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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(MARK ONE)
[_]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended
OR
[X]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from March 1, 1997 to December 31, 1997
COMMISSION FILE NO. 0-22622
INTERACTIVE ENTERTAINMENT LIMITED
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
I.R.S. NO. 98-0170199
(I.R.S. EMPLOYER IDENTIFICATION NO.)
BERMUDA
(JURISDICTION OF INCORPORATION)
845 CROSSOVER LANE, SUITE D-215
MEMPHIS, TN 38117
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: 901 537-3800
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
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Common Stock, Par Value $0.01 per share Nasdaq SmallCap Market
(the "Common Stock")
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
None
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 [X] No [_]
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
be 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. [_]
The aggregate market value of the voting stock held by non-affiliates of the
registrant based upon the closing price of $3.25 for the Common Stock as
reported by the Nasdaq SmallCap Market on March 12, 1998 is $43,206,413.
The number of shares outstanding of the issuer's Common Stock, as of March
12, 1998: 20,181,196 shares
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive Proxy Statement for the 1998 Annual Meeting of
Shareholders, which will be filed within 120 days after the end of the fiscal
year, are incorporated by reference into Part III hereof.
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INTERACTIVE ENTERTAINMENT LIMITED
ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
PAGE
----
Part 1
Item 1 Corporate History and Development...................... 1
Business Overview...................................... 1
The Product............................................ 2
The Industry........................................... 3
Competition............................................ 3
Market and Marketing................................... 3
Manufacturing.......................................... 4
Sky Games System Acquisition........................... 4
The Amalgamations...................................... 4
Major Customers........................................ 5
Employees.............................................. 6
Item 2 Properties............................................. 6
Item 3 Legal Proceedings...................................... 6
Item 4 Submission of Matters to a Vote of Security Holders.... 6
Part II
Item 5 Market for Registrant's Common Equity and Related
Stockholder Matters................................... 7
Item 6 Selected Financial Data................................ 8
Item 7 Management's Discussion and Analysis of Financial
Condition and Results of Operations................... 9
Overview............................................... 9
Results of Operations.................................. 10
Liquidity and Capital Resources........................ 12
Forward-Looking Information............................ 13
Item 8 Financial Statements and Supplementary Data............ 13
Item 9 Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure................... 13
Part III
Item 10 Directors and Executive Officers of the Registrant..... 14
Item 11 Executive Compensation................................. 14
Item 12 Security Ownership of Certain Beneficial Owners and
Management............................................ 14
Item 13 Certain Relationships and Related Transactions......... 14
Part IV
Item 14 Exhibits, Financial Statement Schedules and Reports on
Form 8-K.............................................. 15
Signatures............................................. 18
Financial Statements................................... F-1
PART I
ITEM 1. BUSINESS
Corporate History and Development
Interactive Entertainment Limited (formerly Sky Games International Ltd.,
the "Company" or "IEL") was incorporated pursuant to the laws of the Province
of British Columbia on January 28, 1981 under the name Tu-Tahl Petro Inc. On
May 10, 1990, the Company changed its name to Creator Capital Inc. The Company
was reincorporated through the continuance of its corporate existence from the
Province of British Columbia to the Yukon Territory on July 15, 1992. On
January 23, 1995, the Company changed its name to Sky Games International Ltd.
("SGI"). Effective February 22, 1995, the Company continued its corporate
existence from the Yukon Territory to Bermuda as an exempted company under the
Companies Act 1981 (Bermuda) (the "Bermuda Act"). In June, 1997, the Company
changed its name to Interactive Entertainment Limited following consummation
of the amalgamation of the Company's wholly-owned subsidiary, SGI Holding
Corporation Limited ("SGIH"), and SGIH's formerly 80% owned subsidiary, then
known as Interactive Entertainment Limited ("Old IEL"), which was followed
immediately by an amalgamation of SGI with the survivor of the first
amalgamation, (the "Amalgamations"). Unless the context otherwise requires,
the term "Company" refers to Interactive Entertainment Limited, its wholly-
owned subsidiaries, Sky Games International Corporation ("SGIC"), and Creator
Island Equities Inc., and for periods prior to June 17, 1997, also SGIH and
Old IEL, which was the Company's principal operating subsidiary from December
30, 1994, through such Amalgamations. Also included is IEL (Singapore) Pte.
Ltd., a wholly-owned subsidiary of the Company.
The initial purpose of the Company was natural resource exploration and
development; however, since January 1991 the Company has concentrated its
efforts on acquiring, developing and commercializing a gaming technology
marketed as Sky Games(TM) for inflight use by international airline passengers
and patrons in other non-traditional gaming venues. In pursuit of this
purpose, the Company in 1991 acquired the principal assets of Nevada-based Sky
Games International, Inc. ("SGII"). In late 1994, the Company formed Old IEL
as a joint venture with subsidiaries of Harrah's Entertainment, Inc.,
("Harrah's"), which resulted in the transfer to Old IEL of the Company's
inflight gaming business and the execution of a management agreement with
Harrah's with respect to Old IEL and other related relationships. Pursuant to
such management agreement, Old IEL's operations were managed by a Harrah's
subsidiary. The description herein of the Company's operations from December
30, 1994 through June 17, 1997 with respect to inflight gaming activities
refers to the operations of Old IEL under the management of this subsidiary of
Harrah's. Until the Amalgamations, because the management of the business of
Old IEL had been substantially delegated to a third party manager the
management and affairs of the Company were subject to numerous contractual
requirements and limitations.
Business Overview
The Sky Games(TM) system was developed to introduce gaming to international
airline passengers. The system is designed to enable users to play a number of
casino-type games from their seats by way of a built-in, color, interactive,
in-seat monitor. The product design in its current form has only recently been
possible since audio-video interactive inflight entertainment hardware ("IFE")
systems have only recently been commercially introduced. The IEL system has
been integrated with the IFE systems offered by Matsushita Avionics Systems
Corporation ("MASC") and is also intended to be interfaced with systems
manufactured by other leading manufacturers including, among others, B/E
Aerospace, Inc. ("BEA"), Rockwell International Corp., Sony Trans Com Inc. and
The Network Connection, Inc.
The Company believes that an opportunity exists to introduce casino games on
international air flights, based on the following factors: (i) many commercial
international air routes involve long flights which create the opportunity for
the entertainment of passengers; (ii) many airlines have indicated that they
view IFE systems as a source of additional revenue; (iii) in certain parts of
the world and in certain markets, gaming is increasing in popularity and
public acceptance; and (iv) as with all casino style gaming, the odds are in
favor of the "house" when played over a period of time. The Company has
conducted limited field surveys in conjunction with
1
affiliates of Harrah's to measure passenger reaction to inflight gaming in
general and to gather statistical information related to game preferences,
projected passenger participation, betting limits and acceptance of the
Company's software design. These surveys support the Company's belief
regarding inflight gaming.
The Company has made proposals to and held discussions with major airlines
in Europe and Asia, and in April of 1996, the Company announced the signing of
a three-year contract, subject to a two-year extension term, for the provision
of gaming services to Singapore Airlines ("SIA"). The term would commence with
SIA's acceptance, for use on its aircraft, of the Company's gaming software.
However, the agreement with SIA is subject to a trial period and to
termination by either party upon the occurrence of specified events.
Consequently, the agreement may not be in effect through the entirety of its
initial term or any extension term. The agreements with Singapore Airlines
consist of a license of the Sky Games(TM) system to the airline and a services
agreement under which the Company will manage certain aspects of the airline's
inflight gaming operations. While the Company intends that future contracts
will have a similar structure, the Company recognizes that different
arrangements may be required to work with different airlines. Fees payable by
the airline are a percentage of the net revenues generated from inflight
gaming activities. If results from the SIA operation are successful, the
Company believes additional contracts can be reached with additional carriers.
The commencement of gaming operations on an airline will require the
successful installation on the airline's aircraft of an IFE system. The
Company currently does not manufacture, provide, install or service IFE
systems. The Company understands that in the past, several airlines have
experienced difficulties with the installation and testing of IFE systems, but
based on discussions among the Company, various airlines and the IFE system
providers, the Company believes that these difficulties will be overcome. SIA
has installed IFE systems on their total fleet of 53 wide-body aircraft.
On January 13, 1998, IEL completed the acquisition of London-based Inflight
Interactive Limited ("IIL"). The acquisition has resulted in increased product
offerings in the way of games of skill and amusement. As a result of the
acquisition, IEL anticipates that it will gain greater market access to the
world's leading air carriers.
The Product
The IEL system is a self-contained, computerized gaming system that enables
airline passengers to play popular casino-style games at their seats. Airlines
can add gaming to aircraft fitted with compatible IFE equipment with only
nominal retrofitting cost and little or no aircraft downtime.
The IEL software was designed and written in layers. This layered approach
effectively insulates the top-level applications (gaming software) from the
specifics of the underlying hardware. The first level of software is composed
of device and system drivers. Where the hardware is unique to the specific
system, the drivers are provided by the hardware supplier. As additional
layers of software are added, the interface becomes less hardware specific.
The goal is to reach a level of abstraction sufficiently removed from the
hardware details so that the application software needs to have little, or
perhaps no, direct knowledge of the hardware that is supporting the operating
environment. This top-level interface is the Application Programming Interface
("API"). The IEL software is written to the Microsoft Windows API. The service
integrator will provide an API or APIs that will extend the Windows API by
providing access to IFE specific functions. Any Intel based platform that can
support Microsoft Windows will provide the necessary operating environment for
the gaming software.
The Company has been granted federal registration of the Sky Games logo and
the slogan "We Make Time Fly" by the U.S. Patent and Trademark Office. In
addition, the Company has applied for registration of the Sky Casinos
International logo and the marks "Sea Games International" and "Sky Play." At
this time the Company has not applied for any patents. Upon completion of
successful testing results, an assessment will be made of the Company's gaming
systems and designs and patent applications may be filed where appropriate.
The Company's proprietary software is copyrighted and contains security
features designed to "lock" the software if it is tampered with.
2
In order to operate the Sky Games(TM) system in commercial settings, the
Company must provide additional hardware and software systems necessary to
properly record and account for gaming activities by patrons. The Company has
designed accounting and financial control systems for the management of
inflight gaming operations. Inflight gaming transactions will be conducted
through major credit cards. The major credit card companies have developed
rules for the use of their cards in connection with inflight gaming wherein,
presently, the maximum purchase of gaming credits on a credit card is U.S.
$350 and winnings are capped at U.S. $3,500.
The Industry
The Boeing Company's 1997 Current Market Outlook forecast passenger traffic
growth of 4.9% annually over the next 20 years. The report noted that, to meet
that growth, airlines are expected to add over 16,000 airplanes worth more
than $1.1 trillion to their fleets. Other industry sources estimate that
approximately half of new aircraft deliveries are expected to be wide body,
long-haul aircraft that will represent a substantial market for IFE systems
and inflight gaming.
Industry statistics indicate that gaming, in general, is gaining increased
market acceptance in many regions of the world and that U.S. casino revenue
increased from U.S. $8.9 billion in 1991 to U.S. $22.8 billion in 1996. North
Americans account for only a portion of the worldwide gaming industry. Casino
gambling, for example, also exists in Australia, the Bahamas, Canada, Denmark,
Chile, Germany, Great Britain, Malaysia, Monaco, the Netherlands, Puerto Rico,
South Africa, Switzerland, Turkey and Uruguay. The U.S. Department of
Transportation estimated in March, 1996, that the potential inflight gaming
revenue for non-U.S. airlines is approximately $480 million per year.
The Company anticipates that the IFE industry will grow rapidly over the
next three to five years as airlines commit to interactive IFE hardware based
on improved product reliability and demonstrated revenue generation.
Accordingly, the Company is committed to building its core business by
focusing initially on the airline market but also investigating the potential
of other venues such as cruise ships, ferry boats, trains and hotel rooms.
Competition
The Company understands that several companies are working on inflight
gaming systems, including InterGame and Interactive Flight Technologies, Inc.
("IFT"). Both of these companies have announced agreements with airlines to
provide inflight gaming systems. Unlike the Company, IFT provides the IFE
hardware in addition to gaming software. IFT's business plan was based on
allowing airlines to finance the purchase of the system out of a share of
gaming revenues. IFT launched inflight gaming with Swissair in January 1997
and announced shortly thereafter that gaming revenues were not sufficient to
support the financing of their system. IFT is currently seeking areas for
alternative business development. InterGame announced in March 1998 that it
had launched its gaming software with Lauda Air. These companies may have
significantly greater financial and technical resources than the Company, and
there can be no assurance that the Company will be able to compete effectively
with such companies. The Company believes that in the event inflight gaming
and related activities become more established, additional competitors with
alternate approaches are likely to enter the business. Other inflight
offerings, such as shopping and movies, could also be considered as indirect
competition.
Competition in the development of products for the inflight entertainment
industry is strong; however, the Company believes that few products currently
are being developed that provide the airlines with a means to generate revenue
comparable to inflight gaming.
Market and Marketing
In the very competitive airline market, airlines are seeking a distinctive,
competitive edge to attract and retain paying customers. Entertainment and
service systems are forming a part of airlines' current business strategy.
3
The Company's primary target market is Asian and Pacific Rim airlines whose
passengers, with certain exceptions, generally have a broad cultural
acceptance of gaming. The Company believes that the Latin American and
European markets may also hold strong potential. Gaming is prohibited on the
aircraft of U.S. commercial air carriers and on all flights to and from the
United States.
