this is no longer a related transaction
because Mr. Chell has no beneficial interest in CALP II.
On January 7, 2003, the Company, JGUN, Mr. Chell and the holders of our
8% convertible notes entered into an agreement pursuant to which Mr. Chell
agreed that if a registration statement under the Securities Act relating to the
resale of the shares of common stock issuable upon conversion of such notes is
not declared effective on or prior to September 1, 2003, the noteholders could
"put" these shares of common stock to Mr. Chell at $0.475 per share. This
agreement was amended on December 4, 2003 and February 26, 2004, and may be
amended as of April 29, 2004. See "Management's Discussion of Financial
Condition and Results of Operations 00 Liquidity and Capital Resources".
On January 22, 2002, Mr. Chell guaranteed liabilities of Logicorp to its
principal lender, HSBC, in the amount of Cdn$1.0 million. On December 24, 2002,
Mr. Chell guaranteed trade credit of Logicorp to Synnex in the amount of
approximately Cd. $1.0 million. On January 7, 2003, the board determined that
the Company would grant 3.5 million shares of common stock to Mr. Chell for such
guarantees and other consideration in support of the Company. See "Management's
Discussion and Analysis of Financial Condition and Results of Operation" for a
description of the loans.
34
During the year ended August 31, 2003, B.O.T.B., a company controlled by
Cameron Chell, advanced Logicorp Data Systems $820,000, and during the period of
September 1, 2003 through April 30, 2004, advanced Logicorp Data Systems
$567,399. The advances are due on demand and do not carry a stated interest
rate. Due to their long-term nature, the Company has imputed interest on the
advances at a rate of 9% per annum. As of April 30, 2004, the aggregate amount
of such advances was $1,387,399.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
AUDIT FEES
Lazar Levine & Felix, LLP audited our financial statements for the
fiscal year ended August 31, 2001 and 2000. In addition, Lazar Levine & Felix,
LLP had reviewed our 10-Q's for the period and had begun the audit process for
the August 31, 2002 until we hired our new auditors Stonefield Josephson, Inc.
in August 2003. Fees for there services relating to the 2002 fiscal year audit
will be reflected in the period incurred. The aggregate fees billed for
professional services rendered by Lazar were as follows:
------------------------------------------------------
Year Audit Fees
------------------------------------------------------
2002 $159,842
2001 $244,560
2000 $173,860
------------------------------------------------------
ALL OTHER FEES
No other services were rendered by Lazar Levine & Felix in fiscal year
2002, 2001 and 2000.
35
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) The following financial statements and supplementary financial
information are filed as part of this Annual Report on Form 10-K:
(1) The financial statements listed in the Index to Consolidated
Financial Statements are filed as part of this report.
(2) Schedule of Valuation and Qualifying Accounts
(b) The following 8-K's have been filed since the Company's last 10-Q: None
(c) The following list sets forth the applicable exhibits (numbered in
accordance with Item 601 of Regulation S-K) required to be filed with
this Annual Report on Form 10-K:
36
CHELL GROUP CORPORATION
ANNUAL REPORT ON FORM 10-K
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT LOCATION
2.1 Stock Purchase Agreement, dated October 1, 1996,
among Connolly-Daw Holdings Inc., 1199846 Ontario
Ltd., Douglas Connolly, Wendy Connolly and NTN
Interactive Network Inc., minus Schedules thereto ... +1, Exh. 10.1
3.1 Articles of Incorporation, as amended to date ....... p. 59
3.2 By-Laws, as amended to date ......................... p. 62
4.1 Specimen Stock Certificate .......................... p. 71
10.1 License Agreement, dated March 23, 1990, between
NTN Communications, Inc. and NTN Interactive
Network Inc. ........................................ +2, Exh. 10.9
10.2 Stock Purchase Agreement, dated as of October 4,
1994, between NTN Canada and NetStar Enterprises
Inc. (formerly, Labatt Communications Inc.) ......... +3, Exh. A
10.3 Option, dated as of October 4, 1994, registered in
the name of NetStar Enterprises Inc. (formerly,
Labatt Communications Inc)........................... +3, Exh. B
10.4 Designation Agreement dated as of October 4, 1994,
among NTN Canada, Inc., NTN Interactive Network Inc.
and NetStar Enterprises Inc. (formerly Labatt
Communications Inc.) ................................ +3, Exh. C
10.5 Registration Rights Agreement, dated as of
October 4, 1994, between NTN Canada and NetStar
Enterprises Inc. (formerly, Labatt Communications
Inc.)................................................ +3, Exh. D
10.6 Promissory Note of NTN Interactive Network Inc.
registered in the name of Connolly-Daw Holdings,
Inc. ................................................ +1, Exh. 10.2
10.7 Promissory Note of NTN Interactive Network Inc.,
registered in the name of 1199846 Ontario Ltd. ...... +1, Exh. 10.3
10.8 Option Agreement, dated October 1, 1996, among
Connolly-Daw Holdings Inc., NTN Interactive
Network Inc. and NTN Canada, Inc. ................... +1, Exh. 10.5
10.9 Option Agreement, dated October 1, 1996, among
1199846 Ontario Ltd., NTN Interactive Network Inc.
and NTN Canada, Inc. ................................ +1, Exh. 10.6
10.10 Registration Rights Agreement, dated October 1,
1996, among NTN Canada, Inc., Connolly-Daw
Holdings Inc. and 1199846 Ontario Ltd. .............. +1, Exh. 10.4
10.11 Employment Agreement dated as of August 31, 1994,
between NTN Interactive Network Inc. and Peter
Rona. ............................................... +4, Exh. 10.11
10.12 Management Agreement dated October 1, 1996,
between Magic Lantern Communications Ltd. and
Connolly-Daw Holdings Inc............................ +4, Exh. 10.12
10.13 Employment Agreement dated October 1, 1996,
between Magic Lantern Communications Ltd. and
Douglas Connolly..................................... +4, Exh. 10.13
10.14 Employment Agreement dated October 1, 1996,
between Magic Lantern Communications Ltd. and
Wendy Connolly....................................... +4, Exh. 10.14
10.15 Asset Purchase Agreement, dated September 10,
1999, by and between 1373224 Ontario Limited,
Networks North Inc. and Arthur Andersen Inc., to
acquire the property and assets of GalaVu
Entertainment Inc., from the person appointed by
the court of competent jurisdiction as the
receiver or receiver and manager of the property,
assets and undertaking of GalaVu .................... +5, Exh. 10.15
1
10.16 Promissory Note, dated September 10, 1999, by and
between 1373224 Ontario Limited, as Debtor, and
the Holder, as Creditor ............................. +5, Exh. 10.16
10.17 General Security Agreement, dated September 10,
1999, by and between 1373224 Ontario Limited, to
acquire the property and assets of GalaVu
Entertainment Inc., from the person appointed by
the court of competent jurisdiction as the
receiver or receiver and manager of the property,
assets and undertaking of GalaVu .................... +5, Exh. 10.17
10.18 Securities Pledge Agreement, dated September 10,
1999, by and between 1373224 Ontario Limited to
acquire the property and assets of GalaVu
Entertainment Inc., from the person appointed by
the court of competent jurisdiction as the
receiver or receiver and manager of the property,
assets and undertaking of GalaVu .................... +5, Exh. 10.18
10.19 Certificate to the Escrow Agent certifying that
the conditions of Closing have been satisfied or
waived .............................................. +5, Exh. 10.19
10.20 Certificate to the Escrow Agent certifying that
the conditions of Closing have not been satisfied
or waived ........................................... +5, Exh. 10.20
10.21 Occupancy and Indemnity Agreement, dated September
10, 1999, by and between 1373224 Ontario Limited
to acquire the property and assets of GalaVu
Entertainment Inc., from the person appointed by
the court of competent jurisdiction as the
receiver or receiver and manager of the property,
assets and undertaking of GalaVu .................... +5, Exh. 10.21
10.22 Order of the Ontario Superior Court of Justice,
dated September, 1999, approving the transaction
contemplated herein, and vesting in the Purchaser
the right, title and interest of GalaVu and the
Receiver, if any, in and to the Purchased Assets,
free and clear of the right, title and interest of
any other person other than Permitted Encumbrances .. +5, Exh. 10.22
10.23 Bill of Sale, dated September 13, 1999, by and
between 1373224 Ontario Limited to acquire the
property and assets of GalaVu Entertainment Inc.,
from the person appointed by the court of
competent jurisdiction as the receiver or receiver
and manager of the property, assets and
undertaking of GalaVu ............................... +5, Exh. 10.23
10.24 Covenant of Networks North Inc. for valuable
consideration to allot and issue and pay to the
Receiver 100,000 common shares in accordance with
the Purchase Agreement date September 10, 1999,
between 1373224 Ontario Limited and the Receiver .... +5, Exh. 10.24
10.25 Agreement of Purchase and Sale dated August 4,
2000 by and among Networks North Inc., Networks
North Acquisition Corp., Chell.com Ltd. and
Cameron Chell........................................ +6, Exh. A
10.26 Valuation of Chell.com Ltd. as of May 31, 2000 by
Stanford Keene....................................... +6, Exh. B.
10.27 Share Purchase Agreement by and among Chell Group
Corporation, Chell Merchant Capital Group, Inc.,
Melanie Johannesen, Randy Baxandall, Morris
Chynoweth, Elaine Chynoweth, the Johannesen Family
Trust, the Baxandall Family Trust, the Merc Family
Trust, Logicorp Data Systems Ltd., 123557 Alberta
Ltd., Logicorp Service Group Ltd. and 591360
Alberta Ltd. ........................................+7, Exhibit 2.1
10.28 Share Purchase Agreement, dated as of April 25,
2003 between DVOD Networks Inc., and Chell Group
Corporation, minus schedules thereto;
10.29 Assignment of Debt and Security, dated April 25,
2003 between Chell Group Corporation and DVOD
Networks Inc;
10.30 Assignment of Debt and Security, dated April 25,
2003 among NTN Interactive Network Inc., DVOD
Networks Inc and GalaVu Entertainment Network
Inc.;
2
10.31 Form of Assignment of Debt and Security, dated
April 25, 2003 among 488605 Ontario Limited, Ruth
Margel and DVOD Networks Inc., minus schedules
thereto
22 List of Subsidiaries
31.1 Certification of the Acting Chief Executive
Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
32.1 Certification of the Acting Chief Executive
Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
- ----------------
+1 All Exhibits so indicated are incorporated herein by reference to the
exhibit listed above in the Company's Current Report on Form 8-K (Date
of Report: October 2, 1996) (File No. 0-18066), filed on October 17,
1996.
+2 All Exhibits so indicated are incorporated herein by reference to the
exhibit listed above in the Annual Report on Form 10-K of NTN
Communications, Inc., for its fiscal year ended December 31, 1990) (File
No. 2-91761-C), filed on April 1, 1991.
+3 All Exhibits so indicated are incorporated herein by reference to the
exhibit listed above in the Company's Current Report on Form 8-K (Date
of Report: October 4, 1994) (File No. 0-18066), filed on October 18,
1994.
+4 All Exhibits so indicated are incorporated herein by reference to the
exhibit listed above in the Company's Annual Report on Form 10-K (Date
of Report: November 27, 1996) (File No. 0-18066), filed on December 16,
1996.
+5 All Exhibits so indicated are incorporated herein by reference to the
exhibit listed above in the Company's 8-K (Date of Report: September 13,
1997) (File No. 0-18066), filed on December 16, 1996.
+6 All Exhibits so indicated are incorporated herein by reference to the
exhibit number listed above in the Definitive Proxy Statement on Form
14A of the Registrant (File No. 000-18066), filed with the Securities
and Exchange Commission on August 8, 2000.
+7 All Exhibits so indicated are incorporated herein by reference to the
exhibit number listed above in the Company's Current Report on Form 8-K
(Date of Report: December 13, 2001) (File No. 0-18066), filed on
December 28, 2001.
++ Filed electronically pursuant to Item 401 of Regulation S-T.
3
EXHIBIT 22. LIST OF SUBSIDIARIES OF CHELL GROUP CORPORATION AS AT NOVEMBER
26, 2002
NAME OF SUBSIDIARY(1) JURISDICTION OF INCORPORATION
Logicorp Data Systems Ltd. (2)...........................................Alberta
Logicorp Service Group Ltd (2)...........................................Alberta
123557 Alberta Ltd. (2)..................................................Alberta
591360 Alberta Ltd. (2)..................................................Alberta
eTelligent Solutions Inc. (3)............................................Alberta
Chell Merchant Capital Group, Inc........................................Ontario
NTN Interactive Network Inc. (sold December 2003).........................Canada
3484751 Canada Inc........................................................Canada
GalaVu Entertainment Network Inc. (sold April 2003)......................Ontario
Viewer Services (4)......................................................Ontario
Chell.com (USA) Ltd.......................................................Nevada
- ----------
NOTES:
(1) Unless otherwise indicated, all named entities are wholly-owned
subsidiaries of Chell Group Corporation
(2) Wholly-owned subsidiary of Chell Merchant Capital Group, Inc.
(3) Wholly-owned subsidiary of Logicorp Data Systems Ltd.
(4) Wholly-owned subsidiary of NTN Interactive Network Inc.
4
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.
CHELL GROUP CORPORATION
/s/ David Bolink
Date: May 11, 2004 By:
--------------------------------------------
David Bolink, Acting Chief Executive Officer
and Acting Chief Accounting Officer
Pursuant to the requirements of the Securities Exchange Act of
1934, this report on has been signed below by the following persons on behalf of
the Registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE(S) DATE
/s/ David Bolink Acting Chief Executive Officer, May 11, 2004
- ----------------------- Acting Chief Accounting Officer
David Bolink and Director
5
INDEX TO FINANCIAL STATEMENTS
Report of Independent Auditors
Current....................................................... F - 1
Predecessor................................................... F - 2
Consolidated Balance Sheets...................................... F - 3
Consolidated Statements of Operations............................ F - 4
Consolidated Statements of Shareholders' Equity.................. F - 5
Consolidated Statements of Cash Flows............................ F - 6, F - 7
Notes to Consolidated Financial Statements....................... F - 7 thru
F-41
6
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of Chell Group Corporation
We have audited the consolidated balance sheet of Chell Group
Corporation (a New York corporation) and subsidiaries as of August 31, 2002 and
the related consolidated statements of operations, shareholders' equity
(deficit) and cash flows for the year ended August 31, 2002. Our audit also
included the financial statement schedule listed in Item 14. These consolidated
financial statements and financial statement schedule are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
consolidated financial statements and financial statement schedule based on our
audit.
We conducted our audit in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Chell Group Corporation and subsidiaries, as of August 31, 2002, and the results
of their consolidated operations and their consolidated cash flows for the year
ended August 31, 2002, in conformity with accounting principles generally
accepted in the United States of America. Also in our opinion, the related
financial statement schedule, when considered in relation to the basic
consolidated financial statements taken as a whole, presents fairly, in all
material respects, the information set forth therein.
The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. As discussed in Note
1 to the consolidated financial statements, the Company's significant recurring
operating losses, working capital deficit, shareholders' deficit, and negative
cash flows from operations raise substantial doubt about its ability to continue
as a going concern. Management's plans regarding those matters also are
described in Note 1. The consolidated financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
As discussed in Note 17, the Company has restated its financial
statements as of August 31, 2001 and 2000, and for the years then ended,
previously audited by other auditors.
/s/ STONEFIELD JOSEPHSON, INC.
- ----------------------------------
STONEFIELD JOSEPHSON, INC.
IRVINE, CALIFORNIA
DECEMBER 29, 2003
F-1
INDEPENDENT AUDITORS REPORT
The Board of Directors
Chell Group Corporation
Toronto, Ontario
We have audited the accompanying consolidated balance sheets of
Chell Group Corporation and subsidiaries as of August 31, 2001 and 2000 and the
related consolidated statements of operations and shareholders' equity and cash
flows for each of the two years in the period ended August 31, 2001. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards
generally accepted in the United States of America. Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to
above present fairly, in all material respects, the financial position of Chell
Group Corporation and subsidiaries as of August 31, 2001 and 2000, and the
results of their operations and their cash flows for the years then ended in
conformity with accounting principles generally accepted in the United States of
America.
