-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, AaNeQ/y5v/mXBgH/dZ41SqE4WqV+So31nsp3qCtVWBSJGqwYGjgbyQoZe0KfvriB oQqkJUYLk66jITvy77vpNg== 0001005477-97-002641.txt : 19971201 0001005477-97-002641.hdr.sgml : 19971201 ACCESSION NUMBER: 0001005477-97-002641 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19970831 FILED AS OF DATE: 19971128 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: NTN CANADA INC CENTRAL INDEX KEY: 0000797313 STANDARD INDUSTRIAL CLASSIFICATION: CABLE & OTHER PAY TELEVISION SERVICES [4841] IRS NUMBER: 112805051 STATE OF INCORPORATION: NY FISCAL YEAR END: 0831 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-18066 FILM NUMBER: 97730309 BUSINESS ADDRESS: STREET 1: 14 METEOR DR STREET 2: BLDG 18 CITY: ETOBOCOKE ONTARIO STATE: A6 ZIP: L4W 5A1 BUSINESS PHONE: 4166756666 MAIL ADDRESS: STREET 1: 14 METEOR DR CITY: ETOBICOKE ONTARIO STATE: A6 10-K 1 FORM 10-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington D.C. 20549 FORM 10-K (Mark One) |X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED] For the fiscal year ended: August 31, 1997 OR |_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] For the transition period from _________ to __________ Commission file number: 0-18066 NTN CANADA, INC. (Exact name of registrant as specified in its charter) New York 11-2805051 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 14 Meteor Drive, Etobicoke, Ontario M9W 1A4 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (416) 675-6666 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value US$0.0467 Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes |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 the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. |x| Aggregate market value (i.e., last price) of voting stock held by non-affiliates of the Registrant, as of November 10, 1997 US$6,708,195 Indicate the number of shares outstanding of each of the Registrant's classes of common stock, as of November 10, 1997 2,535,359 shares of common stock, par value US$.0467 per share DOCUMENTS INCORPORATED BY REFERENCE: NONE PART I EXCHANGE RATES The currency amounts in this Annual Report on Form 10-K, including the financial statements, are, unless otherwise indicated, expressed in Canadian dollars ("Cdn$"). This Form 10-K contains translations of certain amounts in Canadian dollars into United States dollars ("US$") based upon the exchange rate in effect at the end of the period to which the amount relates, or the exchange rate on the date specified. For such purposes, the exchange rate means the noon buying rate in New York City for cable transfers in Canadian dollars as certified for customs purposes by the Federal Reserve Bank of New York (the "Noon Buying Rate"). These translations should not be construed as representations that the Canadian dollar amounts actually represent such U.S. dollar amounts or that Canadian dollars could be converted into U.S. dollars at the rate indicated or at any other rate. The Noon Buying Rate at the end of each of the five years ended August 31, 1997, the average of the Noon Buying Rates on the last day of each month during each of such fiscal years and the high and low Noon Buying Rate for each of such fiscal year's were as follows:
August 31, ---------------------------------------------------------------- 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- At end of period......... Cdn$1.3885 Cdn$1.3685 Cdn$1.3432 Cdn$1.3712 Cdn$1.3208 Average for period....... 1.3676 1.3634 1.3742 1.3573 1.2718 High for period.......... 1.3942 1.3815 1.4193 1.3890 1.3208 Low for period........... 1.3381 1.3401 1.3410 1.3095 1.1943
On November 19, 1997 the Noon Buying Rate was Cdn$1.3876. Item 1. Business. Formation NTN Canada, Inc. (the "Company") was originally incorporated under the laws of the State of New York on May 12, 1986 under the name Triosearch Inc. On June 9, 1988, Triosearch changed its name to NTN Canada, Inc. The Company presently conducts its operations through a wholly owned subsidiary, NTN Interactive Network Inc. ("NTNIN") which is the principal operating company of the entity. On October 4, 1994, NetStar Enterprises Inc. ("NetStar") (formerly Labatt Communications Inc.), an integrated broadcasting and communications enterprise, acquired approximately 35% of the Company's outstanding common stock for Cdn$4,252,500 (US$3,150,000 on October 4, 1994). On October 2, 1996, NTNIN acquired, effective October 1, 1996, all of the outstanding stock of Magic Lantern Communications Ltd. ("Magic"), pursuant to which Magic became a wholly-owned subsidiary of NTNIN. Magic conducts its operations directly and through its wholly owned subsidiaries 745695 Ontario Ltd. ("Custom Video"), and B.C. Learning Connection ("BCLC"), and its 75% ownership of the outstanding shares of Sonoptic Technologies Inc. ("Sonoptic"). On October 10, 1996, Magic acquired 50% of the outstanding shares of 1113659 Ontario Ltd. ("Viewer Services"), a joint 2 venture operated with International Tele-Film Enterprises Ltd. Reference is hereby made to the Company's current report on Form 8-K, filed with the Securities and Exchange Commission on October 17, 1996, for further information with respect to the Company's acquisition of Magic. Recent Developments Magic entered into an agreement dated August 18, 1997 to acquire certain of the business assets of