The Company believes that the principal benefits of its product to the
airlines will be the ability to enhance entertainment offerings to passengers
and airline participation in a potential revenue stream. IFE systems are
capital intensive; however, providing passenger service and comfort,
especially for first and business class travelers, is a major area of
competition for airlines. The Company believes that new methods of increasing
revenues while providing a high level of service will be seriously considered
by airlines; however, there can be no assurance that IFE systems or inflight
gaming will be among the alternatives selected by airlines. Although the
system is designed for gaming using money, the Company believes that the
system could be adapted to "pay-for-play" mode in those circumstances where
gambling for money is not legal and that a system utilizing frequent flyer
credits and other rewards can be integrated as part of the gaming program.
Recent economic developments in Asia may cause airlines to cancel or delay
purchases of new aircraft and/or IFE systems. Most airlines serving the Asian
market have recently reported a decrease in passenger load factors, and some
have announced reductions in flight frequencies and eliminations of service to
some markets. It is possible that these events will adversely affect the
Company's ability to execute its business plan.
The Company expects to derive its income from a share of gaming earnings and
does not anticipate selling its gaming products to generate revenue. Airlines
will receive a percentage of net revenue generated by Sky Games(TM) on their
respective flights. Passenger payouts and certain direct operating costs will
be deducted from revenue and the "win" split on a negotiated basis. Airlines
currently have similar revenue-sharing arrangements with other product/service
providers, such as inflight communication companies (e.g. GTE Airfone). The
Company expects to provide certain training, banking, accounting and
administrative functions. The airline will provide the aircraft, the
equipment, the passengers and inflight personnel.
Manufacturing
As a software producer and operator, the Company has no manufacturing
capability. The Company's software is being designed to interface with in-
cabin hardware, including onboard computers, file servers, distribution and
communication systems, manufactured by various suppliers for the airlines.
Sky Games System Acquisition
On November 7, 1991, the Company entered into an agreement, with subsequent
amendments, with Sky Games International, Inc. ("SGII") to purchase
technology, proprietary rights and prototypes of the casino games known as
"Sky Games." The purchase price of the assets was 300,000 shares of the
Company's $.01 par value common stock (the "Common Stock") issued to SGII at a
deemed price of $1.65 per share, plus an additional 3,000,000 shares of Common
Stock held in escrow to be released on the basis of one share for each U.S.
$1.78 of net cash flow generated from the assets over a ten-year period (the
"Performance Shares"). Of the 3,000,000 shares, 2,000,000 were issued to SGII
and 1,000,000 shares to Anthony Clements, an advisor to and director of the
Company. The Performance Shares are held in escrow by Montreal Trust Company
of Canada. As of April 30, 1997, the holders of the Performance Shares have
agreed with the Company to tender such shares to the Company when and if they
are released from the escrow, and the Company has agreed to cancel such
shares. The holders of the Performance Shares have also granted an irrevocable
proxy to a bank which has irrevocably agreed not to vote such shares. Since
the Performance Shares are subject to cancellation and may not be voted,
management of the Company does not consider the Performance Shares to be
outstanding.
The Amalgamations
Effective as of December 30, 1994, the Company, through SGIH, and Harrah's
Interactive Investment Company ("HIIC") completed the formation of Old IEL as
a joint venture corporation incorporated as an
4
exempted company under the Bermuda Act. At the same time, (i) Old IEL entered
into a management agreement (the "Management Agreement") with Harrah's
Interactive Entertainment Company (the "Manager"), (ii) the prior consulting
agreement between Harrah's and SGIC was terminated, (iii) SGIC assigned all
right, title and interest in the Sky Games(TM) system and related trademarks
and trade names to the Company, and (iv) the Company licensed the Sky
Games(TM) system and certain related trademarks and trade names to Old IEL. In
connection with the Amalgamations, the contractual agreements with the
affiliates of Harrah's were terminated.
The ownership interests of the Company and HIIC in Old IEL were 80% and 20%,
respectively, prior to the Amalgamations. The Company and HIIC had funded a
total of $5 million to Old IEL. Additional capital, if not available from
third parties, was to have been provided by the Company and HIIC in proportion
to their shareholdings. The Executive Committee of Old IEL was to determine
whether additional capital was to be provided as equity or debt. Under the
shareholders agreement, each party had certain options with respect to the
other party's stock. The shareholders agreement was terminated effective June
17, 1997.
The Manager had been granted and had assumed broad responsibility for
managing the business of Old IEL, including completing the development of and
improving the Sky Games(TM) software and all other systems, marketing to
airlines and customers and day-to-day gaming operations. The Management
Agreement had a two-year term, but could have been renewed at the Manager's
option for successive two-year terms up to a maximum term of 10 years. The
Manager had a right of first negotiation on a renewal agreement. Management
fees were dependent on the amount of gross revenues with a maximum fee of 7.5%
of gross revenues and a minimum monthly fee of $10,000. Old IEL was required
to pay all operating costs (including capital expenditures) of the business,
which included the cost of services and goods provided by the Manager and its
affiliates under the Management Agreement.
The Manager could have declared a default under the Management Agreement if
IEL, SGIH, any of SGIH's affiliates or any of their officers, directors or
employees committed any act that the Manager determined could have affected
any gaming license or approval (whether or not any regulatory action was
commenced or threatened) held by the Manager, any of its affiliates, Old IEL,
SGIH or any of SGIH's affiliates.
The Amalgamations were consummated on June 17, 1997, and, in conjunction
with the Amalgamations, the Management Agreement was terminated, and
management of the Company assumed direct responsibility for day to day
operations. The Company also entered into a Continuing Services Agreement with
Harrah's for certain services.
The Company had exclusively licensed Old IEL to use certain of the Sky Games
trademarks, trade names and other trade rights. This license was replaced in
the Amalgamations by a similar license to Harrah's for use of the Company's
software, as it existed on June 17, 1997, in traditional casino venues owned,
operated or managed by Harrah's. The license is royalty-free, worldwide and
non-terminable.
In 1994, the Company terminated certain contractual rights previously
granted to BEA in connection with the development of an earlier generation
product for inflight gaming use. In connection with this termination, the
Company issued a U.S. $2,500,000 convertible promissory note due March 30,
1997. The unpaid balance of the note, including accrued interest, was
exchanged for Redeemable Convertible Class A Preference Shares in the Company
on June 16, 1997.
Major Customers
The Company's only contract for its gaming application is with Singapore
Airlines. On January 13, 1998, the Company completed the acquisition of IIL.
IIL is a U.K. company that provides games of amusement to Cathay Pacific
Airways, Egypt Air, Lauda Air, Malaysia Airlines and Virgin Atlantic Airways.
5
Employees
During the current fiscal year, the Company consolidated the operations of
its former Vancouver corporate office into the Memphis, Tennessee headquarters
office of its former operating subsidiary. The Company had 18 employees as of
March 1, 1998. Fifteen employees work out of its Memphis headquarters, one
employee is based in Seattle, Washington, and one is based in Singapore. The
acquisition of IIL in January, 1998 added one employee based in London. Labor
relations with employees are good, and none of the Company's employees are
covered by collective bargaining agreements.
ITEM 2. PROPERTIES
The Company maintains its principal office in Memphis, Tennessee in
approximately 9,400 square feet pursuant to a sublease from Harrah's. The
lease provides for a monthly payment of approximately $11,000 and expires
April 30, 1999.
The Company rents approximately 400 square feet of office space from SIA on
a month-to-month basis for its Singapore subsidiary at a cost of approximately
$800 per month.
ITEM 3. LEGAL PROCEEDINGS
The Company is not currently a party to any material pending legal
proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company held its Annual General Meeting for the fiscal year ended
February 28, 1997 on October 17, 1997. The following matters were voted upon
at the meeting:
1. Election of seven persons to the Board of Directors;
2. Approval and ratification of the Company's Management Incentive Plan;
and
3. Appointment of Ernst & Young LLP as the Company's independent public
accountants.
There were 13,398,086 shares of Common Stock voted at the 1997 Annual
General Meeting as follows:
1. Election of Directors:
VOTES FOR VOTES WITHHELD ABSTAIN
--------------- -------------- -----------
NOMINEE NUMBER % NUMBER % NUMBER %
------- ---------- ---- --------- ---- ------- ---
Malcolm Burke................... 12,936,846 96.6 350,440 2.6 110,800 0.8
Anthony P. Clements............. 12,889,206 96.2 398,080 3.0 110,800 0.8
Brian Deeson.................... 13,129,857 98.0 157,429 1.2 110,800 0.8
Laurence Geller................. 11,130,036 83.1 2,157,250 16.1 110,800 0.8
Phillip Gordon.................. 11,161,256 83.3 2,126,030 15.9 110,800 0.8
Amnon Shiboleth................. 11,008,039 82.2 2,279,247 17.0 110,800 0.8
Gordon Stevenson................ 13,114,357 97.9 172,929 1.3 110,800 0.8
2. Approval of Management Incentive Plan
For...................................................... 8,205,815 61.3%
Against.................................................. 2,966,713 22.1%
Abstain.................................................. 115,183 0.9%
Not Voted................................................ 2,110,375 15.7%
3. Approval of Ernst & Young LLP
For..................................................... 13,289,226 99.2%
Against................................................. 91,081 0.7%
Abstain................................................. 17,779 0.1%
6
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Since July 8, 1997, the Company's Common Stock has been traded on the Nasdaq
SmallCap Market under the symbol "IELSF." From March 1, 1994 until July 8,
1997, the Company's shares traded on the Nasdaq SmallCap Market under the
symbol "SKYGF."
The table below sets forth, for each fiscal quarter within the last two
years, the reported high and low closing prices of the Common Stock as
reported by the Nasdaq SmallCap Market.
TWELVE MONTHS TEN MONTHS
ENDED ENDED
FEBRUARY 28, DECEMBER 31,
1997 1997
------------- -------------
HIGH LOW HIGH LOW
------ ------ ------ ------
First Quarter................................. $6.250 $2.625 $5.000 $4.125
Second Quarter................................ $5.875 $2.875 $4.625 $2.625
Third Quarter................................. $4.625 $3.375 $4.938 $2.375
Fourth Quarter................................ $5.000 $3.125 $4.500 $2.375
As of February 12, 1998, there were 250 shareholders of record. Since
certain of the shares of Common Stock are held by brokers or other nominees,
the number of record holders may not be representative of the number of
beneficial holders. The Company believes there are approximately 2,600
beneficial holders of the Company's Common Stock.
The Company has not paid any cash dividends on its Common Stock and does not
anticipate paying any such dividends in the foreseeable future.
The Nasdaq SmallCap Market adopted revised Marketplace Rules for continued
listing which became effective February 23, 1998. Except as discussed below,
the Company believes that it is in compliance with the new listing
requirements. The listing requirements state that a company's by-laws must
provide that a quorum for any meeting of the shareholders is at least 33 1/3%
of the outstanding shares of a company's common voting shares. The Company's
bye-laws are consistent with the Bermuda Companies Act 1981 which provide that
at least two shareholders may constitute a quorum. The Company has requested
an exemption from the revised rules.
On October 22, 1997, the Company completed agreements with two investors for
the private placement of 987,463 shares of Common Stock for an aggregate
purchase price of $3.2 million. $1.7 million was received upon closing, while
the remaining $1.5 million is to be funded upon, and is contingent upon,
completion of the first flight with the Company's software available in the
entire cabin of a Singapore Airlines aircraft. For each five shares of Common
Stock purchased and held for a minimum of six months, the investors will
receive warrants for the purchase of one additional share. Warrants will be
exercisable at a price of $3.8125 per share for 18 months from their issue.
On March 19, 1998, the Company began negotiating the modification of the
terms of the remaining $1.5 million of the private placement. Under the
proposed terms, 50% of the remaining portion ($750,000) would be funded
immediately, while the other 50% would be funded under the terms of the
original agreement. The subscription price for the Common Stock would be
revised to $2.62. Warrants scheduled to be issued in connection with the
initial funding of $1.5 million would not be issued. For each Common Share
purchased under the proposed revised agreement and held for a six-month
period, the investor would receive 0.85 of a warrant to purchase Common Stock.
The warrants, if issued, would have an exercise price of $2.62 and a term of
18 months.
7
On December 17, 1997, the Company issued 1,000 shares of Series A
Convertible Preference Shares of the Company's Class B Preferred Stock for a
total consideration of $1,000.000. The Series A Class B Preference Shares are
convertible after three months into a number of shares of Common Stock,
determined by dividing the stated value of $1,000 per share by the lesser of:
$3.2038 (the "Fixed Conversion Price") and a price (the "Floating Conversion
Price") calculated by (i) determining the average of the three lowest closing
bid prices for the Common Stock during the thirty trading days occurring
immediately prior to, but not including, the conversion date, and (ii)
multiplying such average by a defined conversion percentage (the "Conversion
Percentage"). The Conversion Percentage decreases from 100% to 85% as the
holding period increases. Dividends are cumulative and may be paid, at the
option of the Company and with prior notice, in additional shares of Common
Stock at an annual dividend rate of 8%. Warrants for the purchase of 61,718
shares of Common Stock were issued in connection with the issuance of the
Series A Class B Convertible Preference Shares. The warrants, which have an
exercise price of $3.2038, are exercisable beginning June 17, 1998 and expire
on December 17, 1999. Under the agreement, the Company has the option of
selling a second tranche with 123,432 warrants for an aggregate purchase price
of $2,000,000. The Company's option with respect to the second tranche, which
expires on June 17, 1998, is not exercisable until the Company's gaming
software has been installed and is available to paying passengers in the
entire cabin of a Singapore Airlines aircraft. The Series A Class B Preference
Shares do not have any voting rights.