/S/ LAZAR LEVINE & FELIX LLP
- ----------------------------
Lazar Levine & Felix LLP
New York, New York
November 16, 2001
F-2
CHELL GROUP CORPORATION
CONSOLIDATED BALANCE SHEETS
(Expressed in Canadian dollars)
================================================================================
August 31, 2002 August 31, 2001
(Restated)
$ $
- --------------------------------------------------------------------------------
ASSETS
CURRENT
Cash and cash equivalents 107,258 133,160
Short-term investments -- 19,676
Accounts receivable, trade - net of allowance
for doubtful accounts of $160,000 and $0,
respectively 4,944,843 --
Other receivables 31,406 84,914
Income taxes receivable -- 2,481
Inventory 268,980 --
Prepaid expenses -- 158,304
- --------------------------------------------------------------------------------
TOTAL CURRENT ASSETS 5,352,487 398,535
================================================================================
Property and equipment, net 3,460,763 2,533,494
Licenses, net of accumulated amortization 47,015 54,861
Goodwill 276,794 --
Other assets 109,696 212,541
Deposit on purchase -- 1,689,710
Net assets from discontinued operations -- 4,648,078
- --------------------------------------------------------------------------------
9,246,755 9,537,218
================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
CURRENT
Bank overdraft 603,740 --
Bank indebtedness 2,990,914 --
Current portion, long-term debt 1,534,073 --
Accounts payable and accrued liabilities 5,268,874 1,406,678
Payable on acquisition 4,852,976 --
Loan payable, related party 200,000 --
Short-term note and loan payable, other 443,189 2,280,000
Deferred revenue 422,980 --
Convertible debt 6,587,622 --
Net liabilities from discontinued operations 408,973 --
- --------------------------------------------------------------------------------
TOTAL CURRENT LIABILITIES 23,313,341 3,686,678
- --------------------------------------------------------------------------------
Long-term debt, net of current portion 2,914,656 2,417,388
- --------------------------------------------------------------------------------
TOTAL LIABILITIES 26,227,997 6,104,066
- --------------------------------------------------------------------------------
COMMITMENTS AND CONTINGENT LIABILITIES -- --
PREFERRED SERIES B SHARES: 454,545 SHARES
[AUGUST 2001 - NIL] 7,294 --
SHAREHOLDERS' EQUITY (DEFICIT)
10,504,913 common shares
[August 2001 - 9,028,239] 712,652 604,109
Due from shareholder (227,365) (25,086)
Additional paid in capital 26,220,561 15,849,971
Accumulated other comprehensive income 215,097 --
Accumulated deficit (43,909,481) (13,020,928)
- --------------------------------------------------------------------------------
TOTAL SHAREHOLDERS' EQUITY (DEFICIT) (16,988,536) 3,408,066
- --------------------------------------------------------------------------------
9,246,755 9,537,218
================================================================================
The accompanying notes are an integral part of these
consolidated financial statements
F-3
CHELL GROUP CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED AUGUST 31
[Expressed in Canadian dollars]
===============================================================================================
2002 2001 2000
(Restated) (Restated)
$ $ $
- -----------------------------------------------------------------------------------------------
REVENUE
Product sales 32,468,400 -- --
Service sales 1,739,524 -- --
Other -- 16,595 13,703
- -----------------------------------------------------------------------------------------------
34,207,924 16,595 13,703
- -----------------------------------------------------------------------------------------------
COST OF SALES
Product sales 30,725,499 -- --
Service sales 594,488 -- --
- -----------------------------------------------------------------------------------------------
31,319,987 -- --
- -----------------------------------------------------------------------------------------------
GROSS PROFIT 2,887,937 16,595 13,703
OPERATING EXPENSES
Selling, general and administrative expenses 7,622,873 7,258,609 1,288,190
Write off of leasehold improvements -- 355,560 --
Depreciation and amortization 1,027,242 594,803 47,055
Impairment of goodwill 10,489,549 -- --
- -----------------------------------------------------------------------------------------------
19,139,664 8,208,972 1,335,245
- -----------------------------------------------------------------------------------------------
LOSS FROM OPERATIONS (16,251,727) (8,192,377) (1,321,542)
Loss on extinguishments of debt 521,120 -- --
Interest expense 10,123,183 1,146,708 46,360
Loss from equity investment in Engyro -- 301,100 --
Loss on disposal of investments 1,838,140 -- --
Miscellaneous 1,627 -- --
- -----------------------------------------------------------------------------------------------
Loss before provision for income taxes (28,735,797) (9,640,185) (1,367,902)
Provision for income taxes -- -- --
- -----------------------------------------------------------------------------------------------
LOSS FROM CONTINUING OPERATIONS (28,735,797) (9,640,185) (1,367,902)
--------------------------------------------------
DISCONTINUED OPERATIONS
Loss on disposal/sale of subsidiary
(net of applicable income tax of $0) (305,091) (937,711) --
Loss from discontinued operations
(net of applicable income tax of $0) (1,710,649) (1,169,743) (955,719)
--------------------------------------------------
LOSS FROM DISCONTINUED OPERATIONS (2,015,740) (2,107,454) (955,719)
--------------------------------------------------
NET LOSS (30,751,537) (11,747,639) (2,323,621)
OTHER COMPREHENSIVE INCOME - FOREIGN
CURRENCY TRANSLATION 215,097 -- --
- -----------------------------------------------------------------------------------------------
COMPREHENSIVE LOSS (30,536,440) (11,747,639) (2,323,621)
===============================================================================================
- ---------------------------------------------
LOSS PER SHARE:
Basic and diluted from continuing operations (2.91) (1.15) (0.48)
Basic and diluted from discontinued operations (0.20) (0.25) (0.33)
- -----------------------------------------------------------------------------------------------
Net loss per share (3.11) (1.40) (0.81)
===============================================================================================
The accompanying notes are an integral part of these
consolidated financial statements
F-4
CHELL GROUP CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
FOR THE YEARS ENDED AUGUST 31, 2002, 2001 AND 2000
(Expressed in Canadian dollars)
Accumulated Accumu-
other lated Total
Preferred shares Common shares Additional Due from compre- retained shareholders'
-------------------------------------- paid in stock- hensive earnings equity
Shares Amount Shares Amount capital holder income (deficit) (deficit)
====================================================================================================================================
Balance, August 31, 1999 900,000 10,917 2,756,641 171,635 9,559,883 -- -- 1,050,332 10,792,767
GalaVu acquisition -- -- 100,000 6,897 288,463 -- 295,360
Change in preferred share
conversion rate -- -- -- 7,887 329,892 -- 337,779
Exercise of 68,500 stock options -- -- 68,500 4,703 276,431 -- 281,134
Net loss (restated - Note 17) -- -- -- -- -- (2,323,621) (2,323,621)
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, August 31, 2000
(restated - Note 17) 900,000 10,917 2,925,141 191,122 10,454,669 -- -- (1,273,289) 9,383,419
Purchase of assets and shares -- -- 5,426,772 372,923 2,229,291 -- 2,602,214
Shares issued in lieu of salary -- -- 131,974 9,484 315,577 -- 325,061
Settlement of debt -- -- 36,602 2,694 109,085 -- 111,779
Preferred shares converted (900,000) (10,917) 300,000 13,065 (9) -- 2,139
Warrants -- -- -- -- 117,359 -- 117,359
Receivable from stockholder (25,086) (25,086)
Consulting services rendered -- -- 145,000 10,405 456,218 -- 466,623
Exercise of 62,750 stock options -- -- 62,750 4,416 208,637 -- 213,053
Beneficial conversion on Debt -- -- -- -- 1,959,144 -- 1,959,144
Net loss (restated - Note 17) -- -- -- -- -- (11,747,639) (11,747,639)
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, August 31, 2001
(restated - Note 17) -- -- 9,028,239 604,109 15,849,971 (25,086) -- (13,020,928) 3,408,066
Settlement of debt -- -- 1,226,986 90,126 1,833,280 -- 1,923,406
Loss on extinguishments of debt -- -- -- -- 521,120 -- 521,120
Preferred shares issued (Note 10) -- -- -- -- 169,225 -- 169,225
Foreign currency translation
adjustment 215,097 215,097
Receivable from stockholder (202,279) (202,279)
Deemed dividend on Preferred
shares issued -- -- -- -- 137,016 (137,016) --
Warrants -- -- -- -- 947,711 -- 947,711
Beneficial conversion feature
on Gunnar convertible note -- -- -- -- 5,743,924 -- 5,743,924
Beneficial conversion feature
on change of terms on
convertible note -- -- -- -- 677,216 -- 677,216
Consulting services rendered -- -- 63,500 4,674 111,189 -- 115,863
Exercise of 186,188 stock
options -- -- 186,188 13,743 229,909 -- 243,652
Net loss -- -- -- -- -- (30,751,537) (30,751,537)
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE, AUGUST 31, 2002 -- -- 10,504,913 712,652 26,220,561 (227,365) 215,097 (43,909,481) (16,988,536)
====================================================================================================================================
The accompanying notes are an integral part of these
consolidated financial statements
F-5
CHELL GROUP CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED AUGUST 31
(Expressed in Canadian dollars)
=======================================================================================================================
2002 2001 2000
(Restated) (Restated)
$ $ $
- -----------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net loss for the year from continuing operations (30,751,537) (11,747,639) (2,323,621)
Adjustments to reconcile net loss to net cash
used in operating activities:
Compensation costs related to the change in the conversion rate
of preferred shares -- -- 337,799
Depreciation and amortization 1,019,396 3,040,407 2,249,321
Accretion of interest on non-interest bearing promissory notes -- 183,513 173,076
Amortization of discount on Gunner 6,531,218 -- --
Impairment of goodwill 10,489,549 -- --
Loss on disposal of capital assets 1,838,140 -- --
Interest cost from amortization of discount -- 589,628 --
Loss on extinguishments of debt 521,120 -- --
Loss on sale of MLC 305,091 -- --
Deferred taxes (59,173) -- --
Write-off of leasehold improvements -- 355,560 --
Services rendered for shares 115,863 659,359 --
Warrants issued 947,711 174,084 --
Write-off of prepaids arising from Chell asset purchase -- 367,235 --
Write-off of assets arising from discontinued operations 939,513 --
Provision for doubtful accounts 299,918 -- --
Changes in assets and liabilities:
Decrease (increase) in short-term investments -- 250,051 (7,801)
Decrease (increase) in accounts receivable, trade 3,697,333 790,018 (614,830)
Decrease (increase) in other receivables 84,814 -- --
Decrease (increase) in income taxes receivable 46,365 (11,977) (143,227)
Decrease (increase) in inventory (181,439) 100,626 54,652
Decrease (increase) in prepaid expenses 742,490 98,779 119,616
Decrease (increase) in other accounts receivable -- 133,580 (30,796)
Decrease (increase) in other assets -- 42,859 (202,799)
Decrease (increase) in assets from discontinued operations -- 103,710 (267,046)
Increase (decrease) in liabilities from discontinued operations -- -- --
Increase (decrease) in accounts payable and accrued liabilities (3,883,743) 1,072,244 919,707
Increase (decrease) in deferred revenue (782,660) -- --
- -----------------------------------------------------------------------------------------------------------------------
CASH USED IN OPERATING ACTIVITIES (9,019,544) (2,858,450) 264,031
=======================================================================================================================
INVESTING ACTIVITIES
Purchase of property and equipment (2,098,150) (1,430,962) (1,162,146)
Proceeds from disposal of property and equipment 1,111,000 -- --
Purchase of Logicorp (1,500,000) -- --
Purchase of eTelligent Solutions (75,000) -- --
Proceeds from sale of Magic Lantern 1,850,000 -- --
Proceeds from sale of Interlynx -- 50,000 --
Increase in deposit on purchase -- (1,689,710) --
Due from shareholder (227,365) -- --
Note receivable 160,000 -- --
- -----------------------------------------------------------------------------------------------------------------------
CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES (779,515) (3,070,672) (1,162,146)
=======================================================================================================================
FINANCING ACTIVITIES
Bank Indebtedness 3,480,223 -- --
Net borrowings on line of credit 4,579,849 -- --
Increase in notes and loans payable 3,973,189 5,006,134 21,908
Payment on Logicorp note (1,800,000) -- --
F-6
=======================================================================================================================
2002 2001 2000
(Restated) (Restated)
$ $ $
- -----------------------------------------------------------------------------------------------------------------------
Borrowing from Logicorp shareholders 200,000 -- --
Repayment of notes and loans payable (1,408,287) (102,447) (67,436)
Proceeds from exercise of options 243,652 26,243 281,134
- -----------------------------------------------------------------------------------------------------------------------
CASH PROVIDED BY FINANCING ACTIVITIES 9,268,626 4,929,930 235,606
- -----------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------
EFFECTS OF FOREIGN EXCHANGE 215,097 -- --
- -----------------------------------------------------------------------------------------------------------------------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS DURING THE (315,336) (999,192) (662,509)
PERIOD FROM CONTINUING OPERATIONS
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS DURING THE
PERIOD FROM DISCONTINUED OPERATIONS
Cash and cash equivalents, beginning of period 356,421 1,355,613 2,018,122
- -----------------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS, END OF PERIOD 41,085 356,421 1,355,613
=======================================================================================================================
Income taxes paid -- 98,491 59,956
Interest paid 412,388 146,781 121,579
2002 Fiscal Year - Non cash items arose from the purchase of Logicorp
Group of Companies and eTelligent Solutions during the 2002 Fiscal Year. They
are $2,677,782 of property & equipment, $5,000,000 of goodwill.
2001 Fiscal Year - Non cash items arose from the purchase of Chell.com
assets during the 2001 Fiscal Year. They are $1,936,272 of property & equipment,
$107,589 of goodwill, $45,044 of prepaids, $1,404 in other accounts receivable
and in addition shares were issued. Other assets of $174,084 arose from the
issue of warrants, shares were issued for consulting fees and salaries in the
amount of $659,359, shares were issued for a debt payment on the GalaVu purchase
in the amount of $115,165, write-off of leaseholds of $355,560 and write-off of
prepaids from Chell purchase of $367,235.
2000 Fiscal Year - Non cash items arose from the purchase of GalaVu
Entertainment Network Inc. during the 2000 Fiscal Year. They are: $3,300,000 of
long-term debt, and the associated unamortized discount of ($637,302), accretion
of interest of $173,076 in accrued liabilities; assumption of liabilities of
$529,440, $337,779 one-time compensation charge arising from the change in the
preferred share conversion rate and the issuance of shares amounting to
$295,360.
The accompanying notes are an integral part of these consolidated financial
statements.
1. DESCRIPTION OF BUSINESS AND OPERATIONS
Chell Group Corporation [the "Company"] was incorporated under the laws
of the State of New York on May 12, 1986. The Company is the holding company for
NTN Interactive Network Inc. ["Interactive"], GalaVu Entertainment Network Inc.
["GalaVu"], Chell Merchant Capital Group ["CMCG"], and Chell.com ("USA"), all of
which are wholly-owned operating companies. The Company also owns all of the
outstanding stock of 3484751 Canada Inc., a corporation the Company established
and incorporated under the Canada Business Corporations Act on April 20, 1998.
3484751 Canada Inc. was incorporated for the sole purpose of owning a property,
purchased in 1998, on behalf of the Company, which is currently unoccupied. CMCG
owns all the outstanding stock of Logicorp Data Systems Ltd. ["LDS"], Logicorp
Service Group Ltd. ["LSG"], 123557 Alberta Ltd. and 591360 Alberta Ltd.
(collectively " Logicorp"). LDS also owns all the outstanding stock of
eTelligent Solutions Inc., ["eTelligent"]. Interactive owns all of the
outstanding stock of 1113659 Ontario Ltd., which is inactive.
LDS was incorporated on March 31, 1988 as an Alberta, Canada corporation
and is registered in the provinces of British Columbia, Saskatchewan and
Ontario, Canada. LDS is a computer service organization, which specializes in
the supply and integration of computer products. LDS serves both large and small
organizations and is particularly valued by organizations having complex data
and communication configurations.
LSG was incorporated on December 10, 1993 under the name 591363 Alberta
Ltd., as an Alberta, Canada corporation. On February 28, 1995, LSG changed its
name to Logicorp Service Group Ltd. LSG is a computer service organization
specializing in the servicing of computer products in Edmonton. LSG serves both
as a warranty depot for manufacturers of computer products and as a technical
resource for small, medium and large commercial businesses.
F-7
eTelligent was incorporated on July 21, 2000. eTelligent is a team of
business system consultants specializing in implementing and integrating
e-business, CRM (customer relationship management) and financial services
solutions from Microsoft Great Plains. eTelligent is comprised of professional
accountants and information technology specialists, all certified through
Microsoft Great Plains University.
CMCG is incorporated under the Ontario Business Corporations Act and is
the parent company for Logicorp Data Systems Ltd. ("LDS"), Logicorp Service
Group Ltd. ("LSG"), 591360 Alberta Ltd. and 123557 Alberta Ltd. eTelligent
Solutions Inc. is a wholly-owned subsidiary of LDS. These subsidiaries of CMCG
(collectively "Logicorp") operate in the information technology systems
integration industry, predominantly in western Canada.
Interactive is incorporated under the Canada Business Corporations Act
and has signed a license agreement [the "NTNC license"] with NTN Communications,
Inc., an unrelated Delaware company, for exclusive representation of their
interactive communications for all industry sectors in Canada. This interactive
entertainment network allows viewers to participate actively with a variety of
television programs, trivia and sports games. Present subscribers to the
Company's networks are hotels, restaurants, bars and university clubs. Each
subscriber either purchases the system hardware directly or rents the system
from Interactive. Interactive purchases the subscriber system from NTN
Communications, Inc. and various other suppliers. Following the installation,
each subscriber pays a monthly fee to Interactive for the program content and
maintenance services, which ranges from $650 to $750. The monthly fees for
rental systems range from approximately $255 to $290. On July 2003, the Company
signed a letter of intent to sell certain assets of Interactive.
GalaVu is incorporated under the Ontario Business Corporations Act and
is a technology-based entertainment provider of interactive in-room
entertainment systems for small and mid-sized hotels. GalaVu's interactive
system is based upon proprietary technology and provides a suite of products
including movies on demand, premium television programming and other information
and entertainment services. Effective April 25, 2003, the Company sold GalaVu.
The Company's primary market to date has been Canada.
GOING CONCERN ASSUMPTION
The accompanying consolidated financial statements have been prepared in
conformity with accounting principles generally accepted in the United States of
America, which contemplate continuation of the Company as a going concern.
However, the Company has reported net losses of $30,751,537, $11,747,639 and
$2,323,621 for the years ended August 31, 2002, 2001 and 2000, respectively, and
has an accumulated deficit of $43,909,481 as of August 31, 2002. Also, the
Company has negative cash flows from operations for each of the years ended
August 31, 2002, 2001 and 2000. In addition, the Company has working capital
deficit of $17,960,854 and net asset deficit of $16,988,536 as of August 31,
2002. These factors raise substantial doubtful about the Company's ability to
continue as a going concern.
The Company cannot be certain that anticipated revenues from operations
will be sufficient to satisfy its ongoing capital requirements. Management's
belief is based on the Company's operating plan, which in turn is based on
assumptions that may prove to be incorrect. If the Company's financial resources
are insufficient, the Company may require additional financing in order to
execute its operating plan and continue as a going concern. The Company cannot
predict whether this additional financing will be in the form of equity, debt,
or another form. The Company may not be able to obtain the necessary additional
capital on a timely basis, on acceptable terms, or at all. In any of these
events, the Company may be unable to implement its current plans for expansion,
repay its debt obligations as they become due or respond to competitive
pressures, any of which circumstances would have a material adverse effect on
its business, prospects, financial condition and results of operations.