Image Media Ltd. and 802117 Ontario Inc., trading as Pilot Software ("Image Media"). The agreement was completed on August 31, 1997. On August 20, 1997, NTNIN signed a licensing agreement, through its Hospitality Group, with the Canadian Olympic Association, in which the Company will broadcast a weekly, half-hour interactive game called the Olympic Trivia Challenge. On September 10, 1997 and effective September 1, 1997, NTNIN acquired 51% of the outstanding stock of Interlynx Multimedia, Inc., a Toronto corporation ("Interlynx"). This acquisition will be accounted for as a purchase in fiscal 1998. Financial Information About Industry Segments Reference is hereby made to the Business Sector Data for the years ended August 31 1997 and 1996 in Exhibit 23 below. General Description of Business The Company, through NTNIN, currently provides its products and services through eight business units or subsidiaries. Of these eight, two are considered to be the traditional core of the Company's business, that is, directly related to multi-player interactive entertainment programs. The two traditional core business units are the Hospitality Group and the Corporate Events/Home Market Group. Five units, collectively referred to as the "Magic Lantern Group," are (i) NTNIN's wholly-owned subsidiary Magic, which is involved in the marketing and distribution of Educational video and media resources, (ii) Magic's wholly-owned subsidiary Custom Video, which is involved in the manufacturing of videotape copies, (iii) Custom Video's wholly-owned subsidiary BCLC, which is involved in the marketing and fulfilment services of educational video titles, (iv) Magic's 75%-owned subsidiary Sonoptic, which is involved in the conversion of analog video to digital video formats, and (v) Magic's 50%-owned subsidiary Viewer Services, which is involved in the inbound telemarketing and fulfilment services for television broadcasters and others. The eighth unit, Interlynx, is a leader in the design and development of educational and corporate multimedia, programming for CD-ROMs and web-sites, animation and 3-D rendering. The Hospitality Group is engaged in the marketing and distribution of NTN Entertainment Network services (the "Network") throughout Canada. These activities are being conducted through an exclusive license covering Canada granted to the Company by NTN Communications, Inc. of Carlsbad, California ("Communications"). The license grants NTNIN the right to market the products and programs of Communications throughout Canada for a 25 year term ending December 31, 2015. Communications does not have an equity position in the Company or in NTNIN. The former President of Communications (Daniel C. Downs) is a director of the Company. 3 The Network is designed to capitalize on the growing trend for more leisure activities through two-way interactive television ("IATV") communications. Programming can be offered 24 hours a day and consists of two-way interactive games. The Network features a wide variety of sports and game programs permitting viewer interaction and participation for 16 hours each day. It is currently available to over 3,100 subscriber sites (each a "Group Subscriber") across North America which are primarily hotels, restaurants, taverns, colleges, military bases and other group viewing locations. Over 500 Group Subscribers are located in Canada. Designed to be hardware independent, the Network can be transmitted through a variety of techniques: direct satellite, cable, gateway service, FM sideband, Internet, TV vertical blanking interval, and telephone. The Company's revenues have traditionally been primarily derived from the delivery of Network programming to customer sites, typically by satellite ("broadcast services"), the rental and sale of equipment used in the reception of broadcast services and on-subscriber-site interactive participation in broadcasts over the Network, maintenance services, and event programming for corporate clients. Revenue from broadcast services was Cdn$3,932,912 (US$2,832,489) for the Company's fiscal year ended August 31, 1997 (the "1997 Fiscal Year"). Over the past two years, revenue from equipment sales has gradually decreased, while revenue from equipment rental has risen. These changes reflect the success of the system rental program introduced over two years ago. Revenue from equipment sales was Cdn$144,748 (US$104,248), while revenue from equipment rental was Cdn$1,642,305 (US$1,182,791) for the 1997 Fiscal Year. Revenues from maintenance services grows in proportion to the number of Hospitality Network customers, which pay a monthly fee based on the size of their system. These revenues were Cdn$539,349 (US$388,440) for the 1997 Fiscal Year. The Corporate Events/Home Market Group is engaged in developing and delivering interactive programs for corporate clients for use at sales and training meetings, trade shows, and special events. Revenues from the Corporate Events/Home Market Group's activities for the 1997 Fiscal Year were Cdn$434,965 (US$313,263). The Magic Lantern Group is involved in marketing and distributing Educational video and media resources, the manufacturing of videotape copies, the marketing and fulfilment services of educational video titles, the conversion of analog video to digital video formats and the inbound telemarketing and fulfilment services for television broadcasters and others. Revenues from the Magic Lantern Group for the 1997 Fiscal Year were $2,816,152 (US$2,028,197). The expanding revenue base from Hospitality system clients in the 1997 Fiscal Year was the major contributor to net profit of Cdn$609,387 (US$438,882). Research and Development The Company has not been involved in basic or applied technology research. The Company's major contribution to the research and development efforts involving the Network has been to provide market feedback and recommendations to Communications on product and program developments which would improve marketing efforts in Canada. There is little, if any, direct expense incurred in this effort. 