ITEM 6. SELECTED FINANCIAL DATA
(in thousands, except share and per share data)
TEN MONTHS
ENDED FISCAL YEAR ENDED FEBRUARY 28 OR 29
DECEMBER 31 ---------------------------------------
1997 1997 1996 1995 1994
----------- --------- --------- --------- ---------
Statement of Operations
Data:
Loss before extraordinary
item.................... $ 28,988 $ 4,180 $ 4,167 $ 5,684 $ 1,709
Extraordinary loss....... 1,824 -- -- -- --
---------- --------- --------- --------- ---------
Net loss................... $ 30,812 $ 4,180 $ 4,167 $ 5,684 $ 1,709
========== ========= ========= ========= =========
Loss per share before
extraordinary item........ $ 1.87 $ 0.46 $ 0.52 $ 0.79 $ 0.26
Extraordinary loss......... .12 -- -- -- --
---------- --------- --------- --------- ---------
Loss per share............. $ 1.99 $ 0.46 $ 0.52 $ 0.79 $ 0.26
========== ========= ========= ========= =========
Weighted number of common
shares outstanding (1).... 15,562,834 9,043,687 7,942,332 7,160,279 6,465,854
Number of common shares
outstanding at period end
(1)....................... 19,428,334 9,789,020 8,521,434 7,290,624 7,076,124
AS OF AS OF FEBRUARY 28 OR 29
DECEMBER 31 ------------------------------
1997 1997 1996 1995 1994
----------- ------ ------ ------ ------
Balance Sheet Data:
Working capital (deficit)......... $ 697 $ (172) $ (280) $ (522) $2,275
Total assets...................... 17,395 3,525 3,861 3,602 4,200
Long term debt.................... 530 2,600 2,346 2,550 --
Redeemable preferred stock........ 2,737 -- -- -- --
Shareholders' equity (deficit).... 16,221 (333) (54) (695) 4,117
Equity (deficit) per common share. $ 0.83 $(0.03) $(0.01) $(0.10) $ 0.58
- --------
(1) Excludes Performance Shares
8
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Overview
Interactive Entertainment Limited ("IEL" or the "Company"), formerly known
as Sky Games International Ltd. ("SGI"), is a Bermuda exempted company which
was incorporated on January 28, 1981. The Company's activities are focused on
providing inflight gaming software and services by developing, implementing
and operating a computer-based interactive video entertainment system of
gaming and other entertainment activities on, but not limited to, the aircraft
of international commercial air carriers.
On December 30, 1994, the Company entered into a Shareholders Agreement with
SGI Holding Corporation Limited ("SGIH"), a wholly-owned subsidiary of SGI,
and an affiliate of Harrah's Entertainment, Inc. ("Harrah's"), to form a joint
venture then known as Interactive Entertainment Limited ("Old IEL"), the
result of which was that Old IEL became owned 80% by SGIH and 20% by Harrah's.
Pursuant to a management agreement, (the "Management Agreement"), Old IEL was
managed by an affiliate of Harrah's.
At a Special General Meeting of shareholders held on June 16, 1997, pursuant
to a Plan and Agreement of Merger and Amalgamation dated May 13, 1997, (the
"Amalgamation Agreement"), Old IEL was merged into SGIH and then into SGI (the
"Amalgamations"). Prior to the Amalgamations, Harrah's owned 20% of the
capital stock of Old IEL and did not own any capital stock or other securities
of SGI and had no representatives on the Board of Directors. As a result of
the amalgamation of Old IEL and SGIH and the termination of the Management
Agreement, the outstanding shares of Old IEL common stock held by Harrah's
were converted into 5,879,040 shares of $.01 par value common stock of the
Company (the "Common Stock"). Harrah's also received 1,007,875 shares of
Common Stock upon conversion of a loan, (the "Harrah's Loan"), made to Old
IEL. Harrah's therefore became the largest shareholder of the Company holding
approximately 38.6% of the outstanding shares at the time of the amalgamation.
Pursuant to the Amalgamation Agreement, Harrah's was provided with the right
to appoint persons to the Board and to specified committees in a number
generally proportionate to their share holdings calculated on a "fully
diluted" basis as defined in the Company's bye-laws. Additionally, Harrah's
was provided with the right to approve specified significant corporate actions
by the Company for as long as the ownership of Common Stock by Harrah's is in
excess of 20% (10% in some cases) of the outstanding voting shares of Common
Stock computed on a fully-diluted basis.
Upon consummation of the Amalgamations, SGI changed its name to Interactive
Entertainment Limited, and the Board appointed Gordon Stevenson as President
and Chief Executive Officer. The Company has consolidated operations formerly
performed at its Vancouver, British Columbia office into its Memphis,
Tennessee headquarters.
The Company has yet to generate any operating revenues and has no assurance
of future revenues. Its principal activities through December 31, 1997,
consisted of developing, testing and marketing the inflight gaming software.
As of December 31, 1997, IEL had a contract to provide its gaming software to
Singapore Airlines, ("SIA"), which has various termination provisions. The
contract provides for a six-month minimum trial period for the parties to
assess the operation of the inflight gaming system and public acceptance of
the inflight gaming business. The Company and Singapore Airlines are not yet
in the six-month trial period which begins following acceptance by SIA of the
Company's software for operation on one of SIA's aircraft. During this trial
period, the airline has no affirmative obligation to install the system on any
or all of its aircraft; although, if 12 aircraft are not installed with the
system within 18 months from the date inflight gaming begins, IEL may
terminate the contract. The contract with Singapore Airlines is the Company's
only contract to provide its gaming software to an airline. The Company is
pursuing additional contracts. However, gaming is prohibited on the aircraft
of U.S. commercial air carriers and on all flights to and from the United
States. Other countries may introduce similar prohibitions, which could limit
the prospects for additional contracts and result in termination of the
contract with Singapore Airlines or any future contracts with other airlines.
9
Although SIA has been progressively installing the Matsushita Avionics
Systems Corporation ("MASC") 2000E interactive inflight entertainment ("IFE")
system on its wide-body aircraft since 1995, only now are the true interactive
features of the system being implemented. Inflight gaming is expected to
provide the first truly comprehensive interactive use of the IFE system.
Inflight gaming is also expected to be the first use of the IFE system which
generates a significant volume of financial transactions. Therefore, both SIA
and IEL have insisted on rigorous testing prior to offering IEL's product to
SIA's passengers. In October 1997, the Company completed an initial phase of
laboratory testing of its inflight gaming system in conjunction with SIA and
MASC and received laboratory certification from Singapore Airlines. Testing of
the system then progressed to a series of test procedures on various aircraft
on the ground. Among other items, this series of tests revealed
inconsistencies in third party provided software (with which the Company's
software must be integrated) from aircraft to aircraft and, in some cases,
from one server to another server on the same aircraft. Once these issues were
resolved, testing moved to an airborne environment. One airborne test was
completed in March, 1998. The Company is currently addressing issues that
surfaced during this test. The Company's inflight gaming system is comprised
of three primary sets of software programs. One set of programs operates the
games, one set controls the operation and communications between servers on
the aircraft, and one set performs cabin management functions. Current issues
are with the programs controlling cabin management functions which are highly
customized to SIA specifications. Management expects that testing will be
completed and the inflight gaming product will be launched during the second
quarter of 1998.
The Company has developed a version of its gaming product for use on cruise
lines. It is expected that a trial will be initiated during 1998 in a limited
number of cabins on one cruise ship operated by an international cruise line.
This trial will be performed in conjunction with Transdigital Communications
Corporation. There can be no assurances that the trial will be successful, and
if it is successful, that it will be extended to other cabins or to other
cruise ships operated by the owner or result in any agreement with the owner.
The Company does not believe that it has exposure to the "Year 2000
Problem." Software developed by the Company is compliant with dates in the
year 2000. The Company uses commercial software produced by a variety of
vendors and believes that all of its major systems are compliant.
On January 13, 1998, the Company completed the acquisition of all of the
outstanding stock of Inflight Interactive Limited ("IIL") in exchange for
500,000 shares of the Company's Common Stock. IIL is a U. K. developer and
provider of amusement games to the airline industry. IIL's games are currently
operating on over 50 aircraft operated by Cathay Pacific, Egypt Air, Lauda
Air, Malaysia Airlines, Saudi Arabian Airlines and Virgin Atlantic. The
agreement also provides for the Company to issue up to 250,000 additional
shares of Common Stock to the former owners of IIL upon achievement of certain
milestones regarding implementation of the Company's software with an
international airline to be designated by the parties. In February, 1998 IIL
was advised by another major airline that it has been chosen to provide
amusement games for selected aircraft of the airline's fleet. Due to existing
contractual obligations, the airline has asked that IEL not reveal its
identity until late in the second quarter of 1998.
Results of Operations
In April, 1997, the Board of Directors of the Company approved a change in
the Company's fiscal year from the end of February to the end of December.
Ten Months Ended December 31, 1997 and Twelve Months Ended February 28, 1997
General and administrative expense increased by approximately $1.5 million.
This includes an increase in payroll and related costs of approximately
$307,000 due to increased staffing and an expense in the amount of $650,000
for the value of Company stock granted to Geller & Co. whose stock became
vested following the Amalgamations. Accounting and audit fees increased by
$93,000 as a result of increased reporting requirements following a change in
the Company's status from a foreign private issuer. Travel expenses increased
by $75,000
10
due to increased travel for marketing and product development. Recruiting and
relocation expenses increased by $82,000 as a result of the Company building a
permanent staff and reducing reliance on contractors. In conjunction with the
Amalgamations, the Company purchased business insurance resulting in a cost of
$79,000; the Company previously had no business insurance. Rent increased by
$92,000 primarily as a result of relocation of operations from Harrah's
corporate headquarters to dedicated leased space for the Company.
Expenses for consulting and contract labor increased by approximately $1.9
million. These expenses would have decreased by $500,000 except for the $2.4
million expense for the value of 586,077 shares of Common Stock issued to
James P. Grymyr, a former director of the Company, in payment of a consulting
agreement in the second quarter.
Legal expenses increased by approximately $411,000 due to the Amalgamations
and increased financing and reporting activities of the Company.
Interest expense, including amortization of finance fees on Company debt,
totaled $1,012,000 for the ten month period ending December, 1997 and $300,000
for the twelve month period ending February, 1997. The expense for the current
period is composed of interest on convertible debentures and amortization of
finance fees related to the debentures, while the prior period expense is
related to interest on the convertible note due to B/E Aerospace ("BEA"). The
remainder of the convertible debentures were converted into Common Stock
during the first quarter of 1998, and any unamortized finance fees as of
December 31, 1997 have been expensed.
Depreciation and amortization expenses increased by $2.8 million due to
amortization of the excess of the purchase price over assets acquired when the
Company purchased the minority interest in Old IEL previously owned by
Harrah's. There were no comparable expenses in the prior period.
Amalgamation expenses for the ten months ended December 31, 1997 were $18.1
million including: $10,098,000 for the expense of the Common Stock issued to
Harrah's upon termination of the Management Agreement; $3,466,000 upon
expensing the value of Common Stock issued to Harrah's relating to conversion
of the Harrah's Loan; $2,561,000 upon expensing the value of the Common Stock
that may be issuable to Harrah's under a registration and preemptive rights
agreement in the event that BEA converts its Class A Preference Shares to
Common Stock; an expense of $1,840,000 for the value of the Common Stock
issued to SGII, Anthony Clements and Dr. Rex Fortescue upon their agreement to
surrender the Performance Shares for cancellation upon their release from
escrow; and $100,000 relating to closure of the Vancouver office. Except for
the last item, all Amalgamation expenses were non-cash expenses. There were no
Amalgamation expenses in the prior period.
Write-down of assets for the ten months ended December 31, 1997 includes an
adjustment of $449,000 in the value of real estate and other assets owned by
the Company's wholly-owned subsidiary, Creator Island Equities, Inc. These
assets were sold in November, 1997 at the approximate book value following the
adjustment. In December, 1997 the Company wrote off the remaining $210,000
book value of inventory owned by SGIC. The inventory consisted of parts for a
computer gaming system that had previously been in development with BEA. The
$1.3 million write-down of assets for the twelve months ended February 28,
1997 includes the write-off of $138,000 in notes receivable owed to SGIC, the
forgiveness of $550,000 in debt to SGIC in connection with an agreement to
cancel the Performance Shares, and interim write-downs of $442,000 on the
Creator Island Equities real estate and $210,000 on the SGIC inventory.
Following the write-down and disposition of assets, the Company has no
significant remaining assets that are not strategic to its current business
objectives.
An extraordinary expense of $1,824,000 was recorded during the current
period for early extinguishment of the note due to BEA when it was exchanged
for the Class A Preference Shares. There was no extraordinary expense in the
prior period.
Twelve Months Ended February 28, 1997 and February 29, 1996
The net loss for both the 1997 and 1996 periods was approximately $4.2
million. Revenue for 1997 consisted solely of interest income of approximately
$64,000 compared to $118,000 for 1996.
11
General and administrative expenses decreased by approximately $987,000. The
decrease was attributable primarily to an expense of $703,000 for the value of
stock options granted to non-employees and non-directors in the 1996 period
with no comparative expense in the 1997 period. Office and administration
costs decreased by approximately $99,000 due to the closure of corporate
offices in Las Vegas, Nevada and Los Angeles, California in late 1995.