Should these financing sources fail to materialize, management would
seek alternate funding sources through sale of common and/or preferred stock.
The Company's business plans for 2004 contemplate obtaining additional working
capital through refinancings or restructurings of its existing loan agreements,
reducing operating overhead (which has already begun through workforce
consolidation), and sales of some of its existing subsidiaries including sale of
Galavu in April 2003 and NTN in December 2003. Management is of the opinion that
they will be able to obtain enough working capital and that, together with funds
provided by operations, there will be sufficient working capital for the
Company's requirements in the future. Through the acquisition of Logicorp Data
Systems Ltd. and Logicorp Service Group Ltd., the Company expects the revenue
for 2003 and 2004 to be substantially higher than that for 2002 and expects this
division will generate positive cash in 2004 and beyond.
F-8
2. ECONOMIC DEPENDENCE
Interactive is dependent upon NTN Communications, Inc. as its sole
supplier for the transmission of program content to the Company's subscribers.
In the event that NTN Communications, Inc., which operates under the
going-concern assumption, terminates the transmission of program content, the
Company believes, but cannot assure, that such services are likely to be
continued by others. As of September 30, 2002, NTN Communications, Inc. had
shareholders' equity of $1,869,000 and working capital of $1,700,000 according
to its unaudited balance sheet included in its quarterly report. NTN
Communications, Inc. has reported a quarterly net loss for the quarter ended
September 2002 of $689,000, a quarterly net loss for the quarter ended June 2002
of $898,000 and a quarterly net loss for the quarter ended March 2002 of
$166,000. It reported an unaudited net loss for the year ended December 31, 2001
of $3,656,000. All such amounts are quoted in US dollars. In December 2003, the
Company completed the sales of assets and liabilities of Interactive. During the
years ended August 31, 2002, 2001, and 2000, the Company paid commission of
$1,772,375, $1,865,974, and $1,822,684 to NTN Communications, Inc.
3. SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
These consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the United States of America.
They are expressed in Canadian dollars, which is the currency of the primary
economic environment in which operations are conducted.
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenue and expenses during the reporting period. Actual results could differ
from those estimates.
CONSOLIDATION POLICY
These consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries: Logicorp, CMCG, Interactive, GalaVu,
3484751 Canada Inc., Chell.com USA Inc., Magic and Interlynx. In December 2003,
the Company completed the sale of assets and liabilities of Interactive.
Effective April 25, 2003, the Company sold its wholly-owned subsidiary GalaVu.
Effective March 18, 2002, the Company sold Magic and its wholly-owned subsidiary
Tutorbuddy and its 75% ownership of STI for cash consideration of $1,850,000.
Effective June 30th 2001, the Company sold Interlynx, a wholly-owned subsidiary
of Interactive for $50,000 and a promissory note of $45,000. The Company's
consolidated financial statements have been restated to reflect Interactive,
GalaVu, Magic and Interlynx as discontinued operations for all periods
presented. The Company uses the equity method for investments in which it owns
less than 51% but over 20%.
All significant intercompany accounts and transactions have been eliminated.
REVENUE RECOGNITION
Revenue from product sales is recognized when the product is shipped to
customers. For maintenance contracts, revenue is recognized ratably over the
life of the related contract. Provisions for discounts to customers, estimated
returns and allowances and other price adjustments are provided for in the same
periods the related revenue is recorded. Outbound shipping charges to customers
are included in net sales.
Software sales are recognized in accordance with the American Institute
of Certified Public Accountants Statement of Position (SOP) 97-2, "Software
Revenue Recognition," as amended by SOP 98-9, "Modification of SOP 97-2,
SOFTWARE REVENUE RECOGNITION, With Respect to Certain Transactions." Pursuant to
SOP 97-2, software sales are recognized on sales contracts when all of the
following conditions are met: persuasive evidence of an agreement exists (e.g.,
a signed contract is
F-9
obtained), delivery has occurred, the total sales price is fixed or
determinable, collectability is probable, and any uncertainties with regard to
customer acceptance are insignificant. For those contracts that include a
combination of software and services, sales are allocated among the different
elements based on company-specific evidence of fair value of each element. Sales
allocated to software are recognized as the above criteria are met. Sales
allocated to services are recognized as services are performed and accepted by
the customer or, for maintenance agreements, ratably over the life of the
related contract.
Revenue for resale of software and technology equipment and service fee
is recognized based on guidance provided in Securities and Exchange Commission
(SEC) Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial
Statements," as amended, (SAB 101). Software and technology equipment resale
revenue is recognized when all of the components necessary to run software or
hardware have been shipped. Service revenues include maintenance fees for
providing system updates for software products, user documentation and technical
support and are recognized over the life of the contract. Other service
revenues, including training and consulting, are recognized as the services are
performed. The Company records an allowance for uncollectible accounts on a
customer-by-customer basis as appropriate.
DEFERRED REVENUE
Deferred Revenue is recorded when payments are received in advance of
the Company's performance in the underlying service agreement. Deferred revenue
is amortized ratably over the period in which the services are provided.
REBATES AND COOP FUNDS
The Company's wholly-owned subsidiary, Logicorp Data Systems Ltd.,
receives rebates and marketing campaign reimbursements ("coop funds") from
manufacturers based on sales volume and based on special pricing for its
customers. Rebates are classified as reduction of cost of sales, while coop
funds are classified as reductions of selling and marketing expenses. Such
expenses for each reporting period are summarized as follows for the period from
January 1, 2002 (effective date of the acquisition of Logicorp Data Systems
Ltd.) to August 31, 2002:
- --------------------------------------------------------------------------------
2002 2001 2000
================================================================================
Rebates 197,744 -- --
Coop Funds 277,278 -- --
- --------------------------------------------------------------------------------
Total 475,022 -- --
- --------------------------------------------------------------------------------
ADVERTISING
The Company expenses advertising, promotion, and marketing costs when
incurred. Such expenses are summarized as follows:
- --------------------------------------------------------------------------------
2002 2001 2000
================================================================================
Advertising 34,458 29,561 24,665
Promotion 63,344 64,424 65,504
Marketing 27,443 43,482 59,520
- --------------------------------------------------------------------------------
Total 125,245 137,467 149,689
- --------------------------------------------------------------------------------
COMPREHENSIVE INCOME
The Company's consolidated financial statements are reported in Canadian
dollars since the majority of its assets are located in Canada and majority of
its operations took place in Canada. Transactions for Chell Group Corporation,
the registrant, (excluding all the subsidiaries) are conducted in U.S. dollars
and all the related assets and liabilities are translated at exchange rates in
effect at the end of the year. Accounts for statements of operations of Chell
Group Corporation (excluding all the subsidiaries) are translated at weighted
average rates for the year. Gains and losses from translation of
F-10
foreign currency financial statements into Canadian dollars are included in
other comprehensive income (loss). The accumulated foreign currency translation
adjustment was $215,097 and $0, for the years ended August 31, 2002 and August
31, 2001, respectively.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash and term deposits, which mature
in less than three months from the date of issue. The carrying value of cash
equivalents approximates their fair values.
SHORT-TERM INVESTMENTS
Investments at August 31, 2001 consist of marketable equity securities.
The Company has classified its portfolio as "trading". Trading securities are
bought and held principally for the purpose of selling them in the near term and
are recorded at fair value. Unrealized gains and losses on trading securities
are included in the determination of net income (loss) for the year. The fair
value of these securities represents current quoted market offer prices.
CONCENTRATION OF CREDIT RISK
The Company generally extends credit to its customers, who are
concentrated in the government units and large corporations, and performs
ongoing credit evaluations of its customers. Typically, the Company does not
require collateral. The Company routinely reviews the collectability of its
accounts receivable and provides an allowance for potentially uncollectible
amounts and price adjustments. The Company's estimate is based on historical
collection experience and a review of the current status of trade accounts
receivable. It is reasonably possible that the Company's estimate of allowance
for doubtful accounts and price adjustments will change.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying value of accounts receivable, bank indebtedness, accounts
payable, accrued liabilities, long-term debt, and due to shareholders,
approximates fair value because of the near term maturity of these instruments.
USE OF ESTIMATES
The preparation of financial statements in conformity with U.S. GAAP
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities as of the date of the financial statements and the reported amounts
of revenues and expenses during the reporting period. The most significant
accounting estimates inherent in the preparation of our financial statements
include estimates as to the appropriate carrying value of certain assets and
liabilities which are not readily apparent from other sources, primarily
accounts receivable, inventory, property and equipment, intangible assets,
deferred revenue, rebates and coop fund and warranty costs. Actual results in
subsequent periods could differ from management's estimates.
BUSINESS ACQUISITION
Effective January 1, 2002, the Company acquired 100% of Logicorp Data
Systems Ltd. and Logicorp Service Group Ltd. The operating results of these
subsidiaries are included in the accompanying consolidated statements of
operations from the date of acquisition.
DISCONTINUED OPERATIONS
Discontinued operations for 2002 include the disposal loss of the sale
of Magic Lantern Communications ("Magic") which was sold on March 18, 2002. For
2001, it includes the disposal loss on the sale of Interlynx.
The discontinued operations also include the operating results of (1)
Magic from September 1, 2001 to March 18, 2002 the date Magic was sold; (2)
Galavu for the period from September 1, 2001 to August 31, 2002, and (3)
Interactive for the period from September 1, 2001 to August 31, 2002. Operating
results of the above mentioned subsidiaries for the years
F-11
ended August 31, 2002, 2001 and 2000 have been reported as discontinued
operations in the accompanying consolidated statements of operations.
IMPAIRMENT OF GOODWILL
Goodwill represents the excess of the purchase price of an acquired
enterprise or assets over the fair values of the identifiable assets acquired
and liabilities assumed. Commencing September 1, 2001, the Company no longer
amortizes goodwill, but tests for impairment of goodwill on an annual basis and
at any other time if events occur or circumstances indicate that the carrying
amount of goodwill may not be recoverable.
Circumstances that could trigger an impairment test include but are not
limited to: a significant adverse change in the business climate or legal
factors; an adverse action or assessment by a regulator; unanticipated
competition; loss of key personnel; the likelihood that a reporting unit or
significant portion of a reporting unit will be sold or otherwise disposed;
results of testing for recoverability of a significant asset group within a
reporting unit; and recognition of a goodwill impairment loss in the financial
statements of a subsidiary that is a component of a reporting unit.
Due to the substantial increase in operating loss and severe negative
cash flows of Logicorp Data Systems Ltd. and Logicorp Service Group Ltd. since
the acquisitions, the Company assessed the fair value of these reporting units
and determined that the carrying amount of the reporting unit goodwill exceeds
the implied fair value of that goodwill. Accordingly, an impairment loss of
$10,489,549 is recorded in accompanying consolidated statements of operations.
Measurement of the fair value of these reporting units is based on present value
techniques of estimated future cash flows.
WARRANTY COST
The Company does not provide any warranties on its products. Warranties
that are provided are the liability of the manufacturers.
INVENTORY
Inventory consists of finished goods held for sale or rent, which are
valued at the lower of cost, using the first-in, first-out method, or net
realizable value.
ACCOUNTS RECEIVABLE
The Company's division in the computer reselling business often adjusts
its product prices after the products are shipped due to price errors. The
Company estimates an allowance for price adjustments at the end of each
reporting period based on the historical price adjustment to its sales. In
addition, the Company estimates the allowance for doubtful accounts
periodically. The Company has $120,000 in allowance for doubtful accounts and
$40,000 in allowance for price adjustments as of August 31, 2002. No such
allowance was accrued prior to the acquisition of this division on January 1,
2002.
CHANGES IN THE ALLOWANCE FOR DOUBTFUL ACCOUNTS ARE AS FOLLOWS:
2002 2001
--------- ---------
Beginning balance $ 227,000 $ 178,000
Increase through acquisition
of Logicorp Data Systems 270,000 --
Provision for doubtful accounts (11,223) 166,500
Write-offs (218,477) (117,500)
Reclassification to discontinued
operations (107,300) (227,000)
--------- ---------
Ending balance $ 160,000 $ -0-
========= =========
F-12
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost less accumulated depreciation.
Depreciation and amortization of equipment are provided over the estimated
useful lives of 1 to 3 years using the straight-line method. Leasehold
improvements are amortized on a straight-line basis over the shorter of the
economic useful lives or the lease term. Buildings are amortized on a
straight-line basis over the economic useful lives of 25 years.
EVALUATION OF LONG-LIVED ASSETS
The Company requires long-lived assets to be held and used to be analyzed for
impairment whenever events or changes in circumstances indicate that the related
carrying amounts may not be recoverable. The Company evaluates at each balance
sheet date whether events and circumstances have occurred that indicated
possible impairment. If there are indications of impairment, the Company uses
future undiscounted cash flows of the related asset or asset grouping over the
remaining life in measuring whether the assets are recoverable. In the event
such cash flows are not expected to be sufficient to recover the recorded asset
values, the assets are written down to their estimated fair value. Long-lived
assets to be disposed of are reported at the lower of carrying amount or fair
value of the assets, less the costs to sell.
GOODWILL AND OTHER INTANGIBLE ASSETS
Effective September 1, 2001, we adopted SFAS 142, GOODWILL AND OTHER
INTANGIBLE ASSETS. SFAS 142 requires that goodwill and certain intangibles no
longer be amortized, but instead tested for impairment at least annually. Prior
to September 1, 2001, goodwill was stated at cost less accumulated amortization.
SFAS 142 requires that goodwill be tested for impairment at the
reporting unit level (operating segment or one level below an operating segment)
on an annual basis (Aug 31st for the Company) and between annual tests in
certain circumstances. Application of the goodwill impairment test requires
judgment, including the identification of reporting units, assigning assets and
liabilities to reporting units, assigning goodwill to reporting units, and
determining the fair value of each reporting unit. Significant judgments
required to estimate the fair value of reporting units include estimating future
cash flows, determining appropriate discount rates and other assumptions.
Changes in these estimates and assumptions could materially affect the
determination of fair value and/or goodwill impairment for each reporting unit.
On an ongoing basis, management reviews the valuation and amortization
of the licenses and goodwill, taking into consideration any events and
circumstances which might have impaired the fair value. The Company assumes
there is an impairment if the carrying amount is greater than the expected net
future cash flows. The amount of impairment, if any, is measured based on
projected discounted future cash flows, using a discount rate that reflects the
Company's average cost of funds.
There was an impairment of goodwill arising from the Logicorp purchase. This
impairment has been recorded in the fourth quarter of the year ended August 31,
2002.
OTHER ASSETS
Other assets includes legal cost related to debt financing which are
being amortized over the term of the convertible debt. Any remaining unamortized
costs at date of conversion will be netted against additional paid in capital.
INCOME TAXES
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities, and their respective tax
basis. Deferred tax assets, including tax loss and credit carry forwards, and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date. Deferred income tax expense represents the change during the
period in the deferred tax assets and deferred tax liabilities. The components
of the deferred tax assets and liabilities are individually classified as
current and non-current based on their characteristics. Realization of the
deferred tax asset is dependent upon generating sufficient taxable income in
future years. Deferred tax assets are reduced by a valuation allowance when, in
the opinion of management, it is more likely than not that some portion or all
of the deferred tax assets will not be realized.
F-13
LOSS PER SHARE
Basic loss per share is computed by dividing income available to common
shareholders by the weighted average number of common shares outstanding for the
period excluding contingent shares issued in accordance with SFAS No. 128,
EARNINGS PER SHARE. Diluted earnings per share are calculated in accordance with
the treasury stock method (which assumes that proceeds from the exercise of all
warrants and options are used to repurchase common stock at market value) and
are based on the weighted average number of common shares and dilutive common
share equivalents outstanding. The Company has outstanding options and warrants
of 1,543,840, 1,325,000 and 1,297,000 as of August 31, 2002, 2001 and 2000,
respectively. These options and warrants are not included in the calculation of
diluted loss per share as their effect is anti-dilutive.
STOCK-BASED COMPENSATION
The Company accounts for stock-based compensation in accordance with
Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued
to Employees," and complies with the disclosure provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation." Under APB No. 25, compensation cost
is recognized over the vesting period based on the excess, if any, on the date
of grant of the fair value of the Company's shares over the employee's exercise
price. When the exercise price of the option is less than the fair value price
of the underlying shares on the grant date, deferred stock compensation is
recognized and amortized to expense in accordance with Financial Accounting
Standards Board ("FASB") Interpretation No. 44, "Accounting for Certain
Transactions Involving Stock Compensation-an Interpretation of APB Opinion No.
25," over the vesting period of the individual options. Accordingly, if the
exercise price of the Company's employee options equals or exceeds the market
price of the underlying shares on the date of grant, no compensation expense is
recognized. Options or shares awards issued to non-employees are valued in
accordance with SFAS 123 using the Black-Scholes pricing model and expensed over
the period services are provided.
EMPLOYEE STOCK OPTIONS
The Company has adopted a Long-Term Incentive Plan [the "Plan"] designed
to compensate key employees of our Company for the performance of their
corporate responsibilities. The benefits to employees under the Plan are
dependent upon improvement in market value of the Company's common shares. The
Plan offers selected key employees the opportunity to purchase common shares
through the exercise of a stock option. An option entitles the employee to
purchase common shares from the Company at a price determined on the date the
option is granted. The option exercise price is the closing trading price of the
stock on the day prior to the grant date. The options vest over a four-year
period from the grant date, at the rate of 25% per year. Options granted prior
to August 31, 1998 vest over a two-year period from the grant date, 50% after
one year and 50% at the end of the second year. The options expire five years
after the grant date. The Plan also provides that selected key employees may
receive common shares as an award of Restricted Stock. Restricted Stock consists
of common shares that are awarded subject to certain conditions, such as
continued employment with the Company or an affiliate for a specified period. Up
to 20% of the outstanding common stock, on a fully diluted basis on the date of
the grant, excluding outstanding options may be issued under the Plan.