4 The Corporate Events/Home Market Group has begun business development and liaison activities which are expected to lead to the development, marketing, and delivery of interactive programs delivered to the home consumer market via third-party providers, through the Internet and distribution systems being developed by telephone and cable companies in Canada. The NTN Entertainment Network The products of Communications include hardware and software which enables groups of people to interact with programming delivered to television monitors. More than 3,100 restaurants, lounges, hotels, and other hospitality sites across North America have installed systems capable of receiving Network broadcasts ("Subscriber Systems"). The Subscriber Systems receive satellite broadcasts containing the Network interactive programs, such that thousands of patrons at Group Subscriber locations can interact with the same programs simultaneously. NTNIN markets the Network throughout Canada to the hospitality industry, installs the systems, and provides technical and marketing support to Network sites. The Network is owned and operated by Communications, a company based in Carlsbad, California. The Network uses existing technology to broadcast two-way interactive live events to Subscriber Systems. The Network provides digital data broadcast transmissions which enable equipment and software at Group Subscriber locations to display text and graphics programming and to interpret responses from Network viewers. All programming is produced at and transmitted from the NTN Broadcast Center in Carlsbad. This facility is equipped with video, satellite and communications equipment, and sophisticated multimedia computers. Communications can provide simultaneous transmission of up to 16 live events for interactive play and a multitude of interactive games and other programs, allowing distribution of different programs to customers in different geographical locations. The Company has no control of such facilities. Each Group Subscriber receives a Subscriber System which includes a satellite dish antenna, a signal decoder, a personal computer with fully integrated proprietary software, a base station, and multiple hand-held wireless response units ("Playmakers") used by customers for interactive play. The computer in each Subscriber System controls the TV monitor display based upon instructions delivered to it over the Network. Viewer responses entered on the Playmakers are ordinarily processed and displayed within the Subscriber System without any need for communication to the Broadcast Center. The Subscriber System can communicate with the Broadcast Center, however, via modem when appropriate commands are sent over the Network, but the comparatively small amount of data traveling inward from the Subscriber System to the Broadcast Center makes it possible to operate the Network at minimal expense. In addition to tabulating local Playmaker responses and communicating with the Broadcast Center, the Subscriber System computer can generate local text inserts at the direction of the Group Subscriber, and can call up computer generated color graphics displays for various purposes, including advertisements sold for broadcast on the Network, all as directed by the Broadcast Center. Network Programming The two-way interactive programming currently featured over the Network includes a variety of 5 interactive sports and trivia games. The broadcast schedule includes between 14 and 17 hours of interactive programs per day. All present Network programming is structured to provide time for national, regional and local advertisements, as well as for local inserts, which permit each Group Subscriber to display announcements of promotional prices or other events at its business location. Communications holds licenses with major sports leagues which enable it to produce and deliver interactive games played in conjunction with live broadcasts of sporting events. Licenses are in place with the National Football League, National Hockey League, Major League Baseball, as well as the Canadian Olympic Association. NTN Play-Along Games are played in conjunction with live, televised events. The best established of these is QB1, a game of football strategy which attracts over 30,000 participants each week across the Network. QB1 is designed to be played simultaneously with the broadcast of a live football game. In a typical Group Subscriber environment, QB1 players watch the televised football game and attempt to call the offensive play about to be played on the field. A QB1 player may enter his or her play selection from among 20 possible plays at any time up until the snap