Consulting and contract labor costs for 1997 were approximately $1,195,000
compared to approximately $707,000 in 1996. Included were Old IEL costs of
approximately $870,000 for 1997 and $434,000 for 1996. The increase is due to
an increase in staffing needs that was fulfilled through the use of contract
labor.
Interest expense declined by approximately $306,000 due to the Company's
efforts at securing equity capital and reducing reliance on debt instruments
to fund operations.
Asset write-down costs increased by $567,000. In the 1996 period, the
Company wrote down $457,000 of previously deferred technology costs and wrote
off approximately $316,000 in notes receivable.
Liquidity and Capital Resources
At December 31, 1997 the Company had working capital of approximately
$697,000. The Company's primary source of funding has been through sales of
its equity and securities convertible into Common Stock.
During the ten months ended December 31, 1997, the Company sold a total of
$2,163,250 in convertible debentures in four different private sales. The
debentures were generally convertible into shares of Common Stock at the lower
of a 15% discount to market at the time of purchase or a 22.5% discount to
market at the time of conversion. A total of $1,633,250 of debentures were
converted into 808,520 shares of Common Stock during the year and a principal
amount of $530,000 remained outstanding as of December 31, 1997. Subsequent to
the end of the year, the remaining debentures have been converted.
In October, 1997, the Company completed agreements with two investors for
the private placement of 987,463 shares of Common Stock for an aggregate
purchase price of $3.2 million. $1.7 million was received upon closing with
the remaining $1.5 million to be funded upon and is contingent upon completion
of the first flight with the Company's software available in all seats of a
Singapore Airlines aircraft. For each five shares of Common Stock purchased
and held for a minimum of six months, the investors will receive one warrant
for the purchase of additional shares. These warrants are exercisable at a
price of $3.8125 per share for 18 months from their issue.
On March 19, 1998, the Company began negotiating the modification of the
terms of the remaining $1.5 million of the private placement. Under the
proposed terms, 50% of the remaining portion ($750,000) would be funded
immediately, while the other 50% would be funded under the terms of the
original agreement. The subscription price for the Common Stock would be
revised to $2.62. Warrants scheduled to be issued in connection with the
initial funding of $1.5 million would not be issued. For each Common Share
purchased under the proposed revised agreement and held for a six-month
period, the investor would receive 0.85 of a warrant to purchase Common Stock.
The warrants, if issued, would have an exercise price of $2.62 and a term of
18 months.
In December, the Company completed agreements with two investors for the
private placement of 3,000 shares of, Series A Class B Convertible Preferred
Stock, (the "Preferred Stock"), at $1,000 per share. The Preferred Stock is
entitled to receive a quarterly dividend at the rate of 8.0%. The Company has
the option of paying the dividend in cash or in additional shares of Common
Stock subject to certain notice provisions. $1.0 million was received upon
closing with the remaining $2.0 million to be funded upon and is contingent
upon completion of the first flight with the Company's software available in
all seats of a Singapore Airlines aircraft. The investors received a total of
61,718 warrants to purchase Common Stock. The Preferred Stock is convertible
into Common Stock at the lower of $3.2038 or a sliding discount to market at
the time of conversion. The
12
warrants are exercisable for a period of 18 months at a price of $3.2038. The
investors will receive an additional 123,432 warrants upon funding of the
second tranche.
Subsequent to the end of the year, the Company sold 300 shares of Series B
Class B Convertible Preferred Stock at $1,000 per share. The Series B Class B
Convertible Preferred Stock has the same dividend and conversion features as
the Series A Class B Convertible Preferred Stock. The investor also received a
warrant to purchase 18,515 shares of Common Stock at a price of $3.2038 for 18
months.
During the second quarter of 1997, the Company established a target of
raising a total of $8.0 million in equity to provide funding for the Company's
operating needs until such time as management believes that the Company will
be receiving a positive cash flow from operations. Through March, 1998 a total
of $6.5 million had been either raised or committed to the Company. The
Company is currently negotiating commitments for additional capital to
complete its equity target and believes that these efforts will be successful
during the second quarter of 1998.
The Company has not yet generated any operating revenue under its agreements
with Singapore Airlines. Until the Company receives sufficient cash flow from
operations, additional funding will be required to allow the Company to
continue operations during 1998. Absent sufficient cash flow from operations,
the short-term viability of the Company and the Company's ability to continue
its operations is directly dependent upon the completion of significant
additional financing.
Forward-Looking Information
Except for historical information contained herein, the matters discussed in
this Annual Report on Form 10-K are forward-looking statements (within the
meaning of Section 27A of the Securities Act of 1993, as amended and Section
21E of the Securities Exchange Act of 1934, as amended) that are subject to
certain risks and uncertainties that could cause actual results to differ
materially from those set forth in such forward-looking statements. Such risks
and uncertainties include the inability to complete integration and testing of
the Company's software, the implementation of the software by Singapore
Airlines and the Company's ability to raise the necessary capital to fund its
operations.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Financial Statements and Supplementary Data are provided as an exhibit to
Item 14.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
As of September 15, 1997, the Company accepted the resignation of Buckley
Dodds, Chartered Accountants, as independent Canadian auditor to the Company.
Buckley Dodds, Chartered Accountants, reports on the financial statements for
the past two years have not contained any adverse opinions or disclaimer of
opinions and have not been qualified as to uncertainty, audit scope, or
accounting principles. There were no disagreements with Buckley Dodds,
Chartered Accountants, during the two most recent fiscal years and any
subsequent interim period. Buckley Dodds, Chartered Accountants, had, since
June 30, 1992, acted as independent auditor for the Company.
As of September 15, 1997, the Executive Committee of the Company approved
the appointment, which was approved by shareholders on October 17, 1997, of
Ernst & Young LLP as a new independent accountant to the Company for the
ensuing year at a remuneration to be negotiated by management and approved by
the board of directors of the Company. Ernst & Young LLP was selected by the
Company on account of the increasing importance of U.S. GAAP to the accounting
practices and disclosures of the Company, which resulted from the Company's
1997 change of its status from that of a foreign private issuer, and the fact
that Ernst & Young LLP is also experienced in auditing financial statements
prepared under Canadian GAAP, which the Company will continue to prepare for
certain continuing Canadian reporting purposes.
13
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTORS
See the information set forth in the sections of the Proxy Statement
entitled "Election of Directors" and "Section 16(a) Beneficial Ownership
Reporting Compliance," which sections are incorporated herein by reference.
EXECUTIVE OFFICERS
See the information set forth in the section of the Proxy Statement entitled
"Executive Officers and Significant Employees," which section is incorporated
herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
See the information set forth in sections of the Proxy Statement entitled
"Executive Compensation," "Summary Compensation Table," and "Option Grants in
the Last Fiscal Year" which sections are incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
See the information set forth under "Security Ownership by Directors,
Officers and Five Percent (or More) Shareholders" as set forth in the Proxy
Statement and incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
See the information set forth in the section of the Proxy Statement entitled
"Certain Relationships and Related Transactions," which section is
incorporated herein by reference.
14
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) EXHIBITS
1.Financial Statements
Consolidated Balance Sheets at December 31, 1997 and February 28, 1997.
Consolidated Statements of Operations for:
Ten Months Ended December 31, 1997
Twelve Months Ended February 28, 1997
Twelve Months Ended February 29, 1996
Consolidated Statements of Shareholder's Equity
February 28, 1995 through December 31, 1997
Statements of Cash Flow
Ten Months Ended December 31, 1997
Twelve Months Ended February 28, 1997
Twelve Months Ended February 29, 1996
Notes to Consolidated Financial Statements
2.Financial Statement Schedule
3.Other Exhibits
EXHIBIT DESCRIPTION
------- -----------
2. Plan and Agreement of Merger and Amalgamation, dated as of May 13, 1997,
among the Company, SGI Holding Corporation Limited, IEL and Harrah's
Interactive Investment Company. (1)
3.i(a) Articles of Incorporation (Yukon Territory). (2)
3.i(b) Certificate of Continuance (Bermuda). (3)
3.ii** Bye-Laws as amended.
4.1 Escrow Agreement dated May 27, 1992, as amended, among Montreal Trust
Company of Canada, the Company and certain shareholders. (4)
4.2 Redemption Agreement, dated as of February 25, 1997, between the Company
and Anthony Clements and Rex Fortescue. (5)
4.3 Redemption and Cancellation Agreement, dated as of April 30, 1997, between
the Company and Sky Games International, Inc. (6)
4.4 Shareholder Rights Agreement, dated June 17, 1997, between the Company and
Harrah's Interactive Investment Company. (7)
4.5 Registration and Preemptive Rights Agreement, dated June 17, 1997, between
the Company and Harrah's Interactive Investment Company. (8)
4.6 Registration Rights Agreement, dated June 17, 1997, between the Company
and B/E Aerospace, Inc. (9)
4.7 Subscription Agreement, dated as of October 22, 1997, between the Company
and Henderson International Investments Limited. (10)
4.8 Subscription Agreement, dated as of October 22, 1997, between the Company
and Michael A. Irwin. (11)
15
EXHIBIT DESCRIPTION
------- -----------
10.1 Asset Purchase Agreement, as amended, dated November 7, 1991, among Sky
Games International, Inc. ("SGII"), the Company and Sky Games
International, Corp. (formerly Forty-Four Inc.) ("SGIC") and amendments
thereto. (12)
10.2 Indemnification Agreement dated February 19, 1993, between SGII and SGIC.
(13)
10.3 Cooperation Agreement dated May 20, 1993, by and among BE Aerospace, Inc.
("BEA"), the Company and SGII. (14)
10.4 Termination Agreement and Mutual Release, dated as of December 30, 1994,
among the Company, BEA and SGIC. (15)
10.5* Services Agreement, dated as of November 7, 1995, between IEL and
Singapore Airlines Limited. (16)
10.6* Software License and Software Services Agreement, dated as of November 7,
1995, between IEL and Singapore Airlines Limited. (17)
10.7 Sublease Agreement dated as of June 5, 1997, between IEL and Harrah's
Operating Company, Inc. (18)
10.8 Consulting Agreement, dated as of April 30, 1997, between the Company and
James P. Grymyr. (19)
10.9* Software License Agreement, dated June 17, 1997, between the Company and
Harrah's Interactive Investment Company. (20)
10.10 Continuing Services Agreement, dated June 17, 1997, between the Company
and Harrah's Interactive Entertainment Company. (21)
10.11 Termination Agreement and Release, dated as of June 17, 1997, among the
Company, SGI Holding Corporation Limited, IEL, Harrah's Interactive
Investment Company, and Harrah's Interactive Entertainment Company. (22)
27** Financial Data Schedule
Footnotes
(1) Incorporated by reference to the same numbered exhibit to the
Registrant's Form 8-K as filed with the Securities and Exchange
Commission on June 27, 1997.
(2) Incorporated by reference to Exhibit 1.1 to the Registrant's Annual
Report on Form 20-F (File No. 0-22622) as filed with the Securities and
Exchange Commission on October 12, 1993.
(3) Incorporated by reference to Exhibit 1.2 to the Registrant's Annual
Report on Form 20-F (File No. 0-22622) as filed with the Securities and
Exchange Commission on September 16, 1996.
(4) Incorporated by reference to Exhibit 3.2 to the Registrant's Annual
Report on Form 20-F (File No. 0-22622) as filed with the Securities and
Exchange Commission on October 12, 1993.
(5) Incorporated by reference to Exhibit 3.12 to the Registrant's Annual
Report on Form 20-F (File No. 0-22622) as filed with the Securities and
Exchange Commission on September 12, 1997.
(6) Incorporated by reference to Exhibit 3.13 to the Registrant's Annual
Report on Form 20-F (File No. 0-22622) as filed with the Securities and
Exchange Commission on September 12, 1997.
(7) Incorporated by reference to Exhibit 3.15 to the Registrant's Annual
Report on Form 20-F (File No. 0-22622) as filed with the Securities and
Exchange Commission on September 12, 1997.
(8) Incorporated by reference to the Exhibit 4(a) to the Registrant's Form 8-
K as filed with the Securities and Exchange Commission on June 27, 1997.
(9) Incorporated by reference to the Exhibit 4(b) to the Registrant's Form 8-
K as filed with the Securities and Exchange Commission on June 27, 1997.
(10) Incorporated by reference to Exhibit 3.22 to the Registrant's Quarterly
Report on Form 10-Q as filed with the Securities and Exchange Commission
on November 19, 1997.
16
(11) Incorporated by reference to Exhibit 3.23 to the Registrant's Quarterly
Report on Form 10-Q as filed with the Securities and Exchange Commission
on November 19, 1997.
(12) Incorporated by reference to Exhibit 3.1 to the Registrant's Annual Report
on Form 20-F (File No. 0-22622) as filed with the Securities and Exchange
Commission on October 12, 1993.
(13) Incorporated by reference to Exhibit 3.4 to the Registrant's Annual Report
on Form 20-F (File No. 0-22622) as filed with the Securities and Exchange
Commission on October 12, 1993.
(14) Incorporated by reference to Exhibit 3.5 to the Registrant's Annual Report
on Form 20-F (File No. 0-22622) as filed with the Securities and Exchange
Commission on October 12, 1993.
(15) Incorporated by reference to Exhibit 3.8 to the Registrant's Annual Report
on Form 20-F (File No. 0-22622) as filed with the Securities and Exchange
Commission on October 30, 1995.