The following is a summary of outstanding stock options:
WEIGHTED AVERAGE TOTAL
EXERCISE PRICE
U.S. $ #
====================================================================
BALANCE AS AT AUGUST 31, 1999 719,000
Issued 9.42 772,000
Exercised 2.79 (68,500)
Expired 2.92 (125,500)
--------------------------------------------------------------------
BALANCE AS AT AUGUST 31, 2000 1,297,000
Issued 4.33 94,500
Exercised 2.68 (62,750)
Expired 2.40 (3,750)
--------------------------------------------------------------------
BALANCE AS AT AUGUST 31, 2001 1,325,000
Issued 0.95 1,731,215
Exercised 0.83 (186,188)
Expired 6.25 (1,326,187)
--------------------------------------------------------------------
BALANCE AS AT AUGUST 31, 2002 0.95 1,543,840
====================================================================
F-14
EXERCISE PRICE RANGES EXPIRATION DATE TOTAL
U.S. $ #
================================================================================
1.00 November 1, 2011 263,965
1.00 November 30, 2011 1,079,875
0.60 January 7, 2012 200,000
- --------------------------------------------------------------------------------
BALANCE AS AT AUGUST 31, 2002 1,543,840
================================================================================
The number of stock options that are exercisable at August 31, 2002,
2001 and 2000 is 959,906, 761,163 and 363,666, respectively.
The weighted average fair value of options granted was U.S. $0.936 during 2002,
$1.17 during 2001, and $1.58 during 2000.
The Company accounts for its stock option plans and its employee stock
purchase plan in accordance with the provisions of APB 25. Accordingly, because
the exercise price of the employee stock options equals the market price of the
underlying stock on the date of grant, no compensation expense has been
recognized in the consolidated financial statements for these plans.
Pro forma information regarding net income and earnings per share is
required by SFAS 123, and has been determined as if we had accounted for the
Company's employee stock options under the fair value method of that Statement.
The fair value for these options was estimated at the date of grant using a
Black-Scholes option valuation model with the following assumptions for 2002,
2001, and 2000: (a) risk-free interest rate of 5.09% for 2002, 5.39% for 2001
and 5.84% for 2000; dividend yield of 0% for 2002, 2001 and 2000; volatility
factor of 120.5% for 2002, 70.7% for 2001, and 84.8% for 2000; and a weighted
average expected life of the options of 3 years for 2002, 3 years for 2001 and 4
years for 2000.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options that have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because our stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of the Company's employee stock options.
Had compensation cost for these stock options been determined consistent
with SFAS No. 123, the Company's net loss and net loss per share would have been
increased to the following pro forma amounts:
2002 2001 2000
- --------------------------------------------------------------------------------
$ $ $
Net loss as reported (30,751,537) (11,747,639) (2,323,621)
================================================================================
Pro forma net loss (32,133,114) (13,000,844) (2,518,310)
================================================================================
Basic and diluted loss per share
as reported (3.11) (1.40) (0.81)
Proforma basic and diluted loss
per share (3.26) (1.49) (0.88)
================================================================================
F-15
RECLASSIFICATIONS
Certain 2001 and 2000 balances have been reclassified to conform to the
fiscal year 2002 presentation. These reclassifications had no effect on
previously reported results of operations or financial position.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In July 2001, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 141 "BUSINESS COMBINATIONS." SFAS No. 141 supersedes Accounting
Principles Board ("APB") Opinion No. 16, "BUSINESS COMBINATIONS," and requires
that any business combination initiated after June 30, 2001, be accounted for as
a purchase, therefore, eliminating the pooling-of-interest method defined in APB
No. 16. The statement was effective for any business combination initiated after
June 30, 2001, and must have been applied to all business combinations accounted
for by the purchase method for which the date of acquisition was July 1, 2001,
or later. The adoption of this statement did not have a material impact to the
Company's financial position or results of operations.
In October 2001, the FASB issued SFAS No. 143, "ACCOUNTING FOR ASSET
RETIREMENT OBLIGATIONS", which requires companies to record the fair value of a
liability for asset retirement obligations in the period in which they are
incurred. The statement applies to a company's legal obligations associated with
the retirement of a tangible long-lived asset that results from the acquisition,
construction, and development or through the normal operation of a long-lived
asset. When a liability is initially recorded, the company would capitalize the
cost, thereby increasing the carrying amount of the related asset. The
capitalized asset retirement cost is depreciated over the life of the respective
asset while the liability is accreted to its present value. Upon settlement of
the liability, the obligation is settled at its recorded amount or the Company
incurs a gain or loss. The statement is effective for fiscal years beginning
after June 30, 2002. The adoption of this statement is not expected to have a
material impact to the Company's financial position or results of operations.
In August 2001, the FASB issued SFAS No. 144, "ACCOUNTING FOR THE
IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF".
SFAS No. 144 addresses financial accounting and reporting for the impairment or
disposal of long-lived assets. SFAS No. 144 requires that long-lived assets be
reviewed for impairment whenever events or changes in circumstances indicate
that its carrying amount may not be recoverable and is measured by a comparison
of the carrying amount of an asset to undiscounted future net cash flows
expected to be generated by the asset. If the carrying amount of an asset
exceeds its estimated future undiscounted cash flows, an impairment charge is
recognized for the amount by which the carrying amount of the asset exceeds the
fair value of the asset. SFAS No. 144 requires companies to separately report
discontinued operations and extends that reporting to a component of an entity
that either has been disposed of (by sales, abandonment or in a distribution to
owners) or is classified as held for sale. Assets to be disposed of are reported
at the lower of the carrying amount or fair value less costs to sell. The
Company adopted SFAS No. 144 on September 1, 2002. The effects of the adoption
will be reflected in the consolidated financial statements for the year ended
August 31, 2003. For the year ended August 31, 2002, the Company has followed
the accounting and disclosure requirements of APB 30 "Reporting the Results of
Operations -- Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions," and
EITF 95-18.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." SFAS-145 eliminates the current requirement that gains and losses
on extinguishments of debt must be classified as extraordinary items in the
income statement. Instead, SFAS-145 requires that gains and losses on
extinguishments of debt be evaluated against the criteria in Accounting
Principles Board (APB) Opinion 30 to determine whether or not it should be
classified as an extraordinary item. If classification as an extraordinary item
is not appropriate, the gain or loss would be included as part of income from
operations. The Company adopted SFAS No. 145 on September 1, 2001 and reported
the loss of extinguishment of debt of $521,120 as loss from operations.
In June 2002, the FASB issued SFAS No. 146, "ACCOUNTING FOR COSTS
ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES". This Statement addresses financial
accounting and reporting for costs associated with exit or disposal activities
and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, "LIABILITY
RECOGNITION FOR CERTAIN EMPLOYEE TERMINATION BENEFITS AND OTHER COSTS TO EXIT AN
ACTIVITY (INCLUDING CERTAIN COSTS INCURRED IN A RESTRUCTURING)". The provisions
of this Statement are effective for exit or disposal activities that are
initiated after December 31, 2002, with early application encouraged. The
Company does not expect the adoption of SFAS 146 to have a material impact to
the Company's financial position or results of operations.
F-16
In December 2002, the FASB issued SFAS No. 148, "ACCOUNTING FOR
STOCK-BASED COMPENSATION - TRANSITION AND DISCLOSURE". SFAS 148 amends FASB
Statement No. 123, "ACCOUNTING FOR STOCK-BASED COMPENSATION", providing
alternative methods of transition for a voluntary change to the fair value based
method of accounting for stock-based employee compensation. SFAS 148 also amends
the disclosure provisions of SFAS 123 and Accounting Principles Board (APB)
Opinion No. 28, "INTERIM FINANCIAL REPORTING", to require prominent disclosures
in both annual and interim financial statements about the method of accounting
for stock-based employee compensation and the effect of the method used on
reported results. Amendments to SFAS 123 related to the transition and annual
disclosures are effective for fiscal years ending after December 15, 2002.
Amendments to disclosure requirements of APB Opinion 28 are effective for
interim periods beginning after December 15, 2002. The Company does not expect
the adoption of SFAS 148 will have a material impact on its financial position,
results of operations or cash flows.
In November 2002, FASB issued FASB Interpretation (FIN) No. 45,
"GUARANTOR'S ACCOUNTING AND DISCLOSURE REQUIREMENTS FOR GUARANTEES, INCLUDING
INDIRECT GUARANTEES OF INDEBTEDNESS OF OTHERS". FIN 45 requires that the
guarantor recognize, at the inception of certain guarantees, a liability for the
fair value of the obligation undertaken in issuing such guarantee. FIN 45 also
requires additional disclosure requirements about the guarantor's obligations
under certain guarantees that it has issued. The initial recognition and
measurement provisions of this interpretation are applicable on a prospective
basis to guarantees issued or modified after December 31, 2002 and the
disclosure requirements are effective for financial statement periods ending
after December 15, 2002. The Company adopted FIN No. 45 on September 1, 2002 and
did not expect the adoption of FIN 45 to have a material impact on the Company's
financial position, results of operations or cash flows.
In January 2003, FASB issued Interpretation No. 46, "CONSOLIDATION OF
VARIABLE INTEREST ENTITIES". FIN 46 changed the criteria by which one company
includes another entity in its consolidated financial statements. Previously,
the criteria were based on control through voting interest. FIN 46 requires a
variable interest entity to be consolidated by a company if that company is
subject to a majority of the risk of loss from the variable interest entity's
activities or entitled to receive a majority of the entity's residual returns or
both. A company that consolidates a variable interest entity is called the
primary beneficiary of that entity. The consolidation requirements of FIN 46
apply immediately to variable interest entities created after January 31, 2003.
The consolidation requirements apply to older entities in the first fiscal year
or interim period beginning after June 15, 2003. Certain of the disclosure
requirements apply in all financial statements issued after January 31, 2003,
regardless of when the variable interest entity was established. During October
2003, the FASB deferred the effective date for applying the provisions of FIN 46
until the end of the first interim or annual period ending after December 31,
2003, if the variable interest was created prior to February 1, 2003 and the
public entity has not issued financial statements reporting such variable
interest entity in accordance with FIN 46. On December 24, 2003, the FASB issued
FASB Interpretation No. 46 (Revised December 2003), CONSOLIDATION OF VARIABLE
INTEREST ENTITIES, (FIN-46R), primarily to clarify the required accounting for
interests in variable interest entities. FIN-46R replaces FIN-46 that was issued
in January 2003. FIN-46R exempts certain entities from its requirements and
provides for special effective dates for entities that have fully or partially
applied FIN-46 as of December 24, 2003. In certain situations, entities have the
option of applying or continuing to apply FIN-46 for a short period of time
before applying FIN-46R. While FIN-46R modifies or clarifies various provisions
of FIN-46, it also incorporates many FASB Staff Positions previously issued by
the FASB. Management is currently assessing the impact, if any, FIN 46 may have
on the Company; however, management of the Company does not anticipate the
adoption will have a material impact to the Company's financial position or
results of operations.
In April 2003, FASB issued SFAS No. 149, "AMENDMENT OF STATEMENT 133 ON
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES". This Statement amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts
(collectively referred to as derivatives) and for hedging activities under SFAS
No. 133, "ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES" and is
effective for contracts entered into or modified after June 30, 2003. This
Statement amends Statement 133 for decisions made (i) as part of the Derivatives
Implementation Group process that effectively required amendments to Statement
133, (ii) in connection with other FASB projects dealing with financial
instruments, and (3) in connection with implementation issues raised in relation
to the application of the definition of a derivative, in particular, the meaning
of an initial net investment that is smaller than would be required for other
types of contracts that would be expected to have a similar response to changes
in market factors, the meaning of underlying, and the characteristics of a
derivative that contains financing components. The Company does not anticipate
that the adoption of this pronouncement will have a material effect on the
financial statements.
In May 2003, FASB issued SFAS No. 150, "ACCOUNTING FOR CERTAIN FINANCIAL
INSTRUMENTS WITH CHARACTERISTICS OF BOTH LIABILITIES AND EQUITY". This Statement
establishes standards for how an issuer classifies and measures certain
financial
F-17
instruments with characteristics of both liabilities and equity, and is
effective for financial instruments entered into or modified after May 31, 2003,
and otherwise is effective at the beginning of the first interim period
beginning after June 15, 2003. SFAS 150 requires that an issuer classify a
financial instrument that is within its scope as a liability (or an asset in
some circumstances). Many of those instruments were previously classified as
equity. Some of the provisions of this Statement are consistent with the current
definition of liabilities in FASB Concepts Statement No. 6, "ELEMENTS OF
FINANCIAL STATEMENTS". The remaining provisions of this Statement are consistent
with FASB's proposal to revise that definition to encompass certain obligations
that a reporting entity can or must settle by issuing its own equity shares,
depending on the nature of the relationship established between the holder and
the issuer. While FASB still plans to revise that definition through an
amendment to Concepts Statement 6, FASB decided to defer issuing that amendment
until it has concluded its deliberations on the next phase of this project. That
next phase will deal with certain compound financial instruments including
puttable shares, convertible bonds, and dual-indexed financial instruments. The
Company does not anticipate that the adoption of this pronouncement will have a
material effect on the financial statements.
In December 2003, the FASB issued a revised SFAS No. 132, "Employers'
Disclosures about Pensions and Other Postretirement Benefits" which replaces the
previously issued Statement. The revised Statement increases the existing
disclosures for defined benefit pension plans and other defined benefit
postretirement plans. However, it does not change the measurement or recognition
of those plans as required under SFAS No. 87, "Employers' Accounting for
Pensions," SFAS No. 88, "Employers' Accounting for Settlements and Curtailments
of Defined Benefit Pension Plans and for Termination Benefits," and SFAS No.
106, "Employers' Accounting for Postretirement Benefits Other Than Pensions."
Specifically, the revised Statement requires companies to provide additional
disclosures about pension plan assets, benefit obligations, cash flows, and
benefit costs of defined benefit pension plans and other defined benefit
postretirement plans. Also, companies are required to provide a breakdown of
plan assets by category, such as debt, equity and real estate, and to provide
certain expected rates of return and target allocation percentages for these
asset categories. The adoption of this pronouncement is not expected to have a
material impact to the Company's financial statements.
4. DISCONTINUED OPERATIONS
SALE OF GALAVU
Pursuant to a Share Purchase Agreement dated 25th day of April, 2003,
the Company, sold to DVOD Networks Inc., an Ontario corporation ("DVOD"), all of
the issued and outstanding shares of capital stock of GalaVu Entertainment
Network Inc., a technology-based entertainment provider ("GalaVu") for $1.00
(Canadian). Concurrently, the Company assigned to DVOD or caused its
subsidiaries to assign to DVOD, for $2.00 (Canadian) promissory notes and other
receivables of GalaVu of the Company or its subsidiaries in the aggregate amount
of $1,672,608 (Canadian). At the same time 488605 Ontario Limited, a
non-affiliated Canadian corporation ("488605") and Ruth Margel (one of the note
holders, an unrelated party) assigned a note payable by GalaVu in the principal
amount of $375,000 (Canadian) to DVOD in return for $170,000 (Canadian) paid by
DVOD and a new note in the amount of $325,000 (Canadian) payable by 3484751
Canada Inc., a Canadian corporation and subsidiary of the Company, which such
new note was issued to reflect additional advances made by 488605 and Ruth
Margel to the Company or subsidiaries of the Company in the past. There have
been no defaults on this agreement. GalaVu is reported as part of the
discontinued business segment (previously entertainment segment).
The following is a listing of the major classes of assets and liabilities of
GalaVu as of August 31, 2002 and 2001 (presented as net with Interactive on
consolidated balance sheet):
----------------------------------------------------------------------
GALAVU: 2002 2001
----------------------------------------------------------------------
Accounts receivable $ 583,837 $ 223,261
Fixed assets 2,211,894 2,999,173
Other current assets 69,186 93,433
Current liabilities 1,178,379 197,917
Long-term debt 2,353,157 2,662,698
Net assets (liabilities) $ (666,619) $ 455,252
----------------------------------------------------------------------
F-18
Summarized operating results of GalaVu's discontinued operations are as follows:
- --------------------------------------------------------------------------------
Year Ended Year Ended Year Ended
August 31, August 31, August 31,
2002 2001 2000
================================================================================
Sales $ 5,564,277 $ 2,937,189 $ 2,764,160
Net loss from discontinued
operations, net of tax (1,516,355) (602,293) 7,261
Loss on disposal of discontinued
operations, net of tax -- -- --
- --------------------------------------------------------------------------------
SALE OF INTERACTIVE
Pursuant to an Asset purchase agreement dated the 15th day of December,
2003, the Company sold to NTN Communications, Inc. (Amex: NTN) the assets and
certain liabilities of NTN Interactive Network, Inc. The Company sold NTN
Interactive Network's assets for approximately USD$1.5 million. The
consideration was composed of USD$250,000 in cash, USD$650,000 in shares of
unregistered NTN common stock (approximately 238,000 shares valued at the
closing market price on the date of sale which was $2.73 per share). The Company
intends to hold the shares of NTN for an indeterminate period of time, no less
than the required time for Rule 144 restrictions to be removed. The remainder
was based upon the application of unpaid licensing payables (approximating
$700,000) owed to NTN Communications, Inc., at the closing of the transaction.
The Company is following the guidance in APB 30, "Reporting the Results of
Operations-Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual, and Infrequently Occurring Events and Transactions," and
EITF 95-18 "Accounting and Reporting for a Discontinued Business Segment When
the Measurement Date Occurs After the Balance Sheet Date but Before the Issuance
of Financial Statements". Following the guidance in these pronouncements, the
Company will be recording the loss on the sale of Interactive in fiscal 2003 as
all of the conditions that arose for the sale to take place did not occur until
after the 2002 fiscal year end. Interactive is reported as part of the
discontinued business segment (previously entertainment segment).