of the ball by pushing the appropriate keys on his Playmaker. As play unfolds on the field, a description of the play that actually takes place is transmitted by the Broadcast Center. The computer in the Subscriber System receives this information and compares it with the QB1 players' selections. Within seconds, it assigns a point value to each player's selection depending on the accuracy of the player's prediction. A dedicated local television monitor then displays that score, together with the names and rankings of the other QB1 players at the Group Subscriber location. The scores and rankings are updated after each play. DiamondBall is an interactive game played simultaneously with the broadcast of a live baseball game. With the use of the Playmaker, selections are made before the pitch which allow the player to predict the outcome. Possible choices include fly balls, ground balls, the direction of hits, walks, strikeouts and home runs. Points are awarded for correct calls and are tabulated and posted in the same manner as in QB1. PowerPlay is an interactive hockey game. Played simultaneously with a live, televised hockey game broadcast, the object of PowerPlay is to predict play opportunities that will result in goals or shots on goal. The game is divided into six separate scoring segments, with the winner being determined by the total points scored in all six segments. Participants use their Playmakers to enter player selections as well as to choose play sequences they believe will result in either a goal or a shot on goal. NTN Fantasy Games are fantasy league games played in conjunction with sporting events or rotisserie leagues. These include DreamTeam, a baseball fantasy league which enables subscribers, through interactive television, to draft actual baseball players and create whole teams; Hoops, a fantasy game in which players "manage" a professional all-star basketball team; Brackets, a basketball or hockey tournament prediction game; and Football Challenge, in which players make a weekly selection of winners of college and professional football games. Players playing these programs gain points based upon the level of their players and teams. NTN Premium Trivia Games are promotion-oriented weekly game shows that usually require an hour of participation. Prizes are awarded to the top finishers. Games include the following: Showdown is designed for competition among all participating Group Subscriber 6 locations for major prizes. Not only do players compete among themselves at each location, but the comparative scores of different locations are also displayed to enhance competition. Showdown is broadcast one night each week, 52 weeks a year. Each hour-long show includes five separate competitive segments. Sports Trivia Challenge is currently broadcast on Thursday evenings and follows a format similar to Showdown, but focussed on sports. Players are invited to play 60 minutes of sports trivia, competing with players in other establishments across the Network. Spotlight, broadcast on Friday evenings, quizzes players about the world of show business and celebrities. This innovative game tests players' knowledge of the entertainment world, and polls their opinions on current media topics. Playback, broadcast on Saturday evenings, challenges players to answer questions on music news, trivia, song titles, and topics from a variety of musical genders from classical to hip hop. Trivial Pursuit Interactive, scheduled on Tuesdays and Fridays, is the interactive television version of the popular trivia board game. Sports IQ is a weekly sports trivia game featured on Monday evenings. Half-hour interactive trivia games comprise the majority of the Network's programming. Countdown and Wipeout are designed for fast competitive play among participants at each Group Subscriber location. The Network broadcasts Countdown and Wipeout daily in half-hour segments. To play the game, players must answer a series of questions using the Playmaker. The faster the questions are answered correctly, the more points the player receives. After each question, the correct answer is displayed on the monitors, together with each player's answer and total score. In addition, the players' rankings are displayed. Each half-hour segment is separate, so that the display of scores and names is reset before the next segment begins. Other Network trivia games include: Hockey Hall of Fame Trivia is a specialty sports trivia program developed by the Company for exclusive distribution in Canada. Similarly, Players Raceworld Trivia and 20th Anniversary Toronto Blue Jays Trivia were developed by the Company in conjunction with the Players Racing Team and the Toronto Blue Jays Baseball Club, respectively. These specialty sports trivia game are sponsored and distributed exclusively on the Canadian portion of the Network. NightSide is a variety show and trivia game dealing with adult topics. It is broadcast one night each week, but may be repeated several times a week. Played like other Network games, players use Playmakers to answer a series of questions which are followed by jokes, quotes and interesting information. NightSide focuses more on entertainment than on competition and the content of the game is designed to foster discussion among players. For subscribers who demand a more challenging trivia game, the Network offers Brainbusters, in which players are asked trivia questions of greater difficulty. Viewer's Revue is a program which features trivia questions submitted by Network viewers. 