(16) Incorporated by reference to Exhibit 3.9 to the Registrant's Annual Report
on Form 20-F (File No. 0-22622) as filed with the Securities and Exchange
Commission on September 16, 1996.
(17) Incorporated by reference to Exhibit 3.10 to the Registrant's Annual
Report on Form 20-F (File No. 0-22622) as filed with the Securities and
Exchange Commission on September 16, 1996.
(18) Incorporated by reference to Exhibit 3.11 to the Registrant's Annual
Report on Form 20-F (File No. 0-22622) as filed with the Securities and
Exchange Commission on September 12, 1997.
(19) Incorporated by reference to Exhibit 3.14 to the Registrant's Annual
Report on Form 20-F (File No. 0-22622) as filed with the Securities and
Exchange Commission on September 12, 1997.
(20) Incorporated by reference to Exhibit 3.16 to the Registrant's Annual
Report on Form 20-F (File No. 0-22622) as filed with the Securities and
Exchange Commission on September 12, 1997.
(21) Incorporated by reference to Exhibit 3.17 to the Registrant's Annual
Report on Form 20-F (File No. 0-22622) as filed with the Securities and
Exchange Commission on September 12, 1997.
(22) Incorporated by reference to Exhibit 3.21 to the Registrant's Annual
Report on Form 20-F (File No. 0-22622) as filed with the Securities and
Exchange Commission on September 12, 1997.
*Confidential treatment has been requested.
**Submitted herewith.
(b) REPORTS FILED ON FORM 8-K
8-K filed October 15, 1997 for capital raising events occurring on September
30, 1997.
8-K filed December 24, 1997 for capital raising events occurring on December
17, 1997.
17
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES AND EXCHANGE ACT OF 1934, THE
REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE
UNDERSIGNED THEREUNTO DULY AUTHORIZED.
Interactive Entertainment Limited
/s/ Gordon Stevenson
By: _________________________________
Dated: March 30, 1998 President and Chief Executive
Officer
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS
REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE
REGISTRANT IN THE CAPACITIES AND ON THE DATES INDICATED.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ Charles L. Atwood Director March 30, 1998
____________________________________
Charles L. Atwood
/s/ John M. Boushy Director March 30, 1998
____________________________________
John M. Boushy
Director March 30, 1998
____________________________________
Malcolm P. Burke
/s/ Anthony P. Clements Director March 30, 1998
____________________________________
Anthony P. Clements
Director March 30, 1998
____________________________________
Brian Deeson
/s/ Laurence S. Geller Director and Chairman March 30, 1998
____________________________________
Laurence S. Geller
/s/ Phillip Gordon Director March 30, 1998
____________________________________
Phillip Gordon
Director March 30, 1998
____________________________________
Amnon Shiboleth
/s/ Gordon Stevenson Director, President and March 30, 1998
____________________________________ Chief Executive Officer
Gordon Stevenson
Director March 30, 1998
____________________________________
Judy Wormser
/s/ David Lamm Chief Financial Officer March 30, 1998
____________________________________
David Lamm
/s/ Michael A. Irwin Controller and Principal March 30, 1998
____________________________________ Accounting Officer
Michael A. Irwin
18
REPORT OF INDEPENDENT AUDITORS
THE SHAREHOLDERS OF INTERACTIVE ENTERTAINMENT LIMITED AND SUBSIDIARIES
We have audited the accompanying consolidated balance sheet of Interactive
Entertainment Limited and Subsidiaries as of December 31, 1997, and the
related consolidated statements of operations, shareholders' equity, and cash
flows for the ten months then ended. Our audit also included the financial
statement schedule listed in the Index at Item 14(a). These financial
statements and schedule are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements and
schedule based on our audit. The consolidated financial statements of
Interactive Entertainment Limited and Subsidiaries for the years ended
February 28, 1997 and February 29, 1996, were audited by other auditors whose
report dated April 28, 1997 (except for Note 11(b), as to which the date is
May 14, 1997), expressed an unqualified opinion on those statements.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the December 31, 1997 financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of Interactive Entertainment Limited and Subsidiaries at December 31, 1997,
and the consolidated results of its operations and its cash flows for the ten
months ended December 31, 1997, in conformity with generally accepted
accounting principles. 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.
Memphis, Tennessee
February 11, 1998, except for the second paragraph of Note 14,
as to which the date is March 19, 1998
F-1
INTERACTIVE ENTERTAINMENT LIMITED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, FEBRUARY 28,
1997 1997
------------ ------------
ASSETS
------
Current assets
Cash and cash equivalents.......................... $ 1,239,864 $ 626,074
Accounts and notes receivable, less allowance for
doubtful accounts of $46,828 at December 31, 1997
.................................................. 3,859 119,768
Prepaid expenses................................... 97,205 61,975
----------- -----------
Total current assets............................. 1,340,928 807,817
Property and Equipment
Land............................................... -- 800,000
Furniture, fixtures and equipment.................. 974,568 643,492
----------- -----------
974,568 1,443,492
Less accumulated depreciation...................... (154,610) (294,189)
----------- -----------
Property and equipment, net.......................... 819,958 1,149,303
Software under development........................... 1,930,218 1,357,869
Other assets......................................... 165,599 209,587
Goodwill............................................. 13,138,704 --
----------- -----------
Total assets..................................... $17,395,407 $ 3,524,576
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Current liabilities..................................
Accounts payable and accrued expenses.............. $ 644,051 $ 979,948
----------- -----------
Total current liabilities........................ 644,051 979,948
Convertible debentures............................... 530,000 --
Notes payable........................................ -- 2,600,000
Minority interest.................................... -- 277,249
Shareholders' equity (deficit)
Class A preferred shares, $.01 par value,
authorized--3,000 shares; outstanding--2,737
shares at December 31, 1997....................... 27 --
Class B preferred shares, $.01 par value,
authorized--5,000,000 shares; outstanding--1,000
shares at December 31, 1997....................... 10 --
Common shares, authorized--50,000,000 shares;
outstanding--19,428,334 par value US$.01 at
December 31, 1997 and 13,314,020 par value C$.01
at February 28, 1997.............................. 194,283 106,752
Additional paid-in-capital......................... 63,512,559 16,027,379
Accumulated deficit................................ (47,485,523) (16,466,752)
----------- -----------
Total shareholders' equity (deficit)............. 16,221,356 (332,621)
----------- -----------
Total liabilities and shareholders' equity....... $17,395,407 $ 3,524,576
=========== ===========
See accompanying notes to consolidated financial statements.
F-2
INTERACTIVE ENTERTAINMENT LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
TWELVE MONTHS ENDED
TEN MONTHS ENDED ----------------------
DECEMBER 31, FEBRUARY FEBRUARY
1997 28, 1997 29, 1996
---------------- ---------- ----------
Operating Expenses
General and administrative.......... $ 2,376,127 $ 875,779 $1,862,742
Consulting and contract labor....... 3,092,289 1,195,068 707,090
Marketing........................... 351,582 378,037 209,196
Management fees..................... 107,584 211,000 171,307
Legal............................... 640,456 229,353 220,989
Interest expense.................... 1,012,243 300,388 605,929
Depreciation and amortization....... 2,846,580 87,976 48,903
Amalgamation expense................ 18,065,734 -- --
Interest income..................... (17,616) (63,738) (118,163)
Write-down of assets................ 676,899 1,339,279 772,731
----------- ---------- ----------
Loss before minority interest and
extraordinary item................... 29,151,878 4,553,142 4,480,724
Minority interest..................... (163,841) (372,829) (313,590)
----------- ---------- ----------
Loss before extraordinary item........ 28,988,037 4,180,313 4,167,134
Extraordinary loss.................... 1,824,222 -- --
----------- ---------- ----------
Net loss.............................. $30,812,259 $4,180,313 $4,167,134
=========== ========== ==========
BASIC AND DILUTED EARNINGS PER SHARE
Numerator for basic and diluted
earnings per share:
Loss before extraordinary item...... $28,988,037 $4,180,313 $4,167,134
Preferred stock dividends........... 206,512 -- --
----------- ---------- ----------
Loss to common shareholders before
extraordinary item................. 29,194,549 4,180,313 4,167,134
Extraordinary loss.................. 1,824,222 -- --
----------- ---------- ----------
Loss to common shareholders......... $31,018,771 $4,180,313 $4,167,134
=========== ========== ==========
Denominator for basic and diluted
earnings per share--weighted average
shares outstanding................... 15,562,834 9,043,687 7,942,332
=========== ========== ==========
Loss before extraordinary item........ $1.87 $0.46 $0.52
Extraordinary loss ................... 0.12 -- --
----------- ---------- ----------
Net loss per share.................... $1.99 $0.46 $0.52
=========== ========== ==========
See accompanying notes to consolidated financial statements.
F-3
INTERACTIVE ENTERTAINMENT LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
CLASS A CLASS B
PREFERRED STOCK PREFERRED STOCK COMMON STOCK
---------------- ---------------- -------------------- ADDITIONAL
NUMBER NUMBER NUMBER PAID-IN ACCUMULATED
OF SHARES AMOUNT OF SHARES AMOUNT OF SHARES AMOUNT CAPITAL DEFICIT TOTAL
--------- ------ --------- ------ ---------- -------- ----------- ------------ ------------
Balance, February 28,
1995................... -- $ -- -- $ -- 10,815,624 $ 88,193 $ 7,792,932 $ (8,119,305) $ (238,180)
Net loss............... -- -- -- -- -- -- -- (4,167,134) (4,167,134)
Exercise of stock
options............... -- -- -- -- 103,500 792 193,459 -- 194,251
Issuance of stock
options to non-
employees............. -- -- -- -- -- -- 703,000 -- 703,000
Issuance of shares on
debt conversion....... -- -- -- -- 125,000 945 499,160 -- 500,105
Issuance of shares..... -- -- -- -- 1,002,310 7,521 2,946,262 -- 2,953,783
----- ----- ----- ----- ---------- -------- ----------- ------------ ------------
Balance, February 29,
1996................... -- -- -- -- 12,046,434 97,451 12,134,813 (12,286,439) (54,175)
Net loss............... -- -- -- -- -- -- -- (4,180,313) (4,180,313)
Exercise of warrants... -- -- -- -- 893,086 6,547 2,784,961 -- 2,791,508
Exercise of stock
options............... -- -- -- -- 37,500 276 63,833 -- 64,109
Issuance of shares on
debt conversion....... -- -- -- -- 162,000 1,191 563,809 -- 565,000
Issuance of shares..... -- -- -- -- 175,000 1,287 479,963 -- 481,250
----- ----- ----- ----- ---------- -------- ----------- ------------ ------------
Balance, February 28,
1997................... -- -- -- -- 13,314,020 106,752 16,027,379 (16,466,752) (332,621)
Net loss............... -- -- -- -- -- -- -- (30,812,259) (30,812,259)
Preferred stock
dividends............. -- -- -- -- -- -- -- (206,512) (206,512)
Change in par value.... -- -- -- -- -- 26,387 (26,387) -- --
Issuance of shares on
debenture conversion.. -- -- -- -- 808,520 8,085 1,625,165 -- 1,633,250
Issuance of shares as
interest on
debentures............ -- -- -- -- 44,289 443 140,120 -- 140,563
Beneficial conversion
feature on convertible
debentures............ -- -- -- -- -- -- 628,041 -- 628,041
Cancellation of
performance shares.... -- -- -- -- (3,525,000) (35,250) 35,250 -- --
Issuance of shares in
connection with
cancellation of
performance shares.... -- -- -- -- 588,923 5,889 1,834,495 -- 1,840,384
Issuance of shares for
consulting agreement.. -- -- -- -- 586,077 5,861 2,411,707 -- 2,417,568
Issuance of shares in
connection with the
amalgamation.......... -- -- -- -- 7,086,915 70,870 33,702,268 -- 33,773,138
Issuance of Class A
preferred stock....... 2,737 27 -- -- -- -- 2,737,416 -- 2,737,443
Beneficial conversion
feature on Class A
preferred stock....... -- -- -- -- -- -- 1,824,222 -- 1,824,222
Issuance of Class B
preferred stock....... -- -- 1,000 10 -- -- 934,000 -- 934,010
Issuance of warrants... -- -- -- -- -- -- 92,223 -- 92,223
Issuance of shares..... -- -- -- -- 524,590 5,246 1,546,660 -- 1,551,906
----- ----- ----- ----- ---------- -------- ----------- ------------ ------------
Balance, December 31,
1997................... 2,737 $ 27 1,000 $ 10 19,428,334 $194,283 $63,512,559 $(47,485,523) $ 16,221,356
===== ===== ===== ===== ========== ======== =========== ============ ============
See accompanying notes to consolidated financial statements.