The following is a listing of the major classes of assets and liabilities of
Interactive as of August 31, 2002 and 2001 (presented as net with Interactive on
consolidated balance sheet):
-----------------------------------------------------------------
INTERACTIVE: 2002 2001
-----------------------------------------------------------------
Accounts receivable $ 338,394 $ 166,700
Fixed assets 464, 348 772,738
Other current assets 335,743 216,718
Intangible assets 130, 509 192,460
Current liabilities 1,011,348 896,082
-----------------------------------------
-----------------------------------------
Net assets $ 257,646 $ 452,534
-----------------------------------------
-----------------------------------------------------------------
Summarized operating results of Interactive discontinued operations are as
follows:
- --------------------------------------------------------------------------------
Year Ended Year Ended Year Ended
August 31, August 31, August 31,
2002 2001 2000
================================================================================
Sales $4,613,673 $2,386,401 $ 2,390,671
Net income from discontinued
operations, net of tax $1,021,845 $609,366 $711,612
Loss on disposal of discontinued
operations, net of tax -- -- --
- --------------------------------------------------------------------------------
F-19
SALE OF MAGIC LANTERN COMMUNICATIONS LTD. ("MAGIC")
Effective March 18, 2002, the Company completed this sale for cash
consideration of $1,850,000. Summarized operating results of Magic's
discontinued operations are as follows:
- --------------------------------------------------------------------------------
Year Ended Year Ended Year Ended
August 31, August 31, August 31,
2002 2001 2000
================================================================================
Sales $ 1,621,287 $4,616,992 $4,971,823
Net loss from discontinued
operations, net of tax (1,216,139) (511,143) (817,176)
Loss on disposal of discontinued
operations, net of tax $ (305,901) -- --
- --------------------------------------------------------------------------------
The Company's financial statements have been restated to reflect Magic as a
discontinued operation for all periods presented.
SALE OF INTERLYNX MULTIMEDIA INC. ("INTERLYNX")
During fiscal 2001, the Company sold Interlynx for cash consideration of
$50,000 and a $45,000 promissory note receivable.
Summarized operating results of Interlynx discontinued operations are as
follows:
- --------------------------------------------------------------------------------
Year Ended Year Ended Year Ended
August 31, August 31, August 31,
2002 2001 2000
================================================================================
Sales N/A 313,555 586,756
Net loss from discontinued
operations, net of tax N/A (665,673) (857,416)
Loss on disposal of discontinued
operations, net of tax N/A (937,711) --
- --------------------------------------------------------------------------------
The Company's financial statements have been restated to reflect Interlynx as a
discontinued operation for all periods presented.
5. SHORT-TERM INVESTMENTS
Short-term investments consist of the following:
2002 2001
$ $
- --------------------------------------------------------------------------------
Common shares in Stardrive Solutions, Inc. -- 19,676
- --------------------------------------------------------------------------------
-- 19,676
================================================================================
The Company was not a significant shareholder in Stardrive. During the year
ended August 31, 2002, the Company sold the investment as the Company was no
longer targeting Stardrive for acquisition.
F-20
6. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
2002 2001
====================================== =====================================
COST ACCUMULATED NET BOOK Cost Accumulated Net book
DEPRECIATION VALUE depreciation value
$ $ $ $ $ $
- -------------------------------------------------------------------------------------------------------
Land 785,500 -- 785,500 503,500 -- 503,500
Buildings 1,396,963 206,151 1,190,812 824,633 161,719 662,914
Equipment 1,094,650 713,963 380,687 409,734 107,456 302,278
Software 335,900 231,946 103,954 58,477 19,492 38,985
Automobiles 23,300 21,055 2,245 -- -- --
Computer Equipment 1,856,983 1,400,393 456,590 464,987 155,055 309,932
Leasehold improvements 1,149,693 608,718 540,975 894,302 178,417 715,885
- -------------------------------------------------------------------------------------------------------
6,642,989 3,182,226 3,460,763 3,155,633 622,139 2,533,494
=======================================================================================================
Depreciation of property and equipment was $1,019,396 for 2002, $586,957 for
2001, and $38,514 for 2000.
7. INCOME TAXES
The provision for income taxes consists of the following:
2002 2001 2000
$ $ $
- --------------------------------------------------------------------------------
Current
FEDERAL -- -- --
PROVINCIAL -- -- --
- --------------------------------------------------------------------------------
-- -- --
================================================================================
The difference between the provision for income taxes and the amount
computed by applying the combined basic federal and provincial income tax rate
of 39.3% for 2002, 42.1% for 2001, and 43.9% for 2000 to income before income
taxes is as set out below:
2002 2001 2000
Taxes on continuing operations $ $ $
- ----------------------------------------------------------------------------------------------------
STATUTORY RATE APPLIED TO LOSS FROM CONTINUING OPERATIONS (12,492,253) (4,051,216) (509,125)
Benefit of current year's losses not recognized (change
in valuation allowance) 12,279,176 3,734,669 405,563
Expenses not deductible for tax purposes 213,077 316,547 117,745
Other -- -- (14,183)
- ----------------------------------------------------------------------------------------------------
-- -- --
====================================================================================================
2002 2001 2000
Taxes on discontinued operations $ $ $
- -----------------------------------------------------------------------------------------------------
STATUTORY RATE APPLIED TO LOSS FROM DISCONTINUED OPERATIONS (792,186) (675,025) (376,406)
Loss of subsidiary sold during the year (672,285) (539,922) --
Capital loss on sale of subsidiary 119,901 1,064,133 --
Benefit of current year's losses not recognized (change in
valuation allowance) 1,344,570 150,814 376,406
- -----------------------------------------------------------------------------------------------------
-- -- --
=====================================================================================================
F-21
For the years ended August 31, 2002, 2001, and 2000, the Company
incurred net operating losses and, accordingly, no provision for income taxes
has been recorded. In addition, no benefit for income taxes has been recorded
due to the uncertainty of the realization of any tax assets.
As at August 31, 2002, the Company's deferred tax assets primarily
relating to the benefit of realizing losses available for carry forward and the
timing difference of the write-off of property and equipment, net of a full
valuation allowance of $16,750,000, was nil. As at August 31, 2001, the
Company's deferred tax assets primarily relating to the benefit of realizing
losses available for carry forward and the timing difference of the write-off of
property and equipment, net of a full valuation allowance of $5,600,000, was
nil. Based on the available objective evidence, including the Company's history
of losses, management believes it is more likely than not that the net deferred
tax assets will not be fully realizable. Accordingly, the Company provided for a
full valuation allowance against its net deferred tax assets at August 31, 2002
and 2001.
At August 31, 2002, the Company and certain subsidiaries have
non-capital loss carry forwards of approximately $30,000,000 that can be carried
forward against future taxable income and capital losses of approximately
$2,800,000 that can be carried forward indefinitely against capital gains
realized in future years. The non-capital losses began to expire in 2002.
8. LOANS AND NOTES PAYABLE/ BANK INDEBTEDNESS
Loans and notes payable consist of the following:
2002 2001
$ $
- --------------------------------------------------------------------------------
BANK INDEBTEDNESS 2,990,914 --
- --------------------------------------------------------------------------------
2,990,914 --
- --------------------------------------------------------------------------------
LOANS PAYABLE
- --------------------------------------------------------------------------------
Short-term note payable [v] -- 2,280,000
- --------------------------------------------------------------------------------
Convertible promissory notes [iv] 6,587,622 --
- --------------------------------------------------------------------------------
6,587,622 2,280,000
- --------------------------------------------------------------------------------
LONG TERM DEBT:
Term Loan [ia] 232,506 --
HP Loan [ii] 212,291 --
Royal Bank of Canada [x] -- 1,206,478
Bank of Montreal [iii] 1,166,667 --
Debenture & Note Payable [v & vi] 1,360,311 1,250,233
RCA Trusts [vii] 1,427,676 --
Term loan [viii] 49,278 --
- --------------------------------------------------------------------------------
4,448,729 2,456,711
LESS CURRENT PORTION 1,534,073 39,323
- --------------------------------------------------------------------------------
LONG TERM DEBT LESS NON CURRENT 2,914,656 2,417,388
- --------------------------------------------------------------------------------
[i] The bank indebtedness consists of debts from the following entities:
--------------------------------------------------------
Company Amount
========================================================
Logicorp Data Systems Ltd. ("LDS") [a] 2,872,850
eTelligent Solutions Inc. 118,064
--------------------------------------------------------
2,990,914
========================================================
[a] In March 2001, LDS Logicorp Data Solutions entered into
a line of credit agreement with HSBC Bank of Canada. Bank advances are
payable on demand. The loan agreement covers (i) a demand revolving
operating loan up to $3,000,000; (ii) equipment loan up to $300,000;
(iii) demand Evergreen Capital loan/lease
F-22
facility up to $300,000; and (iv) loan on forward exchange contracts up
to $500,000. The operating loan carries an interest rate of 0.82% over
the prime rate while the equipment and Evergreen Capital loans carry an
interest rate equal to, at the option of the Company, (a) 1.05% over the
prime rate at the end of each month; or (b) a fixed rate agreed to by
both the Bank and the Company. Under the terms of the agreement, the
Company can borrow, under the operating loan and 31% of the forward
exchange contracts outstanding, up to an aggregate of (i) 70% of
acceptable accounts receivable and (ii) 50% of the lesser of cost or
current market value of its inventory not to exceed $750,000. The
effective rate at August 31, 2002 was 4.32%. Borrowings under the line
are subject to certain financial covenants and restrictions on
additional indebtedness and other related items. As of August 31, 2002,
the Company is in violation of maximum debt to net worth and minimum
working capital covenants. The loans are secured by the assets of the
Company under a general security agreement, and are guaranteed by the
Logicorp Service Group Ltd., through a security agreement and are also
personally guaranteed by the former shareholders of LDS. Under the terms
of the line of credit agreement, the bank may declare all outstanding
amounts immediately due and payable. The Bank has not called the loan. A
forbearance agreement was signed that expired in October 2003. The
Company anticipates signing a new forbearance agreement that will extend
to July 31, 2004.
On January 22, 2002, Mr. Chell guaranteed liabilities of Logicorp to its
principal lender, HSBC, in the amount of Cdn$1.0 million. On December
24, 2002, Mr. Chell guaranteed trade credit of Logicorp to Synnex in the
amount of approximately Cd. $1.0 million. On January 7, 2003, the board
determined that the Company would grant 3.5 million shares of common
stock to Mr. Chell for such guarantees and other consideration in
support of the Company. See "Management's Discussion and Analysis of
Financial Condition and Results of Operation" for a description of the
loans.
[ii] LDS agreed to pay $212, 291 payable to HP in regards to the settlement
of claims (NOTE 20[c]). The loan is payable in monthly installments of $4,423
due on the first day of every month, commencing on May 1, 2003 through April
2007 carrying an interest rate of 0%. This liability has been recorded at its
full settlement value since calculation of imputed interest is considered
immaterial to the accompanying consolidated financial statements.
[iii] In November 2001, the Bank of Montreal made available to the Company a
Demand loan, non-revolving and/or Fixed Rate Term Loan in the amount of
$1,250,000. The loan was for payment of the Matched Fund Term Loan held in the
prior year by The Royal Bank of Canada for properties at 10 Meteor Drive and 775
Pacific Road. Borrowings are repayable by blended monthly principal payments of
$10,417 and interest based on 10-year term which matures in December 2011.
Interest is currently calculated at Prime Rate plus 1.25%. The effective rate at
August 31, 2002 was 5.75%. The Company may convert the Demand loan,
non-revolving advances in part or in total to a Fixed Rate Term Loan advances,
and may be converted back to Demand loan, non-revolving at maturity of terms.
Fixed Rate Term Loan rates are to be determined based on applicable rates at
time of draw and the available terms are from 1 to 5 years. The loan is secured
by accounts receivables, inventory and equipment of Interactive and Galavu under
a general security agreement. The Demand loan is subject to certain financial
covenants and restrictions on additional indebtedness and other related items.
[iv] On December 1, 2001, the Company offered to certain investors 8%
convertible notes up to a maximum amount of US$8,000,000 in a private placement.
The Company received approximately Cdn$6,587,622 through this offering. Under
the terms of this offering, the notes are convertible into shares of common
stock at a price of the greater of (1) 50% of the average closing bid prices for
the ten trading days prior to conversion or (2) US$0.50. These notes were due
August 9, 2002. On April 9, 2002 all of the holders of the notes signed
commitments to voluntarily convert the notes based on the conversion price per
the terms of the agreement, which was determined to be US$0.95 per share. This
conversion was subject to shareholder approval. The conversion of these notes
would have resulted in the issuance of approximately 4,389,000 shares
representing approximately 20% of the total common shares outstanding after the
issuance, and diluting the current common stockholders. As of August 31, 2002,
none of these shares has been issued and the outstanding amount of the
convertible notes was classified as liabilities. As of December 2, 2002, the
Company, Joseph Gunnar & Co., LLC ("JGUN"), the placement agent in this
offering, and the holders of these notes entered into a settlement agreement
providing that the conversion price for these notes shall equal 85% of the two
day weighted average trading price of the common stock for the five trading days
preceeding effective date of the registration statement under the Securities Act
of 1933, as amended, relating to the resale of the shares of common stock
issuable upon such conversion, provided, that such conversion price cannot be
greater than $0.75 or less than $0.40. Effective January 7, 2003, the Company,
JGUN, Cameron Chell and the holders of the notes agreed that if this
registration statement is not declared effective on or prior to September 1,
2003, the noteholders could "put" their shares of common stock to Mr. Chell at a
price of $0.475 per share during the period of December 1-14, 2003. At April 30,
2004, such registration statement has not beem filed. By letter dated December
4, 2003, the noteholders agreed to permit the Company until February 28, 2004 to
file all required filing and periodic reports under the Securities Exchange Act
of 1934, as amended, and to amend the period during which they may "put" their
shares issuable upon such conversion to Mr. Chell from December 1-14, 2003, to
March 1-14, 2004, in exchange for the extension of the "put" period and the
reduction of the conversion price to $0.25 per share, provided, that, if such
deadline was not satisfied by the Company such agreement and reduction of the
conversion price would be null and void. By letter, dated February 26, 2004,
this deadline and the "put" period was amended to be April 30, 2004 and MAy
1-14, 2004, respectively. By letter, dated April 29, 2004, the Company requested
that such deadline and "put" period be further amended to be May 30, 2004 and
June 1-14, 2004, respectively. The Company believes that, as these notes have
been held by the noteholders for an excess of two years, and none of such
noteholders are or have been affiliates of the Company during the preceeding 90
days, the notes may be converted (at any time and the shares of common stock
issuable upon such conversion could be resold pursuant to Rule 144(k), and,
provided that the Company files all filings and periodic reports under the
Securities Exchange Act prior to May 31, 2004, these notes shall be manditorily
converted into shares of common stock. In the event that the notes should be
converted into shares of common stock at the conversion price of $0.25 per
share, the aggregate number of shares of common stock issued upon such
conversion would be approximately 16,640,000, representing approximately 54% of
the common stock outstanding giving effect to such conversion. One noteholder
has indicated to the Company that it believes that it has a cause of action
against the Company with respect to the foregoing and its rights under such
notes, and has threatened to bring such action against the Company. In the event
that the Company should be found to be in default of the notes or the related
agreements, the Company may be required to repay the notes in the event that a
settlement is not reached with the noteholders. In such event the Company does
not believe that it currently has the necessary capital available to repay the
notes and would be required to seek additional sources of capital or seek
protection from creditors. See "Managements Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital Resources."
In addition, since this debt is convertible into equity at the option of
the note holder at beneficial conversion rates, an embedded beneficial
conversion feature was recorded as a debt discount and will be amortized using
the effective interest rate method over the life of the debt in accordance with
EITF 00-27, "APPLICATION OF ISSUE NO. 98-5 TO CERTAIN CONVERTIBLE INSTRUMENTS."
Total cost of beneficial conversion feature of Canadian $6,177,647 is recorded
as a discount of the convertible debt which is fully amortized during the year
ended August 31, 2002.
[v] On January 15, 2001, the Company received US$1,500,000 (approximately
Cnd$2,280,000) in return for a promissory note. The note bears interest at 2%
per month and US$1,000,000 of the principal and accrued interest was due and
payable on December 5, 2001. Effective May 6, 2002, the remaining principal and
interest expense was converted to 725,952 common shares of the Company' stock. A
beneficial conversion and interest expense was calculated as of the date of the
agreement to convert the notes to common shares, as the difference between the
conversion price and the fair value of the common stock into which the notes are
convertible. The Company recognized a loss on extinguishment of debt and
corresponding additional paid in capital in the amount of approximately
$521,120. During the year ended August 31, 2002,
F-23
the Company recorded interest of $522,564, made cash payments of $1,520,000 and
settled the remaining balance of $1,282,564 with 725,952 shares of the Company's
common stock. The Company authorized the settlement of the debt at $1.16 per
share on May 1, 2002 while the quoted market price of the common stock was $1.62
with a discount of approximately $521,120 which is classified as loss on
extinguishment of debt. As of August 31, 2002 and 2001, the outstanding balance
of the note was $0 and $2,280,000, respectively.