F-4
INTERACTIVE ENTERTAINMENT LIMITED AND SUBSIDIARIES
STATEMENTS OF CASH FLOW
TEN MONTHS TWELVE MONTHS ENDED
ENDED --------------------------
DECEMBER 31, FEBRUARY 28, FEBRUARY 29,
1997 1997 1996
------------ ------------ ------------
OPERATING ACTIVITIES:
Net loss............................. $(30,812,259) $(4,180,313) $(4,167,134)
Reconciliation of net loss to net
cash used in operating activities:
Depreciation and amortization...... 2,846,580 87,976 48,903
Write-down of assets............... 676,899 1,339,279 772,731
Other.............................. 1,939 -- --
Minority interest.................. (163,841) (372,829) (313,590)
Issuance of stock options to non-
employees......................... -- -- 703,000
Issuance of warrants............... 92,223 -- --
Issuance of shares for financing
fee............................... 650,000 -- --
Issuance of shares for consulting
agreement......................... 2,417,568 -- --
Extraordinary loss on debt
conversion........................ 1,824,222 -- --
Non-cash interest expense.......... 906,114 -- --
Non-cash amalgamation expenses..... 17,965,734 -- --
Changes in assets/liabilities:
Accounts receivable.............. 115,909 16,915 (78,882)
Prepaid expenses................. (35,230) (58,246) 32,292
Other assets..................... (165,599) -- --
Accounts payable and accrued
expenses........................ (335,897) 157,096 124,119
------------ ----------- -----------
Net cash used in operating
activities.................... (4,015,638) (3,010,122) (2,878,561)
------------ ----------- -----------
INVESTING ACTIVITIES:
Purchases of property and
equipment......................... (683,786) (231,812) (9,278)
Proceeds from sales of property and
equipment......................... 435,034 -- --
Notes receivable................... -- 35,971 14,967
Software development............... (572,349) (963,974) (393,895)
------------ ----------- -----------
Net cash used in investing
activities.................... (821,101) (1,159,815) (388,206)
------------ ----------- -----------
FINANCING ACTIVITIES:
Issuance of common stock........... 1,551,906 3,336,867 3,148,034
Issuance of preferred stock........ 934,010 -- --
Advances from (to) affiliated
companies......................... 1,007,875 11,103 (40,107)
Payments on loans/notes payable.... -- -- (179,727)
Borrowings on note payable......... -- 322,819 --
Proceeds from issuance of
debentures........................ 2,163,250 -- --
Payment of preferred stock
dividends......................... (206,512) -- --
Non-controlling interest........... -- 400,000 500,000
------------ ----------- -----------
Net cash provided by financing
activities........................ 5,450,529 4,070,789 3,428,200
------------ ----------- -----------
Net increase (decrease) in cash.... 613,790 (99,148) 161,433
Cash, beginning of period.......... 626,074 725,222 563,789
------------ ----------- -----------
Cash, end of period................ $ 1,239,864 $ 626,074 $ 725,222
============ =========== ===========
Supplemental Cash Flow Information:
Cash paid for income taxes......... $ 7,469 $ 13,000 $ --
============ =========== ===========
Cash paid for interest............. $ 10,893 $ -- $ --
============ =========== ===========
For supplemental disclosures of cash flow information, see Notes 2, 3, 4, 7, 8,
11, 12 and 13.
See accompanying notes to consolidated financial statements.
F-5
INTERACTIVE ENTERTAINMENT LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--NATURE OF OPERATIONS
The Company is a Bermuda exempted company which, in June 1997, changed its
name from Sky Games International Ltd. ("SGI") to Interactive Entertainment
Limited. The Company's principal business objective is to develop, implement
and manage computerized, remote gaming software for use by passengers on
international airline flights.
The Company has entered into a contract to provide its gaming software to
one international airline, Singapore Airlines ("SIA"). SIA has selected the
Matsushita Avionics Systems Corporation ("MASC") hardware platform and
operating system for its interactive entertainment system. The Company has
been in the process of integrating its software with the MASC network and
operating system, and other third party provided software with which the
Company's software is also required to be integrated pursuant to its
agreements with SIA. Following a series of laboratory tests, the Company's
software was certified by MASC on August 25, 1997. The Company conducted a
series of Application Test Programs ("ATP") with SIA and received
certification from SIA on October 9, 1997. Following additional testing on
November 7, 1997, SIA has authorized the Company to proceed with technical
trials onboard an aircraft. Although the Company believes the technical trials
will be successful, there is no assurance of such success, or if it does
occur, when it will occur. Management continues to believe the success of its
software on Singapore Airlines will be critical to its ability to secure
additional airline contracts. The Company has yet to receive any revenues
under its agreement with Singapore Airlines and may never receive any such
anticipated revenues if its software is not successfully implemented with
Singapore Airlines.
Until the Company receives sufficient cash flow from operations, additional
funding will be required to allow the Company to continue operations. Based on
discussions with potential investors, management believes the Company will be
successful in obtaining sufficient financing to enable the Company to continue
its operations for the foreseeable future; however, such funding may not be on
terms that are as favorable to those available to more stable companies and
may be dilutive to current stockholders.
On April 23, 1997, the Board of Directors of the Company approved and
adopted a resolution changing the fiscal year end of the Company to December
31 of each year from the last day of February of each year.
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Cash and Cash Equivalents
The Company considers cash on hand, deposits in banks and short-term
investments with maturities of three months or less as cash and cash
equivalents.
Software Development
All software production costs are being capitalized until the software is
available for general release to customers, in accordance with the provisions
of Statement of Financial Accounting Standards No. 86, Accounting for the
Costs of Computer Software to be Sold, Leased, or Otherwise Marketed. Once
capitalization ceases, the software costs will be amortized using the
straight-line method over the remaining estimated economic life of the
product, currently estimated at three to five years.
Property and Equipment
The Company's property and equipment is recorded at cost and, beginning
March 1, 1997, depreciated using the straight-line method over its estimated
economic life which is generally three to five years. Prior to March 1, 1997,
depreciation of property and equipment was computed using a declining balance
method which
F-6
INTERACTIVE ENTERTAINMENT LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
approximated the straight-line method. Additions and improvements that
materially extend the useful lives are capitalized, while repairs and
maintenance costs are expensed as incurred. Depreciation expense was
approximately $111,000, $88,000 and $49,000 for the ten month period ended
December 31, 1997 and the twelve month periods ended February 28, 1997 and
February 29, 1996, respectively.
Goodwill
The goodwill, which arose from the acquisition of the minority interest of
Old IEL discussed in Note 3, is being amortized on a straight-line basis over
three years. Management regularly evaluates whether or not the future
undiscounted cash flows of the Company are sufficient to recover the carrying
amount of this asset. Additionally, management continually monitors such
factors as the status of new or proposed legislation, the competitive
environment and advances in the computer software and hardware industries. If
the estimated future undiscounted cash flows are not sufficient to recover the
carrying amount of this asset and, accordingly, an impairment has occurred,
management intends to write down the carrying amount to its estimated fair
value based on discounted cash flows. The amount of amortization expense
recorded for the period from the date of the acquisition (June 17, 1997)
through December 31, 1997, totaled approximately $2,736,000.
Impairment of Long-Lived Assets
In accordance with Statement of Financial Accounting Standard No. 121,
Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets
to be Disposed of, management continually evaluates whether events or changes
in circumstances indicate that the carrying amount of long-lived assets may
not be recoverable. Based on management's evaluations, and except as discussed
below, no significant impairments of long-lived assets occurred through
December 31, 1997.
Through its wholly-owned subsidiary, Creator Island Equities, Inc. the
Company owned approximately 70 acres of land with a net book value of
$800,000. The subsidiary also owned other assets including irrigation
equipment, greenhouses, office equipment, nursery equipment, construction
equipment, vehicles, and shop equipment associated with this real estate.
These other assets had a net book value of approximately $83,000 at September
30, 1997. Based upon the current fair market value of the property, the
Company recorded an asset valuation adjustment of approximately $449,000 in
September 1997. As discussed in Note 11, the asset valuation adjustment is
included in the Consolidated Statement of Operations for the ten months ended
December 31, 1997 as write-down of assets. The land and other assets were sold
in November 1997 for approximately the reduced carrying value.
Through another wholly-owned subsidiary, Sky Games International Corp., the
Company owned certain equipment and other assets, specifically gaming
technology parts, which were written off in the ten months ended December 31,
1997 due to technological obsolescence. The write-downs during the ten months
ended December 31, 1997, were approximately $18,000 and $210,000 for equipment
and other assets, respectively.
Stock-Based Compensation
The Company accounts for employee stock-based compensation using the
intrinsic value method prescribed in Accounting Principles Board Opinion No.
25, Accounting for Stock Issued to Employees, (APB No. 25) and related
interpretations.
Loss Per Share
In 1997, the Financial Accounting Standards Board issued Statement No. 128,
Earnings per Share (SFAS No. 128). SFAS No. 128 replaced the calculation of
primary and fully diluted earnings per share with basic and
F-7
INTERACTIVE ENTERTAINMENT LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
diluted earnings per share. Unlike primary earnings per share, basic earnings
per share excludes any dilutive effects of options, warrants and convertible
securities. Diluted earnings per share is very similar to the previously
reported fully diluted earnings per share. For the periods ended December 31,
1997, February 28, 1997, and February 29, 1996, there is no difference between
basic and diluted loss per share as all stock options, warrants, convertible
debentures and convertible preferred stock are antidilutive for the periods
presented. All loss per share amounts for all periods have been presented, and
where appropriate, restated to conform to the SFAS No. 128 requirements.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries: Sky Games International Corp. (a Nevada
corporation), Creator Island Equities Inc., (a British Columbia corporation)
and IEL (Singapore) Pte. Ltd. (a Singapore corporation). For periods prior to
the acquisition of the minority interest in Old IEL discussed in Note 3, the
consolidated financial statements also include the accounts of SGI Holding
Corporation Ltd. and the Company's 80% ownership of Old IEL. All material
intercompany transactions have been eliminated in consolidation.
Recently Issued Accounting Standards
During 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, Reporting Comprehensive Income (SFAS
No. 130) and Statement of Financial Accounting Standards No. 131, Disclosures
about Segments of an Enterprise and Related Information (SFAS No. 131). Both
statements are effective for fiscal years beginning after December 15, 1997.
SFAS No. 130 establishes new rules for the reporting and display of
comprehensive income and its components in financial statements. The Company
is currently evaluating the reporting formats recommended under this
statement. SFAS No. 131 establishes a new method by which companies report
operating segment information. This method is based on the manner in which
management organizes the segments within a company for making operating
decisions and assessing performance. The Company is currently evaluating the
provisions of this statement.
Foreign Currency Translation
Canadian currency assets and liabilities are translated into United States
dollars at the exchange rate prevailing at the balance sheet date. Revenue and
expenses are translated at the average exchange rate during the year.
Translation gains and losses are not material.
NOTE 3--ACQUISITION OF MINORITY INTEREST
Prior to June 17, 1997, the Company operated its principal business
activities through its indirectly 80%-owned subsidiary, Interactive
Entertainment Limited ("Old IEL"). The remaining 20% of Old IEL was held by an
affiliate of Harrah's Entertainment, Inc. (which, together with its
affiliates, is referred to herein as "Harrah's"). Harrah's also managed the
operations of Old IEL pursuant to a management agreement effective December
30, 1994, (the "Management Agreement").
F-8
INTERACTIVE ENTERTAINMENT LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Effective June 17, 1997, pursuant to a Plan and Agreement of Merger and
Amalgamation dated May 13, 1997, Old IEL was merged into the Company (the
"Amalgamation"). As part of the Amalgamation, the Management Agreement with
Harrah's was terminated. Harrah's received a total of 5,879,040 shares of the
Company's $.01 par value common stock (the "Common Stock") in exchange for its
20% ownership interest in Old IEL and as consideration for the termination of
the Management Agreement. Of the total shares issued to Harrah's, 3,617,871
shares were allocated to the acquisition of Harrah's 20% ownership interest in
Old IEL and 2,261,169 shares were allocated to the termination of the
Management Agreement. This allocation was based on the Amalgamation
negotiation discussions held between the Company and Harrah's.
The acquisition of the minority interest, previously held by Harrah's, has
been accounted for under the purchase method. The value of the purchase price
was based on the average quoted market price of the Company's Common Stock
when the Amalgamation was announced, or $4.466 per share. This transaction
represents a non-cash transaction for purposes of the Consolidated Statements
of Cash Flows.
The shares issued to terminate the Management Agreement were also valued at
$4.466 per share, and the $10,098,000 value of the shares is reflected as part
of the amalgamation expense for the ten months ended December 31, 1997. Prior
to termination, the Company paid Harrah's a monthly fee of $10,000 and was
obligated to pay Harrah's a percentage of future gross revenues.
Prior to the Amalgamation, Harrah's had agreed, pursuant to a funding
agreement, to loan up to $1,000,000 (the "Harrah's Loan") to Old IEL. Upon
closing of the Amalgamation, the outstanding principal and accrued interest of
the Harrah's Loan converted automatically into 1,007,875 shares of Common
Stock at $1.00 per share. Since the Harrah's Loan was convertible into Common
Stock at less than the current market, a beneficial conversion feature was
included in the Harrah's Loan. This beneficial conversion feature was valued
at $3,466,000 and has been included in amalgamation expense for the ten months
ended December 31, 1997.
Amalgamation expense in the Consolidated Statements of Operations is
comprised of the following:
TEN MONTHS ENDED
DECEMBER 31, 1997
-----------------
Termination of Management Agreement..................... $10,098,175
Harrah's Loan........................................... 3,466,000
Harrah's preemptive rights (Note 7)..................... 2,561,175
Cancellation of Performance Shares (Note 13)............ 1,840,384
Closure of Vancouver office............................. 100,000
-----------
Amalgamation expense.................................... $18,065,734
===========
The following unaudited pro forma consolidated results of operations for the
ten months ended December 31, 1997 and the year ended February 28, 1997 assume
the acquisition of the minority interest occurred as of March 1, 1996:
TEN MONTHS ENDED
DECEMBER 31, TWELVE MONTHS ENDED
1997 FEBRUARY 28, 1997
---------------- -------------------
Pro forma loss before extraordinary
item............................... $30,825,666 $9,844,650
Pro forma net loss.................. $32,649,888 $9,844,650
Pro forma basic and diluted loss per
share.............................. $ 1.94 $ 0.78
NOTE 4--CONVERTIBLE DEBENTURES
During the ten months ended December 31, 1997, the Company issued $2,163,250
of 8% convertible debentures due in 1999. At December 31, 1997, $1,633,250 of
the debentures had been converted into 808,520 shares of Common Stock. The
outstanding balance of convertible debentures as of December 31, 1997 totaled
$530,000.
F-9
INTERACTIVE ENTERTAINMENT LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Subscription dates ranged from July 7 through September 29, 1997. The
debentures are convertible at the lower of 85% of the average of the closing
bid prices of the Common Stock for the five trading days immediately preceding
the execution by the subscriber of its individual subscription for debentures
or 77.5% of the average of the closing bid prices of the Common Stock for the
five trading days immediately preceding the date of conversion.
The debentures contain a feature that provides for conversion into Common
Stock at a price below the current market at the time of issue. The value of
this beneficial conversion feature, totaling approximately $628,000, has been
capitalized in other assets with a corresponding increase to additional paid-
in capital. Placement fees of $149,000 incurred upon sale of the debentures
are also capitalized. The value of the conversion feature and the placement
fees are amortized to interest expense over the original life of the
debenture. Any unamortized amount is expensed upon conversion of the
debenture. At December 31, 1997, the unamortized deferred interest charge and
unamortized placement fees of $148,000 are included in other assets.
The book value of the convertible debentures is a reasonable estimate of the
fair value based on the estimated current incremental borrowing rates for
similar types of borrowing arrangements.
NOTE 5--LEASES
The Company leases certain facilities under an operating lease expiring
April 30, 1999. Total lease and rent expense amounted to $139,000, $38,000,
and $32,000 for the ten month period ending December 31, 1997 and the twelve
month periods ending February 28, 1997 and February 29, 1996, respectively.
NOTE 6--EMPLOYEE BENEFITS
On July 1, 1997, the Company established an employee savings plan that
qualifies under Section 401(k). All employees of the Company may participate
after completion of one year of service by deferring from 1 percent to 16
percent of their eligible compensation. There is no provision for Company
contributions to the Plan.
NOTE 7--SHAREHOLDERS' EQUITY
In December 1994, the Company discontinued an engineering and marketing
arrangement with B/E Aerospace, Inc. ("BEA"). As part of the termination, the
Company issued to BEA a promissory note in the original principal amount of
$2.5 million at 12% per annum. On February 28, 1997, an agreement was reached
with BEA to exchange the note, including accrued and unpaid interest, for
Class A Preference Shares at $1,000 per share. The exchange for 2,737 Class A
Preference Shares was completed in June, 1997.
The Class A Preference Shares are convertible at any time into a number of
shares of Common Stock, determined by dividing $1,000 per share of Class A
Preference Shares, plus any accrued and unpaid dividends thereon by: (i) prior
to February 28, 1999, a conversion price equal to 70% of the average mean of
the closing bid and ask prices of the Common Stock for the 20 trading days
prior to the conversion (the "Market Price"); (ii) after February 28, 1999 and
prior to August 31, 1999, a conversion price equal to 65% of the Market Price;
and (iii) after August 31, 1999, a conversion price equal to 60% of the Market
Price. Dividends on the Class A Preference Shares are cumulative and payable
quarterly at an annual dividend rate of 9%. The Company, at its option, may
redeem the Class A Preference Shares, in whole or in part, at any time and
from time to time, at a redemption price of $1,000 per share plus any accrued
and unpaid dividends thereon. The Company is not
F-10
INTERACTIVE ENTERTAINMENT LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
required to redeem the Class A Preference Shares. Upon liquidation, holders of
the Class A Preference Shares will be entitled to repayment of an amount equal
to $1,000 per share plus accrued and unpaid dividends, prior to any
distributions to holders of Common Stock. Dividends of $206,512, or $75.45 per
share, were paid during the ten months ended December 31, 1997. The Class A
Preference Shares do not have any voting rights.
Since the Preference Shares were convertible into Common Stock at less than
the market value at the time of issue, a beneficial conversion feature existed
requiring that the Preference Shares be valued at the market value of the
underlying Common Stock. Since the resulting valuation of the Preference
Shares exceeded the balance of the note, an extraordinary expense of
approximately $1,824,000 was incurred for early extinguishment of the note.
As part of the Amalgamation, Harrah's entered into the "Registration and
Preemptive Rights Agreement" under which, among other things, Harrah's has the
right to receive additional shares of Company Stock at $.01 per share in order
to maintain their ownership percentage in the Company in the event that the
Class A Preference Shares held by BEA are converted into Common Stock. The
market value of the Common Stock issuable to Harrah's in the event that BEA
elects to convert the Class A Preference Shares, was determined to be
$2,561,000, and this amount has been included in amalgamation expense for the
ten months ended December 31, 1997.
On December 17, 1997, the Company issued 1,000 shares of Series A
Convertible Preference Shares of the Company's Class B Preferred Stock.
Proceeds from the issuance were $1 million (approximately $934,000 net of
offering expenses). The Series A Preference Shares are convertible after three
months into a number of shares of Common Stock, determined by dividing the
stated value of $1,000 per share of Series A Preference Shares by the lesser
of: (A) 110% of the average of the closing bid price for the Common Stock on
the five trading days occurring immediately prior to December 17, 1997 (the
"Fixed Conversion Price") and (B) a price (the "Floating Conversion Price")
calculated by (i) determining the average of the three lowest closing bid
prices for the Common Stock during the thirty trading days occurring
immediately prior to, but not including, the conversion date, and (ii)
multiplying such average by a defined conversion percentage (the "Conversion
Percentage"). The Fixed Conversion Price is $3.2038. The Conversion Percentage
decreases from 100% to 85% as the holding period increases. Dividends on the
Class B Preferred Stock are cumulative and payable upon conversion or maturity
at an annual dividend rate of 8%. Warrants for the purchase of 61,718 shares
of Common Stock were issued in connection with the issuance of the Series A
Preference Shares. The Warrants, which have an exercise price of $3.2038, are
exercisable beginning June 17, 1998 and expire on December 17, 1999 (the
"Maturity Date"). On the Maturity Date, any outstanding Series A Preference
Shares shall be automatically converted into the number of shares of Common
Stock equal to the stated value of the shares divided by the conversion price
then in effect.
Under the agreement, the Company has the option of selling a second tranche
of Class B Preferred Stock with 123,432 warrants for an aggregate purchase
price of $2,000,000. The Company's option with respect to the second tranche,
which expires on June 17, 1998, is not exercisable until the Company's gaming
software has been installed and is available to paying passengers in the
entire cabin of one B-747-400, B-777 or A-340 on Singapore Airlines. Upon
liquidation, holders of the Class B Preferred Shares will be entitled to
repayment of an amount equal to $1,000 per share plus accrued and unpaid
dividends, prior to any distributions to holders of Common Stock. The Class B
Preferred Shares do not have any voting rights.
In October 1997, the Company completed agreements with two investors for the
private placement of 987,463 shares of Common Stock for an aggregate purchase
price of $3.2 million. $1.7 million (approximately $1,552,000 net of offering
expenses) was received upon closing while the remaining $1.5 million (see Note
14) is to be funded upon and is contingent upon completion of the first flight
with the Company's software available
F-11
INTERACTIVE ENTERTAINMENT LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
in all seats of a Singapore Airlines aircraft. For each five shares of Common
Stock purchased and held for a minimum of six months, the investors will
receive one warrant for the purchase of additional shares. Warrants will be
exercisable at a price of $3.8125 per share for 18 months from their issue.
During the ten months ended December 31, 1997, the Company changed the par
value of the Common Stock from C$.01 (Canadian dollars) to $.01 (United States
dollars). The change in par value did not affect any of the existing rights of
shareholders and has been recorded as an adjustment to additional paid-in
capital and Common Stock.
As of December 31, 1997, the Company had reserved 7,773,247 shares of its
Common Stock for issuance pursuant to stock option plans, warrants,
convertible debentures, convertible preferred stock, unexercised stock
subscriptions, and preemptive rights agreements.
NOTE 8--STOCK OPTIONS
The Company follows APB No. 25 in accounting for its employee stock options.
Under APB No. 25, no compensation expense is recognized because the exercise
price of the Company's incentive employee stock options is equal to or greater
than the market price of the underlying stock on the date of grant.
Prior to February 28, 1995, the Directors of the Company issued stock
options to employees and directors under individual agreements between the
Company and the individuals. Exercise prices and terms were determined by the
Board of Directors. At December 31, 1997, no stock options issued prior to
February 28, 1995 are outstanding.
During the year ended February 29, 1996, the Company established and the
Company's shareholders subsequently approved the 1996 Stock Program for the
then upper management, directors and major shareholders of the Company. Under
this plan, the Company may grant options to purchase up to 1,500,000 shares of
Common Stock at prices not less than the fair market value of the stock on the
day of grant. The 1,130,000 options issued under the 1996 Stock Program are
exercisable upon the grant date and expire during 2001 through 2002. No
further grants under the 1996 Stock Program will be made by the Company.
The Company adopted on December 6, 1996, a Directors Stock Ownership Plan
covering 500,000 shares of Common Stock pursuant to which all directors
holding office at December 10th of each year will automatically be granted
options for 10,000 shares of Common Stock at the trading price on such day. On
October 17, 1997, the Board of Directors of the Company approved an amendment
changing the grant date from December 10 to the date of the first meeting of
the Board of Directors following the Company's Annual General Meeting of
shareholders. The 150,000 options granted under this plan are exercisable upon
the grant date and expire ten years after the grant date.
Effective June 16, 1997, the Company established a Management Incentive Plan
(the "MIP") by authorizing the issuance of options for 4,070,105 shares of
Common Stock. The Compensation Committee of the Board of Directors has the
authority to determine the allocation and vesting requirements for such
options issued under the MIP. The exercise price of stock options granted
under the MIP is the market price of the Common Stock on the date of the
grant. A total of 1,200,000 options will vest specifically on the earlier of
sustaining certain stock price levels or ten years from the date of the grant.
The remaining 1,337,950 options outstanding under this plan vest partially
upon employees remaining with the Company for a specified period of time but
primarily upon the Company attaining revenue targets established by the
Compensation Committee of the Board of Directors. In any event, the options
vest ten years from the grant.
F-12
INTERACTIVE ENTERTAINMENT LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
A summary of the Company's stock option activity and related information
follows:
TEN MONTHS ENDED TWELVE MONTHS ENDED
DECEMBER 31, 1997 FEBRUARY 28, 1997 FEBRUARY 29, 1996
------------------------ ------------------------- -------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
OPTIONS EXERCISE PRICE OPTIONS EXERCISE PRICE OPTIONS EXERCISE PRICE
--------- -------------- --------- -------------- --------- --------------
Outstanding at beginning
of period.............. 1,190,000 $3.06 1,167,500 $2.98 1,014,300 $5.56
Granted............... 2,627,950 3.14 60,000 4.13 1,130,000 3.00
Exercised............. -- -- (37,500) 2.32 (103,500) 2.57
Expired............... -- -- -- -- (873,300) 6.06
--------- ----- --------- ----- --------- -----
Outstanding at end of
period................. 3,817,950 $3.11 1,190,000 $3.06 1,167,500 $2.98
========= ===== ========= ===== ========= =====
Options exercisable at
period end............. 1,190,000 $3.06 1,190,000 $3.06 1,167,500 $2.98
========= ===== ========= ===== ========= =====
Weighted average fair
value of options
granted during the $1.99 $2.61 $1.90
period................. ===== ===== =====
Exercise prices for stock options outstanding at December 31, 1997, ranged
from $3.00 to $4.13. The weighted average remaining life of the outstanding
stock options is approximately 8 years.
Pro forma information regarding net loss and loss per share is required by
Statement of Financial Accounting Standards No. 123, Accounting for Stock-
Based Compensation (SFAS No. 123) and has been determined as if the Company
had accounted for its employee stock options under the fair value method. The
fair value for these options at the date of grant was estimated using a Black-
Scholes option pricing model with the following weighted average assumptions
for the ten months ended December 31, 1997 and the years ended February 28,
1997 and February 29, 1996: volatility factor of the expected market value of
the Company's Common Stock of 0.715; weighted average expected life of the
options of 5 years; risk-free interest rate of 5.75%; and no dividend
payments.
The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option valuation models require highly
subjective assumptions including the expected stock price volatility. Because
the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a
reliable single measure of the fair value of its employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The
Company's pro forma information follows:
TEN MONTHS ENDED TWELVE MONTHS ENDED
DECEMBER 31, -----------------------------------
1997 FEBRUARY 28, 1997 FEBRUARY 29, 1996
---------------- ----------------- -----------------
Net loss.................. $30,812,259 $4,180,313 $4,167,134
SFAS No. 123 compensation
expense.................. 438,574 156,600 1,444,000
----------- ---------- ----------
SFAS No. 123 pro forma net
loss..................... $31,250,833 $4,336,913 $5,611,134
=========== ========== ==========
Basic and diluted pro
forma loss per share..... $ 2.02 $ 0.48 $ 0.71
=========== ========== ==========
F-13
INTERACTIVE ENTERTAINMENT LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Because SFAS No. 123 applies only to stock-based compensation awards for the
fiscal year ended February 29, 1996 and future years, the pro forma
disclosures under SFAS No. 123 are not likely to be indicative of future
disclosures until the disclosures reflect all outstanding, nonvested awards.