[vi] On October 3, 2000, the Company closed the sale of a US$3,000,000
(approximately Canadian $4,740,000) Convertible 10% Debenture to the VC
Advantage Limited Partnership ("VCALP"). As at August 31, 2001, US$1,700,000
(approximately Canadian $2,635,000) has been advanced to the Company. This
unsecured convertible debenture is due three years from issue. The Convertible
Debenture bears interest at 10% per annum, payable upon conversion, redemption
or maturity. The unpaid principal of the debenture bears interest from the date
that it is actually advanced until paid. Interest is payable in cash or stock at
our option. The Convertible Debenture is convertible into common stock, at
US$3.00 per share, in amounts specified by the VCALP. The maximum number of
common shares VCALP will receive is one million. On the close date, the Company
also issued 50,000 warrants to purchase 50,000 common shares at US$3.00 per
share to VCALP. The warrants have a term of four years. The fair value of these
warrants totaling approximately $220,000 was computed using the Black-Scholes
model under the following assumptions: (1) expected life of 1 1/2 years; (2)
volatility of 80% (3) risk free interest of 5.87% and (4) dividend of 0%. This
convertible debt matured in October 2003. The Company can elect to pay the
outstanding loan balance in shares of common stock at a fixed conversion price
of US$3.00 per share. In addition, since this debt is convertible into equity at
the option of the note holder at beneficial conversion rates, an embedded
beneficial conversion feature was recorded as a debt discount and will be
amortized using the effective interest rate method over the life of the debt in
accordance with EITF 00-27. Total cost of beneficial conversion feature of
$1,728,134 and the relative fair value of the warrants of $220,000 are recorded
as a discount of the convertible debentures. During the year ended August 31,
2001, the Company amortized $563,367 as interest expense. As of August 31, 2001,
the outstanding balance of this debt net of unamortized discount totaled
$1,250,233.
On November 30, 2000 the convertible debenture was assigned by VCALP to
CALP II Limited Partnership.
During the 2002 Third Fiscal Quarter, the convertible debenture held by
CALP II Limited Partnership ("CALP II") on behalf of Canadian Advantage Limited
Partnership ("CALP") and Advantage (Bermuda) Fund Ltd. ("ABFL") was exchanged
for a note payable to CALP in the amount of US$1,365,100 and a note payable to
ABFL in the amount of US$504,900. These notes provide for payment of principal
and interest at the rate of 10% per annum on August 31, 2006. The notes are
secured by a general security agreement against the assets of the Company in
priority to all other claims subject to the existing security of the Bank of
Montreal and the Canadian Imperial Bank of Commerce ("CIBC").
Effective April 15, 2002, the Company entered into an agreement with
CALP to convert the principal amount of the note plus accrued interest into
Common Stock at the rate of US$0.80 pursuant to which CALP received 1,314,000
shares of the Company. CALP will receive an additional 442,145 shares upon the
approval of the Company's shareholders.
Effective April 15, 2002, the Company also entered into an agreement
with ABFL to convert the principal amount of the note plus accrued interest into
Common Stock at the rate of US$0.80 pursuant to which ABFL received 486,000
shares of the Company. ABFL will receive an additional 163,533 shares upon the
approval of the Company's shareholders.
Certain terms of the convertible debt have been changed including the
fixed conversion price reduced from $3 to $0.80. During the year ended August
31, 2002, the Company recorded additional discount of $677,216 and amortized
$787,294. As of August 31, 2002, outstanding balance of this debt net of
unamortized discount totaled $1,360,311.
The conversion of the debt has been approved and the debt will be
converted from debt to equity upon the filling of the registration statement and
issuance of the shares.
[vii] The retirement compensation trusts were set up pursuant to section
248(1) of the Income Tax Act of Canada to provide retirement income to the three
individuals who owned Logicorp. Pursuant to the original and amended purchase
agreements of Logicorp, the Company will make monthly payments including
interest in various amounts through December 2005. The loan carries an interest
rate of prime plus 4.75% (8.75% at August 31, 2002).
F-24
[viii] The Term loan is comprised of the following:
[a] Loan bearing interest at Prime plus 1.25% per annum, repayable
in monthly principal installments of $6,643 together with interest. Loan is due
July 31, 2005. Outstanding balance of this loan totaled $38,050 as of August 31,
2002.
[b] Small Business Equipment Loans bearing interest at Prime plus
2.25% per annum. Outstanding balance of this loan totaled $11,228 as of August
31, 2002.
Approximate future annual principal payments for long-term debt, exclusive of
the above bank indebtedness, are as follows:
--------------------------------------------------
Years ended August 31,
2003 $ 450,739
2004 2,378,634
2005 656,266
2006 254,755
2007 125,000
Thereafter 583,335
--------------------------------------------------
4,448,729
==================================================
[ix] Other loans
In May 2002, the Company did a private financing raise in the amount of
US$290,000 ($443,189). Since the shares have not been issued the raise has been
placed as a note payable. Upon the issuance of the Company's shares, the note
will be converted from debt to equity. Per the agreement with the private
investors, the Company agreed to sell the share of its common stock at $1 per
share which results in issuance of 290,000 shares of common stock in relation to
this private financing. As of December 29, 2003, the Company has not yet issued
these shares to the private investors.
[x] In April 1998, the Royal Bank of Canada made available a Matched Fund
Term Loan in the amount of $1,319,000 in order to finance the purchase of 10
Meteor Drive, including leaseholds, and to refinance the demand installment loan
on 775 Pacific Road, a property owned by Magic. Borrowings are repayable by
blended monthly payments of principal and interest based on a 20-year
amortization period with the balance due and payable at the end of the 5-year
term on April 7, 2003. The interest rate in effect for the first 5-year term of
the loan is 6.98%. The fair value of the loan approximates its carrying value.
The loan is collateralized by a fixed debenture of $1,000,000, hypothecated to
Magic's land and buildings, a guarantee and postponement of claim of $650,000
signed by Magic, a collateral first mortgage in the amount of $490,000 covering
the property at 10 Meteor Drive, and a general security agreement covering all
the assets of Interactive, other than real property.
During the year ended August 31, 2002, the Company paid off this debt. At August
31, 2001, $1,206,478 was outstanding under this loan agreement.
9. COMMITMENTS
[a] Commissions expense to NTN Communications, Inc.
Pursuant to an agreement dated March 23, 1990, Interactive pays
commissions to NTN Communications, Inc. when the related revenues are earned at
the rate of U.S. $2,205 per year per subscriber. Interactive also pays NTN
Communications, Inc. a royalty fee equal to 25% of the net revenues as defined
in the agreement derived from all services except for certain hospitality and
special projects that existed at March 23, 1990; a royalty fee equal to the
production quotation submitted by NTN Communications, Inc. plus 10% of the gross
profit of special projects [special broadcasts for a non-continuous selective
event]; and a one-time royalty fee equal to NTN Communications, Inc.'s
production costs for any new programming developed by Interactive to be added to
the existing programming schedule. The agreement expires on December 31, 2015.
The Company has signed a Letter of Intent for the sale of certain Interactive
assets to NTN Communications, Inc.
F-25
Total amounts expensed under this agreement were $1,770,275 for 2002, $1,865,675
for 2001 and $1,822,684 for 2000.
[b] Lease commitments
During the fiscal year ended August 31, 2002, Chell Merchant Capital
Group leased 12,043 square feet of office space in Suites 301, 500 and 700 in a
building located at 630 - 8th Avenue S.W. Calgary, Alberta, T2P 1G6. The
combined annual rent of the three suites was Cdn$202,087. We subleased this
space to unaffiliated third parties upon the discontinuation of the operations
of this subsidiary for Cdn$150,000 per annum.
Logicorp leases approximately 17,502 square feet in Edmonton, 11,800
square feet in Calgary and approximately 4,500 square feet in Vancouver for
approximately annual rent of $220,350, $115,640 and $62,300 respectively. The
leases expire as follows: Edmonton - December 2006, Calgary - July 31, 2006, and
Vancouver - March 31, 2006.
The future minimum annual lease payments under operating leases are as follows:
Years ended August 31,
----------------------------------------------------
2003 $ 319,157
2004 342,445
2005 342,445
2006 226,715
----------------------------------------------------
$1,230,762
====================================================
Operating lease expenses were $682,084 for 2002, $398,073 for 2001, and $264,177
for 2000.
[c] Employment agreements
The Company and certain subsidiaries have entered into employment
agreements with certain executive management employees with terms of between one
and two years. These agreements expire in fiscal 2003. The remaining commitment
for 2003 is approximately $208,000.
On September 19, 2000, the Company entered into an employment agreement
with Cameron Chell, pursuant to which Mr. Chell served as the Company's
President and Chief Executive Officer. The agreement provided for an initial
annual base compensation of $360,000, together with automobile expenses of
$8,400 annually. In addition to the fixed remuneration, the Company provided Mr.
Chell with the services of an Executive Assistant on an ongoing basis and an
Accountant for a reasonable period of time to allow for the completion of
outstanding accounting work related to existing companies in which Mr. Chell was
involved. It was the understanding of the parties that this agreement was to be
replaced by a definitive employment agreement before October 10, 2000; however,
such an agreement has not been entered into at this time. Since the signing of
this agreement, Mr. Chell has eliminated both his salary and automobile
allowance in an effort to reduce our cash requirements. These were eliminated
with the understanding that the compensation of Mr. Chell will be mutually
agreed upon between the parties. During 2002 Mr. Chell resigned as President and
Chief Executive Officer of the Company.
10. STOCKHOLDERS' EQUITY
[A] AUTHORIZED SHARES
The Company's authorized share capital comprises 50,000,000 common
shares (increased from 20,000,000 shares on February 28, 2001), with a par value
of $0.063 [U.S. $0.0467] per share and 1,500,000 non-cumulative Series B
preferred shares with a par value of $0.012 [U.S. $0.010] per share. The Series
B preferred shares are voting and convertible such that 3 preferred shares are
exchangeable for 1 common share, at the option of the holders.
F-26
[b] ISSUED AND OUTSTANDING SHARES
On February 6, 2002, the Company issued 454,545 Series B preferred
shares that have a par value of US$.01 per share to acquire all the issued and
outstanding preferred shares of Wareforce.com. The value of the Series B
preferred shares was determined based on the estimated market capitalization of
the Company on February 6, 2002 which approximated $170,500. Since these
preferred shares are convertible into equity at the option of the note holder,
an embedded beneficial conversion feature of $137,016 has been recorded as a
dividend in accordance with EITF 0027. There is a limitation on the conversion
feature whereby shares are not convertible if the conversion would result in the
holder owning more than 5% of the outstanding common shares of the Company. As
of February 6, 2002, the maximum number of shares that can be converted into
common stock was 474,565. During the year ended August 31, 2002, the Company
wrote off the carrying value of the investment in Wareforce of $176,518.
At August 31, 2001, there were no preferred shares outstanding.
[c] RESERVED FOR FUTURE ISSUANCES
As of December 29, 2003, the Company has reserved 5,046,682 common
shares for future issuance. This is comprised of 1,543,840 options outstanding
as of August 31, 2002 and 3,502,842 warrants, of which 466,342 were outstanding
as of August 31, 2002.
[d] WARRANTS OUTSTANDING
The Company has the following warrants outstanding:
REMAINING
NUMBER PRICE AVG. TERM
Warrants outstanding
as of August 31, 2000 -- --
Issued 50,000 $3.00 4.0 years
-------------------------
Warrants outstanding
as of August 31, 2001 50,000 $3.00 2.8 years
Issued 416,342 $1.00 - 2.00 3.0 years
-------------------------
Warrants outstanding
as of August 31, 2002 466,342 $1.00 - $3.00 2.5 years
-------------------------
11. LOSS PER SHARE
Loss per share was calculated in accordance with Statement of Financial
Accounting Standards No. 128, "EARNINGS PER SHARE." The following table sets
forth the computation of basic and diluted loss per share for the years ended
August 31:
- ---------------------------------------------------------------------------------------------------------------
2002 2001 2000
$ $ $
- ---------------------------------------------------------------------------------------------------------------
NUMERATOR:
Net loss (numerator for basic and diluted loss per share)
from continuing operations (28,735,797) (9,640,185) (1,367,902)
Net loss (numerator for basic and diluted loss per share)
from discontinued operations (2,015,740) (2,107,454) (955,719)
- ---------------------------------------------------------------------------------------------------------------
Net loss (numerator for basic and diluted loss per share) (30,751,537) (11,747,639) (2,323,621)
===============================================================================================================
DENOMINATOR FOR BASIC LOSS PER SHARE - adjusted weighted
average number of shares and assumed conversions 9,879,836 8,393,589 2,873,042
F-27
- ---------------------------------------------------------------------------------------------------------------
2002 2001 2000
$ $ $
- ---------------------------------------------------------------------------------------------------------------
EFFECT OF DILUTIVE SECURITIES
Convertible preferred shares -- -- --
Convertible promissory notes -- -- --
Employee stock options -- -- --
- ---------------------------------------------------------------------------------------------------------------
DENOMINATOR FOR DILUTED LOSS PER SHARE - adjusted
weighted average number of shares and assumed conversions 9,879,836 8,393,589 2,873,042
===============================================================================================================
Basic and diluted loss per share from continuing operations (2.91) (1.15) (0.48)
Basic and diluted loss per share from discontinued operations (0.20) (0.25) (0.33)
- ---------------------------------------------------------------------------------------------------------------
Net loss per share (3.11) (1.40) (0.81)
===============================================================================================================
During the year ended August 31, 2002, 454,545 preferred shares were
issued. In addition, options to purchase 1,543,840 common shares and warrants to
purchase 466,342 common shares were outstanding. These securities were not
included in the diluted loss per share calculation because the effect would be
anti-dilutive.
At August 31, 2001, 900,000 preferred shares convertible to 300,000
common shares were exercised and are no longer outstanding. In addition, options
to purchase 1,325,000 common shares were outstanding. These securities were not
included in the diluted loss per share calculation because the effect would be
anti-dilutive.
At August 31, 2000, 900,000 preferred shares convertible to 300,000
common shares were outstanding. In addition, options to purchase 1,297,000
common shares were outstanding. These securities were not included in the
diluted loss per share calculation because the effect would be anti-dilutive.
12. CONTINGENT LIABILITIES
On January 27, 2003, a former President of LDS, filed a wrongful
dismissal claim against LDS and the Company. A round of examinations for
discovery has been held and preparation of the affidavit of records is underway.
Further discoveries were held during the week of September 8, 2003. The
Company's counsel has determined that it is too early in the process to evaluate
the merits of the case. The Company has not accrued any liabilities related to
this claim as of August 31, 2002. The Company has filed a counter-suit stating
that the former President was fraudulent in his representation to the Company in
connection with the Company's acquisition of LDS.
In June 2001, a former employee filed a wrongful dismissal claim against
LDS. Subsequently the employee offered to settle for which LDS rejected. No
further action has taken place since October 2001 and accordingly, LDS believes
it will prevail and has not accrued liabilities on the accompanying financials
statements related to this claim.
On June 12, 1992, the Company filed a lawsuit against an unrelated
company, Interactive Network Inc. of Mountain view, California, U.S.A. and its
president. The suit seeks a non-infringement declaration with respect to a
Canadian patent. This action was discontinued on September 9, 1998.
On June 18, 1992, Interactive Network Inc., a third party, instituted
proceedings against NTN Communications, Inc. ("Communications"), NTN Interactive
Network Inc. and the Company in the Federal Court of Canada and in the
California Supreme Court claiming patent infringement. It is the opinion of our
Company's management and counsel that this patent infringement claim will be
successfully defended.
Canada Customs and Revenue Agency is currently in discussions with the
Company regarding a potential liability with respect to withholding tax on
certain amounts paid to Communications. An assessment of approximately $550,000
has been made to date by Canada Customs and Revenue Agency and the Company has
filed a notice of objection. Management and counsel believe that it has valid
defenses with respect to these matters and, accordingly, no amount has been
recorded in these consolidated financial statements. In the event that such
matters are settled in favor of Canada Customs and Revenue Agency, the amounts
could be material and would be recorded in the period in which they became
determinable. In December 2003, the Company entered into an agreement to sell
certain operating assets and liabilities of the NTN Interactive Network Inc. to
NTN Communications. As part of the agreement, NTN Communications will assume the
liabilities related to this claim, if any.
F-28
The Company and its subsidiaries are not a party or subject to any other
material pending legal proceedings, other than ordinary routine litigation
incidental to its business. To the knowledge of management no other proceedings
of a material nature have been or are contemplated against the Company.
13. BUSINESS ACQUISITIONS
[a] PURCHASE OF LOGICORP DATA SYSTEMS LTD., LOGICORP SERVICE GROUP LTD., 123557
ALBERTA LTD. AND 591360 ALBERTA LTD.
Effective January 1, 2002, the Company acquired 100% of the outstanding
common stock of Logicorp Data Systems Ltd. ("LDS"), Logicorp Service Group Ltd.,
123557 Alberta Ltd. and 591360 Alberta Ltd. (collectively "Logicorp") for a
collective purchase price of $13,879,686. Logicorp is a Canadian systems
integrator handling all aspects of IT systems integration and solutions
development, including network integration and management, desktop support,
hardware/software procurement, systems architecture design and consulting.
Systems Integration is an area of business in which the Company can offer
systems solutions to companies of various sizes. These solutions can be through
the delivery and installation of computer hardware solutions; through offering
services to companies to aid in their business processes or infrastructures or
through personalized solutions aided for growing technology with their
organization.
The acquisition was recorded using the purchase method of accounting
and, accordingly, the purchase price has been allocated as set out below:
$
- --------------------------------------------------------------------------------
Goodwill (see below for discussion
on amended purchase price and impairment) 13,429,307
Accounts receivable 8,252,652
Inventory 738,081
Fixed assets 2,366,038
Other current assets 783,932
Accounts payable and accrued expenses (8,800,327)
Other current liabilities (2,889,997)
- --------------------------------------------------------------------------------
13,879,686
- --------------------------------------------------------------------------------
The purchase price was satisfied by $1,500,000 in cash, the issuance of
two non-interest bearing promissory notes with a maturity value of $2,300,000
and the issuance of 5,355,000 shares of CMCG which had a fair value
approximating $10,000,000. As the shares were exchangeable into Company shares
at inception, the fair value of the shares issued was determined by using an
average trading price of the Company's common stock for a reasonable period
before and after the acquisition date, in accordance with SFAS 141 "Business
Combinations". These shares of CMCG are exchangeable on a one for one basis for
common shares of the Company. The election to exchange is not subject to or
contingent on any future events or conditions and is solely at the option of the
sellers. The first promissory note with a maturity value of $1,800,000 was due
June 30, 2002. Prior to payment of the first promissory note, the Company had
the option to adjust the purchase price by substituting the $1,800,000 note for
an interest-free promissory note in the amount of $2,040,000 one half of which
would be due June 30, 2002 and the second half would be due December 31, 2002.
The Company did not make this election and paid the $1,800,000 promissory note
in cash. The second promissory note has a maturity value of $500,000 and was
initially due March 31, 2003.
In addition, the purchase price may be adjusted upwards because the
Company is required to pay an amount by which the earnings before taxes,
interest, depreciation and amortization (EBITDA) of Logicorp exceeds $1,000,000
for the year ended December 31, 2002. The purchase price may be adjusted
downward by three times the amount that EBITDA for this period is less than
$1,000,000.
The purchase price could be further adjusted on June 30, 2002, in the
event that the weighted average closing stock price of the Company's common
shares for the 10 trading days prior to June 30, 2002 was less than US$1.00. The
weighted average closing stock price was greater than US$1.00 during this period
and accordingly, no adjustment to the purchase price was required.
During the fourth quarter of fiscal 2002, the Company began negotiations
to adjust the purchase price of Logicorp due to an investigation of claims filed
by Logicorp owed by Hewlett-Packard (Canada) Ltd. ("HP"). As a result, the
purchase
F-29
price for Logicorp has been amended, the issuance of exchangeable common shares
has been decreased by 2,000,000 to 3,355,000 (from 5,355,000 originally) and the
second promissory note of $500,000 has been cancelled. This has resulted in a
balance of $200,000 still owed which is classified as a loan payable, related
party on the August 31, 2002 balance sheet. In addition, a historical audit of
Logicorp resulted in significant restatement issues which resulted in combined
negative book values of ($2,074,567) as of December 31, 2001 (the date
immediately prior to acquisition date). The purchase price has been adjusted for
these events. For financial reporting purposes, goodwill is being allocated to
the integrated systems segment. For tax purposes, all of the goodwill is
expected to be deductible. The following is the revised purchase price
allocation which was recorded in the fourth quarter of fiscal 2002:
AMENDED PURCHASE PRICE $
--------------------------------------------------------------------
Goodwill (see below for discussion on impairment) 10,489,549
Accounts receivable 7,754,995
Inventory 377,016
Fixed assets 743,118
Other current assets 489,817
Accounts payable and accrued expenses (6,056,814)
Line of credit (3,119,979)
Other current liabilities (1,401,728)
Long Term debt (861,425)
--------------------------------------------------------------------
8,414,549
--------------------------------------------------------------------
As a result of the financial statement restatement issue discussed
above, and in addition to the significant operating losses incurred by the
Logicorp entities subsequent to the acquisition date, management of the Company
has determined that an impairment of goodwill had occurred as of August 31,
2002. Accordingly, the $10,489,549 was written off in its entirety effective in
the fourth quarter of fiscal 2002.
The operating results of Logicorp are included in the Company's
consolidated statements of operations from the effective date of acquisition
(January 1, 2002).
PRO FORMA INFORMATION (UNAUDITED)
The following pro forma information on results of operations assumes
that Logicorp was purchased at the beginning of each period presented.
For Year Ended
Aug 31, 2002 Aug 31, 2001 Aug 31, 2000
$ $ $
------------ ------------ ------------
Revenues 48,640,400 61,926,494 64,885,421
Net loss (28,146,376) (10,606,336) (12,265,788)
Net loss per share - basic and diluted (2.85) (1.26) (1.58)
The pro forma information is presented for informational purposes only and is
not necessarily indicative of the results of operations that actually would have
been achieved had the acquisition been consummated as of that time, nor is it
intended to be a projection of future results.
[b] PURCHASE OF ETELLIGENT SOLUTIONS INC.
Effective June 1, 2002, Logicorp Data Systems Ltd. acquired 100% of the
shares of eTelligent Solutions Inc. ("eTelligent"), for a purchase price of
$165,000 which was payable as follows: $75,000 was paid at the date of closing
and the balance is to be paid by four interest free promissory notes due on the
following dates: $22,500 payable on March 1, 2003, June 1, 2003, September 1,
2003 and January 1, 2004.
F-30
The purchase price may be adjusted downward dollar for dollar by the
amount that the earnings before taxes of eTelligent from June 1, 2002 until
October 31, 2003 is less than $245,000. However, the purchase price cannot be
less than $150,000.
The purchase price may be adjusted upward eighty cents for every dollar
that eTelligent's Earnings before taxes exceed $245,000 from June 1, 2002 until
October 31, 2003. The purchase price may be further adjusted:
a. By any increase in the Loans above $75,000
b. By any increase in the eTelligent line of credit before June 1,
2002 above $135,000, or
c. If the Term Loan was increased above $65,000 before June 1, 2002
The operating results related to the acquisition are included in the
Company's consolidated statements of operations from the date of acquisition.
Pro-forma information has not been provided for the prior year because it is not
material.
[c] PURCHASE OF ASSETS AND SHARES FROM CHELL.COM LTD. AND CAMERON CHELL
On September 19, 2000, pursuant to an Agreement of Purchase and Sale
dated as of August 4, 2000, the Company and its subsidiary Chell Merchant
Capital Group acquired certain assets from Chell.com Ltd. ("Chell.com") and the
following shares for an aggregate purchase price of US$27,002,086:
(a) 480,000 shares of cDemo were acquired by the Company which
represents approximately 14.3% of cDemo's issued and outstanding
stock;
(b) 875,000 shares of Engyro Inc. were acquired by the Company which
represents approximately 34% of Engyro's issued and outstanding
stock;
(c) 60,000 Common Shares of Chell.com (USA) Inc., a Nevada
corporation were acquired by the Company which represents 100%
of Chell.com (USA)'s outstanding stock; and
(d) 962,500 Common Shares of eSupplies, Inc., which were held in
escrow as discussed below, were subsequently released.
Pursuant to the Purchase and Sale Agreement, the Company acquired the
above-referenced shares for an aggregate purchase price of US$25,234,583. The
Company also acquired certain assets from Chell.com including office leases,
office equipment and computers, insurance contracts, employment contracts and
service agreements for a price of US$1,767,503. The sole director and
shareholder of Chell.com is Cameron Chell. Chell Merchant Capital Group also
assumed a liability owing by Chell.com to Canadian Advantage Limited Partnership
II, in the amount of US$1,767,499 on the condition that Canadian Advantage
Limited Partnership II accept full settlement of such indebtedness by Chell
Merchant Capital Group issuing 451,868 exchangeable shares. The aggregate
purchase price payable by the Company under the Purchase and Sale Agreement of
US$27,002,086 was paid by the Company issuing a total of 5,396,733 Common Shares
at the deemed price of US$3.91155 per share and 1,506,439 shares of CMCG which
were exchangeable for the Company's Common Shares on a one-for-one basis. The
1,476,398 exchangeable shares of CMCG that were originally issued for the
962,500 eSupplies shares had been held in escrow pursuant to an escrow agreement
dated October 11, 2000 among Cameron Chell, the Company and Wolff Leia Huckell,
Barristers and Solicitors. These CMCG exchangeable shares were to be released
from escrow after receiving written notice from the Company that the new course
of business being taken by eSupplies fit with the Company's business model and
provided significant value to the Company. Since the Company has subsequently
determined that eSupplies' business profile does not fit with the Company's
business profile, the CMCG exchangeable shares have been cancelled and the
962,500 eSupplies shares have been returned to Cameron Chell. Subsequent to the
cancellation of the eSupplies transaction, the aggregate purchase price was
reduced to US$21,227,081.
This acquisition was not reflected in the financial statements for the
year ended August 31, 2000 since shareholder approval to ratify the above
purchase transaction was not voted on and approved until September 8, 2000. As a
result of the above, Cameron Chell and Chell.com owned greater than 50% of the
Company's outstanding common stock, that is the Company has in effect been
acquired in a reverse acquisition.
This acquisition of the Company by Cameron Chell and Chell.com and the
acquisition by the Company of the equity interests, as described in the first
paragraph, are reflected at historical cost in the Company's financial
statements.
F-31
[d] GALAVU ENTERTAINMENT NETWORK INC.
On September 13, 1999, pursuant to an Asset Purchase Agreement dated as
of the 10th day of September, 1999, the Company, through its wholly-owned
subsidiary, GalaVu, acquired, effective as of September 13th, 1999,
substantially all of the property and assets [excluding accounts receivable] of
GalaVu Entertainment Network, Inc. The purchase price of $2,958,058 was
satisfied by the issuance of 100,000 common shares of the Company's stock and
the issuance of a promissory note [the "Note"]. The Note is secured by a general
security interest in all of GalaVu's present and after-acquired assets. The Note
shall be payable in cash or in common shares of the Company's stock annually,
for the term consisting of each of the next five fiscal years in an amount equal
to 50% of the earnings before interest, taxes, depreciation and amortization of
GalaVu for the immediately preceding annual period. Pursuant to the provisions
of the Note, the minimum amount to be received by the holder of the Note is as
follows: fiscal 2001 - $300,000, fiscal 2002 - $500,000, fiscal 2003 - $750,000,
fiscal 2004 - $875,000 and fiscal 2005 - $875,000.
The present value of the Note, discounted at the Company's average
borrowing rate (6.5%) amounted to $2,662,698. The fair value of the Note at
August 31, 2001 approximated its carrying value. The interest accretion on the
discounted note amounted to $173,076 during fiscal 2001. This acquisition was
recorded using the purchase method of accounting and accordingly the purchase
price has been allocated as follows:
$
----------------------------------------------------------------
Property and equipment 3,487,498
Assumption of liabilities (529,440)
----------------------------------------------------------------
PURCHASE PRICE 2,958,058
================================================================
Subsequentto year-end, GalaVu entered into an agreement for the settlement
of the note payable to CIBC.
In April 2003 the Company sold GalaVu (see Note 4).
14. DEPOSIT ON PURCHASE OF APPLICATIONSTATION.COM, INC. SHARES
On November 22, 2000, the Company entered into an agreement with
Chell.com Ltd. to participate in the purchase of a 51% interest in the shares of
ApplicationStation.com, Inc., an unrelated party. The Company has provided a
deposit of $1,689,710 to Chell.com Ltd. for its 25% share of the 51% interest in
the shares of ApplicationStation.com, Inc. The purchase transaction did not
close. A demand for repayment has been sent to Chell.com Ltd. It does not appear
that the deposit will be recoverable. It has therefore been written off in
fiscal 2000. The Company is no longer pursuing the matter.
15. SEGMENT INFORMATION
The Company operates in the entertainment, education and merchant
services industries. Reportable segments have been identified by the Company due
to differences in the services of the entertainment, education and merchant
services industries. Corporate relates to costs that are not associated with a
specific industry segment, but are required for the operations of the Company.
Business segment information for the years ended August 31, 2002, 2001 and 2000
are as follows:
F-32
================================================================================
2002 2001 2000
$ $ $
Restated
- --------------------------------------------------------------------------------
REVENUE
Systems Integration 34,205,614 -- --
Corporate 2,310 16,595 13,703
- --------------------------------------------------------------------------------
34,207,924 16,595 13,703
- --------------------------------------------------------------------------------
OPERATING LOSS
Systems Integration (1,162,568) -- --
Merchant Service -- (5,076,619) --
Corporate (15,089,159) (3,115,758) (1,321,542)
- --------------------------------------------------------------------------------
(16,251,727) (8,192,377) (1,321,542)
- --------------------------------------------------------------------------------
NET LOSS
Systems Integration (12,173,848) -- --
Merchant Service -- (6,524,427) --
Corporate (16,561,949) (3,115,758) (1,367,902)
Discontinued Operations (2,015,740) (2,107,454) (955,719)
- --------------------------------------------------------------------------------
(30,751,537) (11,747,639) (2,323,621)
- --------------------------------------------------------------------------------
TOTAL ASSETS
Systems Integration 6,435,982 -- --
Merchant Service -- 1,589,465 --
Education -- 128,986 1,088,157
Corporate 2,810,773 3,170,689 1,818,027
Discontinued Operations -- 4,648,078 7,725,789
- --------------------------------------------------------------------------------
9,246,755 9,537,218 10,631,973
- --------------------------------------------------------------------------------
CAPITAL EXPENDITURES
Systems Integration 127,737 -- --
Corporate 7,355 46,978 --
- --------------------------------------------------------------------------------
135,092 46,978 --
- --------------------------------------------------------------------------------
DEPRECIATION & AMORTIZATION
Systems Integration 425,692 -- --
Merchant Service -- 431,967 --
Corporate 601,550 162,836 47,055
- --------------------------------------------------------------------------------
1,027,242 594,803 47,055
- --------------------------------------------------------------------------------
INTEREST EXPENSE
Systems Integration 182,209 --- ---
Corporate 10,077,990 1,146,708 46,360
- --------------------------------------------------------------------------------
10,260,199 1,146,708 46,360
- --------------------------------------------------------------------------------
Operating profit (loss) is equal to profit (loss) before income taxes
and minority interest, and includes deductions for items such as interest and
depreciation and amortization. Identifiable assets by industry are those assets
used in our operations in each industry. Corporate assets are principally cash
and cash equivalents, short-term investments and intangible assets.
Our business segment revenues are all generated primarily between customers in
Canada and the United States.
The 2001 and 2000 comparative segment information has been reclassified
from statements previously presented to conform with the presentation of the
2002 segment information.
16. RELATED PARTY TRANSACTIONS
Due From Shareholders
Included in shareholders' equity is $227,365 at August 31, 2002, and $25,086 at
August 31, 2001, of amounts due from shareholders. $25,086 and $202,279 was
advanced during the years ended August 31, 2001 and 2002, respectively. The
amounts are non-interest bearing, unsecured and are due on demand.
17. RESTATED FINANCIAL STATEMENTS
[a] CHANGE IN PREFERRED SHARE CONVERSION RATE (FISCAL 2000 RESTATEMENT)
On April 4th, 2000, the ratio at which preferred shares could be
converted to common shares was changed from 4.67 to 1 to 3 to 1. The resulting
change from 192,857 to 300,000 common shares upon conversion resulted in a
one-time compensation charge of $337,779. In order to reflect this change, the
fiscal 2000 financial statements have been restated.
F-33
[b] DISCOUNT ON CONVERTIBLE DEBT (FISCAL 2001 RESTATEMENT)
On October 3, 2000, the Company closed the sale of a $4,740,000 (US$3,000,000)
Convertible 10% Debenture of which $2,635,000 (US$1,700,000) has been advanced.
EITF-00-27 requires the debt to be discounted resulting from any beneficial
conversion feature. The Company did not book the discount on the debt and
therefore had to make an adjustment to the Fiscal 2001 financial statements. As
a result, the Company has now recorded a beneficial conversion feature of
$1,728,134 and has amortized $563,367 for the year ended August 31, 2001. There
were warrants associated with the debt and the Company recognized a $220,000
cost associated with these warrants. The Company had previously expensed $77,215
and recorded $175,491 in other assets, for which both amounts have now been
reversed out completely because a portion of the proceeds has been allocated to
the value of the warrants.
The following table presents the impact for each of the restatements in fiscal
2000 and 2001:
- --------------------------------------------------------------------------------
As Previously As Restated
Reported in 10-K/A
for 2000
================================================================================
YEAR ENDED AUGUST 31, 2000
Balance sheet:
Share Capital
Common shares 183,235 191,122
Capital in excess of par value 10,124,777 10,454,669
Deficit (935,510) (1,273,289)
Statement of operations:
Selling, general and administration 10,726,556 11,064,335[a]
Net loss (1,985,842) (2,323,621)
EPS
Basic and diluted loss per share $ 0.69 $ 0.81
As Previously As Restated
Reported in 10-K/A
for 2001
- --------------------------------------------------------------------------------
YEAR ENDED AUGUST 31, 2001
Balance sheet:
Other Assets 388,802 212,541
Long-term debt 5,884,339 4,523,822
Share Capital
Capital in excess of par value 14,143,533 15,849,971
Deficit (12,499,514) (13,020,928)
Statement of operations:
Selling, general and administration 16,250,171 16,181,604[a]
Interest and bank charges 881,398 1,471,379[a]
Net loss (9,622,841) (11,747,639)
EPS
Basic and diluted loss per share $ 1.34 $ 1.40
[a] before discontinued operations presentation in 2002 10-K.
F-34
18. INVESTMENTS IN AND ADVANCES TO UNCONSOLIDATED SUBSIDIARIES
Investments in unconsolidated subsidiaries and other investees in which
the Company exercises significant influence are recorded on the equity method,
adjusted for the Company's proportionate share of their undistributed earnings
or losses.
Investments carried on the equity method of accounting during 2002 (and as of
August 2001) were as follows:
Percent
Owned
cDemo Inc. 14.3%
Engyro Inc. 22.1%
Wareforce Inc. $176,518
At August 31, 2002, the investment in Wareforce Inc. was deemed to be
permanently impaired and has been written off in the statement if operations for
2002. At August 31, 2001, the Company's proportionate share of undistributed
losses for cDemo Inc. and Engyro Inc. exceeded its investment and advances by
$301,100. Accordingly, the Company's investment has been reduced to zero and
$301,100 has been recorded as an expense in the statement of operations in 2001.
19. QUARTERLY INFORMATION (UNAUDITED)
The summarized quarterly financial data presented below reflects all adjustments
which, in the opinion of management, are of a normal and recurring nature
necessary to present fairly the results of operations for the periods presented.