During the year ended February 29, 1996, the Company issued 370,000 stock
options under the 1996 Stock Program to non-employees for services provided to
the Company. The fair value of the stock options of $703,000 was determined
using the same method and assumptions described in the fourth preceding
paragraph and was recorded as expense during the year ended February 29, 1996.
The options, which remain outstanding at December 31, 1997, have an exercise
price of $3.00.
NOTE 9--STOCK WARRANTS
As of December 31, 1997, the Company had outstanding stock warrants for
161,718 shares of its Common Stock as follows:
EXERCISE
NUMBER OF WARRANTS PRICE EXPIRATION DATE
------------------ -------- ---------------
20,000 $3.50 March 17, 1999
61,718 $3.20 December 17, 1999
4,900 $4.00 June 30, 2002
17,500 $4.80 June 30, 2002
57,600 $4.80 August 31, 2002
NOTE 10--INCOME TAXES
As a Bermuda exempted company, the Company is not currently subject to
income tax filing requirements in Bermuda. The Company operates in the U.S. as
a branch of a foreign corporation. As a foreign corporation with a U.S. trade
or business, the Company will be subject to tax in the U.S. on the income
earned that is effectively connected with that trade or business. Tax
carryforward in taxable jurisdictions have not been determined. Deferred tax
assets, if any, would be fully reserved. Other than the tax associated with
the U.S. earned interest income, there are no income tax provisions, benefits,
liabilities or assets reflected in the accompanying financial statements.
NOTE 11--WRITE-DOWN OF ASSETS
The following assets were written down to a nominal or current value in the
period due to impairment in the assets value:
TEN MONTHS ENDED TWELVE MONTHS ENDED
DECEMBER 31, -----------------------------------
1997 FEBRUARY 28, 1997 FEBRUARY 29, 1996
---------------- ----------------- -----------------
Land...................... $449,267 $ 442,238 $ --
Furniture, fixtures and
equipment................ 18,045 -- --
Other assets.............. 209,587 209,587 --
Software under
development.............. -- -- 457,275
Notes receivables......... -- 137,803 315,456
Due from affiliated
company.................. -- 549,651 --
-------- ---------- --------
$676,899 $1,339,279 $772,731
======== ========== ========
F-14
INTERACTIVE ENTERTAINMENT LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 12--RELATED PARTY TRANSACTIONS
Pursuant to the Management Agreement, Harrah's managed Old IEL. The
Management Agreement provided for Harrah's to receive a management fee equal
to the greater of $10,000 per whole fiscal month, as defined, or a percentage
of gross revenues, as defined. The Management Agreement was terminated June
17, 1997, in conjunction with the Amalgamation. Management fees totaled
$36,000, $120,000, and $120,000 for the ten month period ending December 31,
1997, and the twelve month periods ending February 28, 1997 and February 29,
1996, respectively.
Under the terms of the Management Agreement, the Company transferred cash to
Harrah's for payments made on the Company's behalf to support its operations,
including accounts payable, payroll and capital expenditures. The net
transfers for the ten month period ending December 31, 1997 and the twelve
month periods ending February 28, 1997 and February 29, 1996 totaled $143,000,
$1,085,000 and $1,391,000, respectively.
The Company was charged a fee by Harrah's for administrative services
(including legal, accounting, information technology and office occupancy).
The Company was charged approximately $150,000 for the ten month period ending
December 31, 1997. This arrangement ended with termination of the Management
Agreement. The Company was charged approximately $523,000 and $184,000 during
the years ended February 28, 1997 and February 29, 1996, respectively.
On June 17, 1997, the Company entered into a Continuing Services Agreement
with Harrah's under which Harrah's provides certain telecommunications,
computer systems support and consulting services to the Company. The Company
incurred a cost of approximately $101,000 during the ten month period ending
December 31, 1997.
Effective June 5, 1997, the Company entered into a lease (the "Sublease
Agreement") with Harrah's for the office space occupied by the Company. The
Sublease Agreement is for a period of 23 months at a monthly cost of
approximately $11,000. Future payments under this Sublease Agreement aggregate
to approximately $132,000 in 1998 and $44,000 in 1999. In conjunction with the
Sublease Agreement and with the Amalgamation, the Company purchased certain
leasehold improvements, computer hardware, computer software and office
equipment from Harrah's. The total purchase price was approximately $42,000.
During 1996, the Company entered into a sublicense agreement with Harrah's,
which provides the Company with rights to use an immediate authorization
credit/debit system that Harrah's is developing. The Company reimbursed
Harrah's for a portion of the development costs which totaled $70,000 and
$180,000 for the ten months ended December 31, 1997 and the year ended
February 28, 1997, respectively.
On June 17, 1997, in conjunction with the Amalgamation, the Company entered
into a Software License Agreement with Harrah's (the "License Agreement"). The
License Agreement is a fully-paid, perpetual, world-wide license to Harrah's
and its affiliates to use the Company's gaming technology in non-competitive
uses in traditional casino venues owned, operated or managed by Harrah's
affiliates. The License Agreement includes source codes for all software, but
neither party to the License Agreement has any obligations to share or provide
any improvements or modifications with the other party.
The Company paid approximately $291,000, $335,000 and $226,000 during the
ten months ended December 31, 1997, and the twelve months ended February 28,
1997 and February 29, 1996, respectively, to directors and companies with
common directors for management and consulting services and for reimbursement
of expenses.
On April 30, 1997, the Company entered into a Consulting Agreement with
James P. Grymyr, then a director of the Company, whereby Mr. Grymyr would
provide consulting services to the Company as requested by the Company from
time to time. Under the terms of the Consulting Agreement, the Company has
issued to
F-15
INTERACTIVE ENTERTAINMENT LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Mr. Grymyr 586,077 shares of Common Stock as consideration for all such
consulting services both past and future. The Company expects any future
consulting services to be minimal. The value of the stock (approximately $2.4
million) is included in the Statements of Operations for the ten months ended
December 31, 1997, as consulting and contract labor.
Geller & Co., of which Laurence Geller is Chairman, performed consulting
services for the Company pursuant to a retainer agreement that commenced in
February, 1996 and terminated August 14, 1997. Geller & Co. was paid a monthly
retainer of $5,000. Pursuant to Geller & Co.'s retainer, a grant of options
for 200,000 shares of Common Stock with an exercise price of $3.00 and a term
of ten years was also made to Geller & Co. On May 29, 1997, the Company
granted an additional 1,000,000 options with the same terms above to Geller &
Co. for Laurence Geller's services as Chairman of the Board. In addition,
Geller & Co. received 200,000 shares of Common Stock that vest upon the
closing of a major financing. The Board has determined that the Amalgamation
which occurred June 17, 1997 constituted a major financing, and, consequently,
the 200,000 share success fee has vested and an expense of $650,000 was
recognized. This amount is included on the Consolidated Statement of
Operations as general and administrative expense. Mr. Geller has been Chairman
of the Board of Directors of the Company since September 30, 1996. The annual
compensation of the Chairman of the Board is $100,000 and is unpaid until the
Company generates revenue under its agreement with Singapore Airlines.
NOTE 13--AGREEMENT REGARDING REDEMPTION OF PERFORMANCE SHARES
When the Company acquired the rights to the inflight gaming software from
Sky Games International, Inc. ("SGII") on November 7, 1991, a portion of the
consideration was 3,000,000 shares of Common Stock which, according to then
applicable requirements, were placed in escrow, to be released on the basis of
one share for each U.S. $1.78 of net cash flow generated from the assets over
a ten-year period (the "Performance Shares"). The Performance Shares were
issued at a deemed price of $.1155 per share with 2,000,000 shares issued to
SGII (87% of the outstanding stock of which was owned by James P. Grymyr,
formerly a director of the Company, and his wife) and 1,000,000 shares were
issued to Anthony Clements, a director of the Company. An additional 525,000
shares, which were issued to Dr. Rex E. Fortescue, formerly a director of the
Company, are held in the escrow on the same terms and are also included as
Performance Shares. Each of Messrs. Clements and Fortescue, as of April 30,
1997, have agreed to allow the Company to redeem and cancel the Performance
Shares when and if they are released from escrow for any reason whatsoever
(the "Redemption Agreement"). As consideration for such agreement to tender
the Performance Shares for cancellation by the Company in the event they are
ever released from the escrow, the Company has issued to Messrs. Clements and
Fortescue, 333,333 and 175,000 shares of Common Stock, respectively. SGII, as
of April 30, 1997, has also agreed that it will tender the 2,000,000
Performance Shares which it holds for cancellation by the Company when and if
such Performance Shares are released from escrow for any reason whatsoever. As
consideration of such agreement, in February, 1997, the Company expensed the
outstanding balance of a note made by SGII to the Company in the approximate
amount of $550,000 and has issued to SGII 80,590 shares of Common Stock (the
"Redemption and Cancellation Agreement"). In the event the Performance Shares
are not released prior to six months after the end of the Company's financial
year ending in the year 2002, the Performance Shares will automatically be
canceled in accordance with the terms of the escrow agreement. The value of
the 588,923 shares of Common Stock issued as consideration for the agreement
was determined to be approximately $1,840,000. This amount is included on the
Consolidated Statement of Operations as amalgamation expense.
Each of Messrs. Clements and Fortescue and SGII have the right to include
the 588,923 shares of Common Stock issued in connection with the Redemption
Agreement and the Redemption and Cancellation Agreement in certain registered
offerings conducted by the Company prior to February 25, 1999. As part of the
agreements to allow the redemption and cancellation of the Performance Shares,
the holders of the Performance Shares have issued an irrevocable proxy to a
bank which has agreed not to vote the Performance Shares at any General
F-16
INTERACTIVE ENTERTAINMENT LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Meeting of Shareholders or otherwise. The irrevocable proxy and the agreement
not to vote the Performance Shares will terminate upon the cancellation of the
Performance Shares. The escrow agent is prohibited from canceling the
Performance Shares under the escrow agreement.
The Performance Shares have no rights and, therefore, are excluded from per
share calculations for all periods presented. Effective April 30, 1997, the
Performance Shares were no longer considered outstanding for financial
statement purposes.
NOTE 14--SUBSEQUENT EVENTS
On January 13, 1998, the Company acquired all of the outstanding capital
stock of Inflight Interactive Limited ("IIL") in exchange for 500,000 shares
of the Company's Common Stock. IIL is a U. K. developer and provider of
amusement games to the airline industry. IIL's games are currently operating
on a number of airlines including Cathay Pacific, Egypt Air, Lauda Air,
Malaysia Airlines, Saudi Arabian Airlines and Virgin Atlantic. The agreement
also provides for the Company to issue up to 250,000 additional shares of
Common Stock to the previous owners of IIL upon achievement of certain
milestones regarding implementation of the Company's software with an
international airline to be designated by the parties. The acquisition will be
accounted for using the purchase method.
On March 19, 1998, the Company began negotiating the modification of the
terms of the remaining portion ($1,500,000) of the private placement of Common
Stock discussed in Note 7. Under the proposed terms, 50% of the remaining
portion ($750,000) would be funded immediately while the other 50% would be
funded under the terms of the original agreement. The subscription price for
the Common Stock would be revised to $2.62. For each Common Share purchased
under this agreement, 0.85 of a warrant to purchase Common Stock would be
issued after a six month holding period of the Common Stock. The warrants, if
issued, would have an exercise price of $2.62 and a term of 18 months.
NOTE 15--QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Financial results by quarter are as follows:
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
-------- ----------- ---------- ----------
Ten Months ended December 31,
1997
Loss before extraordinary
item......................... $219,148(1) $22,435,687(2) $3,183,872 $3,149,330
Extraordinary loss............ -- 1,824,222(3) -- --
-------- ----------- ---------- ----------
Net loss...................... $219,148(1) $24,259,909(2) $3,183,872 $3,149,330
======== =========== ========== ==========
Basic and diluted loss per
share:
Loss per share before
extraordinary item......... $ 0.02(1) $ 2.03(2) $ 0.18 $ 0.17
Extraordinary loss per
share...................... -- 0.17(3) -- --
-------- ----------- ---------- ----------
Loss per share.............. $ 0.02(1) $ 2.20(2) $ 0.18 $ 0.17
======== =========== ========== ==========
Twelve Months ended February
28, 1997
Net loss...................... $563,479 $ 551,542 $ 593,036 $2,472,256
======== =========== ========== ==========
Basic and diluted loss per
share........................ $ 0.07 $ 0.06 $ 0.06 $ 0.26
======== =========== ========== ==========
- --------
(1) Due to the change in the Company's fiscal year end from the last day in
February to December 31, the first quarter amounts represent the results
of operations from March 1, 1997 to March 31, 1997.
(2) Includes effect of the Amalgamation.
(3) Loss on early extinguishment of debt.
F-17
INTERACTIVE ENTERTAINMENT LIMITED AND SUBSIDIARIES
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
TEN MONTHS ENDED DECEMBER 31, 1997 AND YEARS ENDED FEBRUARY 28, 1997 AND
FEBRUARY 29, 1996
BALANCE AT CHARGED TO BALANCE AT
BEGINNING COSTS AND END OF
OF PERIOD EXPENSES DEDUCTIONS PERIOD
---------- ---------- ---------- ----------
Ten months ended December
31, 1997:
Allowance for Doubtful
Accounts............... $ -- $46,828 $ -- $46,828
Year ended February 28,
1997:
None
Year ended February 29,
1996:
None