- -------------------------------------------------------------------------------------------------------------------------------
AS REPORTED FOURTH THIRD SECOND FIRST
- -------------------------------------------------------------------------------------------------------------------------------
YEAR ENDED 8/31/2001
Total net sales 18,222,374[a] 3,857,064 4,569,468 4,792,977 5,002,865
Gross profit 11,404,263[a] 2,062,126 3,022,692 3,071,198 3,248,247
(Loss) before income taxes
and discontinued operations (10,144,255) (1,838,438) (3,549,901) (1,356,506) (3,399,410)
Net (loss) (10,144,255) (752,402) (3,549,901) (2,442,542) (3,399,410)
Net (loss) per share:
Basic and diluted from continuing operations (1.15) (0.21) (0.42) (0.16) (0.36)
Basic and diluted from discontinued operations (0.25) (0.12) -- (0.13) --
-------------------------------------------------------------------------------
Net income (loss) per share (1.40) (1.10) 0.42 (0.29) (0.41)
(Loss) from discontinued operations (1,169,743) (83,707) -- (1,086,036) --
(Loss) on disposal/sale of subsidiary (937,711) (937,711) -- -- --
[a] prior to discontinued operations presentation
F-35
- -------------------------------------------------------------------------------------------------------------------------------
AS REPORTED FOURTH THIRD SECOND FIRST
- -------------------------------------------------------------------------------------------------------------------------------
YEAR ENDED 8/31/2002
Total net sales 34,207,924 (2,775,432) 20,639,179 12,386,011 3,958,166
Gross profit 2,887,937 (5,048,946) 3,038,983 2,327,504 2,570,396
(Loss) before income taxes
and discontinued operations (28,735,797) (14,392,630) (10,810,393) (2,411,735) (1,121,039)
Net (loss) (30,751,537) (15,359,857) (11,473,026) (2,797,615) (1,121,039)
Net (loss) per share:
Basic and diluted from continuing operations (2.91) (1.39) (1.14) (0.26) (0.12)
Basic and diluted from discontinued operations (0.20) (0.08) (0.08) (0.04) --
----------- ----------- ----------- ----------- ----------
Net (loss) per share (3.11) (1.47) (1.22) (0.30) (0.12)
(Loss) from discontinued operations (1,710,649) (963,374) (361,395) (385,880) --
(Loss) on disposal/sale of subsidiary (305,091) (3,853) (301,238) -- --
20. SUBSEQUENT EVENTS
[a] GALAVU NOTE PAYABLE
On November 21, 2002, pursuant to a Debt and Security Purchase Agreement dated
on the 29th day of October, 2002, the Company, through its wholly-owned
subsidiary, GalaVu, settled the promissory note [the "Note"] issued from the
acquisition of substantially all of the property and assets [excluding accounts
receivable] of GalaVu. The present value of the Note, discounted at the
Company's average borrowing rate (6.5%) amounted to $2,662,698. Arthur Andersen
Inc., (the "Assignor") agreed to assign to the Company all of the Assignor's
right, title and interest, if any, in and to the Note for the amount of $500,000
(the "Purchase Price"). The purchase price was paid in the following manner: A
$150,000 deposit was made upon execution of the agreement and $350,000 was paid
at the time of closing.
The $350,000 paid at the time of closing to the Assignor, was financed through a
term loan in the principal sum of $375,000. The loan was secured through a
second mortgage on our 10 and 14 Meteor Drive properties and a general security
agreement on the capital assets of GalaVu. GalaVu can obtain a release from this
security agreement upon a prepayment of $150,000 on account of principal plus
interest on any payment date. The term of this loan is one year with an annual
interest rate of 13%.
[b] CONVERTIBLE PROMISSORY NOTES
During 2002, the Company issued 8% convertible notes in the amount of $6,587,622
under a private placement memorandum. These notes are convertible to common
shares at a conversion price of $0.95 per share. A dispute has arisen with the
note holders with respect to the conversion of these notes. In order to resolve
this dispute, effective December 2, 2002, the Company entered into an agreement
with Joseph Gunnar & Co., LLC ("JGUN") and the note holders. The Company, JGUN
and the note holders have all signed the agreement. Under the agreement the
conversion price will not be less than $0.40 or greater than $0.75. The change
in conversion price could result in the issuance of approximately 4,400,000 to
12,100,000 additional common shares depending on the final conversion price.
F-36
[c] SETTLEMENT OF CLAIMS FILED BY LOGICORP
On December 19, 2002, Hewlett-Packard (Canada) Ltd. ("HP") on behalf of itself
and Compaq Canada ("Compaq"), a HP Company, entered into a settlement agreement
with LDS in respect to certain questioned rebate claims. It was agreed that
under the terms of the settlement agreement that HP will relieve LDS of all of
its obligations owing to HP and Compaq under these questioned rebate claims,
forgiving approximately $1,350,000 of claims, for a note in the amount of
$238,291 (which has been recorded by the Company as of August 31, 2002). The
note will be payable in 48 monthly installments of $4,423 (and HP will offset
$26,000 in outstanding rebate claims). HP will have the right to offset payments
against receivable balances. The note contains no stated interest rate and the
Company imputed interest on the note at a rate of 9%. As a part of the
settlement, the Company committed to pay $1,200 in monthly audit fees in
relation to rebate claims.
[d] SALE OF BUILDINGS AND LAND
On October 12, 2002, we sold an office building owned by 3484751 Canada Ltd.
located at 775 Pacific Road, Oakville Ontario to an unrelated 3rd party for
approximately $560,000. The sale of the building resulted in a loss of
approximately $250,000.
During the fiscal year ended August 31, 2002, we owned an approximately 25,000
square foot parcel of land, located at 14 Meteor Drive in Toronto, Ontario, on
which stands a 12,500 square foot, one story building. On December 19, 2003, we
sold this land and building to an unrelated third party for approximately
$730,000 and recorded a gain on the sale of approximately $100,000.
During the fiscal year ended August 31, 2002, we owned an approximately 29,000
square foot parcel of land, located at 10 Meteor Drive, Toronto, Ontario, on
which stands a 14,000 square foot, two story building. We sold this land and
building to an unrelated party on March 7, 2004 for approximately $710,000. The
Company anticipates a gain of approximately $70,000.
[e] LOGICORP ADVANCES
In December 2002, the three former shareholders of Logicorp Data Systems and
Logicorp Service Group advanced Logicorp Data Systems $200,000 each, totaling
$600,000. These advances were due on demand and did not carry a stated interest
rate. Due to their long-term nature, the Company has imputed interest on these
advances at a rate of 9%. During the year ended August 31, 2003, one of the
advances was fully repaid and total payments of approximately $110,000 have been
paid against the remaining advances.
During the year ended August 31, 2003, B.O.T.B., a company controlled by Cameron
Chell, advanced Logicorp Data Systems $820,000, and during the period of
September 1, 2003 through April 30, 2004, advanced Logicorp Data Systems
$567,399. The advances are due on demand and do not carry a stated interest
rate. Due to their long-term nature, the Company has imputed interest on the
advances at a rate of 9% per annum. As of April 30, 2004, the aggregate amount
of such advances was $1,387,399.
F-37
SCHEDULE OF VALUATION AND QUALIFYING ACCOUNTS
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at Charged to Charged to
Beginning of Costs and Other Balance at End
Year Expenses Accounts Deductions of Year
- ------------------------------------------------------------------------------------------------------------------------------------
For the fiscal year ended August 31, 2000
Allowance for doubtful accounts $ 119,000 $ 59,000 $ -- $ -- $ 178,000
========= ========= =========== ============ =========
For the fiscal year ended August 31, 2001
Allowance for doubtful accounts $ 178,000 $ 166,500 $ -- $ (117,500) $ 227,000[a]
========= ========= =========== ============ =========
For the fiscal year ended August 31, 2002
Allowance for doubtful accounts $ 227,000 $ 270,000[b] $ (229,700) $ (70,218) $ 160,000
========= ========= =========== ============ =========
[a] included in "net assets from discontinued operations"
[b] added from Logicorp acquisition in January 2002.
F-38
CHELL GROUP CORPORATION
FORM 10-K
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT LOCATION
2.1 Stock Purchase Agreement, dated October 1, 1996,
among Connolly-Daw Holdings Inc., 1199846 Ontario
Ltd., Douglas Connolly, Wendy Connolly and NTN
Interactive Network Inc., minus Schedules
thereto.............................................. +1, Exh. 10.1
3.1 Articles of Incorporation, as amended to date........ p. 59
3.2 By-Laws, as amended to date.......................... p. 62
4.1 Specimen Stock Certificate........................... p. 71
10.1 License Agreement, dated March 23, 1990, between
NTN Communications, Inc. and NTN Interactive
Network Inc.......................................... +2, Exh. 10.9
10.2 Stock Purchase Agreement, dated as of October 4,
1994, between NTN Canada and NetStar Enterprises
Inc. (formerly, Labatt Communications Inc.).......... +3, Exh. A
10.3 Option, dated as of October 4, 1994, registered in
the name of NetStar Enterprises Inc. (formerly,
Labatt Communications Inc)........................... +3, Exh. B
10.4 Designation Agreement dated as of October 4, 1994,
among NTN Canada, Inc., NTN Interactive Network
Inc. and NetStar Enterprises Inc. (formerly Labatt
Communications Inc.)................................. +3, Exh. C
10.5 Registration Rights Agreement, dated as of October
4, 1994, between NTN Canada and NetStar
Enterprises Inc. (formerly, Labatt Communications
Inc.)................................................ +3, Exh. D
10.6 Promissory Note of NTN Interactive Network Inc.
registered in the name of Connolly-Daw Holdings,
Inc.................................................. +1, Exh. 10.2
10.7 Promissory Note of NTN Interactive Network Inc.,
registered in the name of 1199846 Ontario Ltd........ +1, Exh. 10.3
10.8 Option Agreement, dated October 1, 1996, among
Connolly-Daw Holdings Inc., NTN Interactive
Network Inc. and NTN Canada, Inc..................... +1, Exh. 10.5
10.9 Option Agreement, dated October 1, 1996, among
1199846 Ontario Ltd., NTN Interactive Network Inc.
and NTN Canada, Inc.................................. +1, Exh. 10.6
10.10 Registration Rights Agreement, dated October 1,
1996, among NTN Canada, Inc., Connolly-Daw
Holdings Inc. and 1199846 Ontario Ltd................ +1, Exh. 10.4
10.11 Employment Agreement dated as of August 31, 1994,
between NTN Interactive Network Inc. and Peter
Rona................................................. +4, Exh. 10.11
10.12 Management Agreement dated October 1, 1996,
between Magic Lantern Communications Ltd. and
Connolly-Daw Holdings Inc............................ +4, Exh. 10.12
10.13 Employment Agreement dated October 1, 1996,
between Magic Lantern Communications Ltd. and
Douglas Connolly..................................... +4, Exh. 10.13
10.14 Employment Agreement dated October 1, 1996,
between Magic Lantern Communications Ltd. and
Wendy Connolly....................................... +4, Exh. 10.14
F-39
10.15 Asset Purchase Agreement, dated September 10,
1999, by and between 1373224 Ontario Limited,
Networks North Inc. and Arthur Andersen Inc., to
acquire the property and assets of GalaVu
Entertainment Inc., from the person appointed by
the court of competent jurisdiction as the
receiver or receiver and manager of the property,
assets and undertaking of GalaVu..................... +5, Exh. 10.15
10.16 Promissory Note, dated September 10, 1999, by and
between 1373224 Ontario Limited, as Debtor, and
the Holder, as Creditor.............................. +5, Exh. 10.16
10.17 General Security Agreement, dated September 10,
1999, by and between 1373224 Ontario Limited, to
acquire the property and assets of GalaVu
Entertainment Inc., from the person appointed by
the court of competent jurisdiction as the
receiver or receiver and manager of the property,
assets and undertaking of GalaVu..................... +5, Exh. 10.17
10.18 Securities Pledge Agreement, dated September 10,
1999, by and between 1373224 Ontario Limited to
acquire the property and assets of GalaVu
Entertainment Inc., from the person appointed by
the court of competent jurisdiction as the
receiver or receiver and manager of the property,
assets and undertaking of GalaVu..................... +5, Exh. 10.18
10.19 Certificate to the Escrow Agent certifying that
the conditions of Closing have been satisfied or
waived............................................... +5, Exh. 10.19
10.20 Certificate to the Escrow Agent certifying that
the conditions of Closing have not been satisfied
or waived............................................ +5, Exh. 10.20
10.21 Occupancy and Indemnity Agreement, dated September
10, 1999, by and between 1373224 Ontario Limited
to acquire the property and assets of GalaVu
Entertainment Inc., from the person appointed by
the court of competent jurisdiction as the
receiver or receiver and manager of the property,
assets and undertaking of GalaVu..................... +5, Exh. 10.21
10.22 Order of the Ontario Superior Court of Justice,
dated September, 1999, approving the transaction
contemplated herein, and vesting in the Purchaser
the right, title and interest of GalaVu and the
Receiver, if any, in and to the Purchased Assets,
free and clear of the right, title and interest of
any other person other than Permitted Encumbrances .. +5, Exh. 10.22
10.23 Bill of Sale, dated September 13, 1999, by and
between 1373224 Ontario Limited to acquire the
property and assets of GalaVu Entertainment Inc.,
from the person appointed by the court of
competent jurisdiction as the receiver or receiver
and manager of the property, assets and
undertaking of GalaVu................................ +5, Exh. 10.23
10.24 Covenant of Networks North Inc. for valuable
consideration to allot and issue and pay to the
Receiver 100,000 common shares in accordance with
the Purchase Agreement date September 10, 1999,
between 1373224 Ontario Limited and the Receiver..... +5, Exh. 10.24
10.25 Agreement of Purchase and Sale dated August 4,
2000 by and among Networks North Inc., Networks
North Acquisition Corp., Chell.com Ltd. and
Cameron Chell ....................................... +6, Exh. A.
10.26 Valuation of Chell.com Ltd. as of May 31, 2000 by
Stanford Keene....................................... +6, Exh. B.
10.27 Share Purchase Agreement by and among Chell Group
Corporation, Chell Merchant Capital Group, Inc.,
Melanie Johannesen, Randy Baxandall, Morris
Chynoweth, Elaine Chynoweth, the Johannesen Family
Trust, the Baxandall Family Trust, the Merc Family
Trust, Logicorp Data Systems Ltd., 123557 Alberta
Ltd., Logicorp Service Group Ltd. and 591360
Alberta Ltd. ........................................+7, Exhibit 2.1
10.28 Share Purchase Agreement, dated as of April 25,
2003 between DVOD Networks Inc., and Chell Group
Corporation, minus schedules thereto;
F-40
10.29 Assignment of Debt and Security, dated April 25,
2003 between Chell Group Corporation and DVOD
Networks Inc;
10.30 Assignment of Debt and Security, dated April 25,
2003 among NTN Interactive Network Inc., DVOD
Networks Inc and GalaVu Entertainment Network
Inc.;
10.31 Form of Assignment of Debt and Security, dated
April 25, 2003 among 488605 Ontario Limited, Ruth
Margel and DVOD Networks Inc., minus schedules
thereto.
22 List of Subsidiaries................................. p. 110
- ----------
+1 All Exhibits so indicated are incorporated herein by reference to the
exhibit listed above in the Company's Current Report on Form 8-K (Date
of Report: October 2, 1996) (File No. 0-18066), filed on October 17,
1996.
+2 All Exhibits so indicated are incorporated herein by reference to the
exhibit listed above in the Annual Report on Form 10-K of NTN
Communications, Inc., for its fiscal year ended December 31, 1990) (File
No. 2-91761-C), filed on April 1, 1991.
+3 All Exhibits so indicated are incorporated herein by reference to the
exhibit listed above in the Company's Current Report on Form 8-K (Date
of Report: October 4, 1994) (File No. 0-18066), filed on October 18,
1994.
+4 All Exhibits so indicated are incorporated herein by reference to the
exhibit listed above in the Company's Annual Report on Form 10-K (Date
of Report: November 27, 1996) (File No. 0-18066), filed on December 16,
1996.
+5 All Exhibits so indicated are incorporated herein by reference to the
exhibit listed above in the Company's 8-K (Date of Report: September 13,
1997) (File No. 0-18066), filed on December 16, 1996.
+6 All Exhibits so indicated are incorporated herein by reference to the
exhibit number listed above in the Definitive Proxy Statement on Form
14A of the Registrant (File No. 000-18066), filed with the Securities
and Exchange Commission on August 8, 2000.
+7 All Exhibits so indicated are incorporated herein by reference to the
exhibit number listed above in the Company's Current Report on Form 8-K
(Date of Report: December 13, 2001) (File No. 0-18066), filed on
December 28, 2001.
++ Filed electronically pursuant to Item 401 of Regulation S-T.
F-41
EXHIBIT 22. LIST OF SUBSIDIARIES OF CHELL GROUP CORPORATION AS AT NOVEMBER
26, 2001
NAME OF SUBSIDIARY(1) JURISDICTION OF INCORPORATION
Chell Merchant Capital Group, Inc........................................Ontario
Logicorp Data Systems Ltd. (2) ..........................................Alberta
Logicorp Service Group Ltd. (2) .........................................Alberta
123557 Alberta Ltd. (2) .................................................Alberta
591360 Alberta Ltd. (2) .................................................Alberta
eTelligent Solutions Inc. (3) ...........................................Alberta
NTN Interactive Network Inc...............................................Canada
1113659 Ontarion Ltd. ("Viewer Services) (4).............................Ontario
3484751 Canada Inc........................................................Canada
GalaVu Entertainment Network Inc. .......................................Ontario
Chell.com (USA) Ltd.......................................................Nevada
- ----------
NOTES:
(1) Unless otherwise indicated, all named entities are wholly-owned
subsidiaries of Chell Group Corporation.
(2) Wholly-owned subsidiary of Chell Merchant Capital Group.
(3) Wholly-owned subsidiary of Logicorp Data Systems Ltd..
(4) Wholly-owned subsidiary of NTN Interactive Network Inc.
F-42