7 The Company launched a new interactive trivia game on August 20, 1997, in which every Wednesday night, between 8:00 PM and 8:30 PM, players are asked trivia questions pertaining to the past 100 years of Olympic history. Other trivia programs include Topix, half hour programs featuring new themes each day; Retroactive, featuring pop-culture trivia with 60s, 70s and 80s content; Football Trivia; and Football Weekend Roundup, a late evening football trivia game featured on Mondays. Hospitality Market The Hospitality market remained the Company's largest traditional core business in the 1997 Fiscal Year. The Company positions the Network to prospects and clients as a means of attracting patrons (to play the games), retaining their patronage (as they return to play again), and increasing the length of time patrons stay in their establishment. As the number of repeat customers and their length of stay increases, the hospitality establishment has an increased opportunity to sell additional food and beverage. The Hospitality Group sales force targets the most potent Hospitality outlets in Canada, including a number of chain accounts. Attractive rental packages are in place to support the Company's sales efforts. The Company promotes the Network as one of the best and technically advanced forms of on-premises advertising to this market, offering long term repetitive exposure to a captive, attentive, and enthusiastic audience. Each hospitality end user receives the Subscriber System, including the equipment and license to the software, from the Company. In most instances, the customer rents the equipment from the Company. The Company, in turn, purchases equipment from several suppliers and the Playmaker devices from Communications. Following installation, each end user pays a monthly fee to the Company for the broadcast services. The Network programming includes advertising, promotional spots (promoting Network competitions and special events), and public service announcements. Ten minutes each hour are available for advertising and promotional spots. Each of the spots are designed to be fifteen seconds in length for a total of 40 spots per hour. Communications, at the direction of the Company, can insert advertising messages into its Network programming for any number or combination of Canadian Group Subscriber locations. In addition, messages can be broadcast over the entire Network or custom-tailored for any specific location or for Canada only. The advertising sales staff within the Hospitality Group sells advertising in blocks of two-fifteen second ad spots per hour for a total of fourteen hours per day. Selected program sponsorships are also sold, in which event the Company's graphics artists incorporate advertisers' logos and messages within a program's content. For example, the Player's Raceworld Trivia shows provide 30 minutes of commercial exposure each week for the Player's Racing Team. Such sponsorships provide advertisers with premium exposure within a sponsored program. Advertising and sponsorship revenues for the 1997 Fiscal Year were Cdn$246,090 (US$177,234). Canadian Network sponsors also contributed prizes for Network game winners, with a total retail value in excess of Cdn$150,000 (US$108,030). 8 Corporate Market The Corporate Events/Home Market Group continues to market, develop, and deliver a variety of corporate training, testing, and entertainment programs to a blue chip clientele across Canada and abroad. The Company promotes its products and services to this market through a direct sales staff, as well as through event agencies whose sales forces sell NTNIN services as part of a full service offering. These agencies generated a number of events at national sales meetings and conferences during the 1997 Fiscal Year. Agents which sell or resell these services do not operate under contract to the Company or NTNIN and they are compensated, on a commission basis, when payment is received for their "sales". None of these firms have "exclusive" arrangements with the Company or NTNIN. The marketing focus changed in the 1997 Fiscal Year in order to attract more extended and repeat corporate events. The Corporate Events/Home Market Group is targeting vertical markets, including the pharmaceutical, automotive, banking, and insurance industries. These industries have diversified workforces spread throughout the country, requiring effective and compelling communications tools, which Management believes the Company provides. The Group also introduced a new product in the 1997 Fiscal Year which targeted the human resources departments of large corporations. This product will enable corporate trainers to develop interactive programs and operate the interactive systems on their own. A monthly license fee will be charged to such clients and will be set at an affordable rate to attract volume sales. The Company has permanent systems installed at several high profile venues, including one in the exhibit area of the Hockey Hall of Fame in Toronto. Another system, located in a large kiosk at GM Place in Vancouver, quizzes passersby about the General Motors products being promoted. These popular installations support the Company's efforts to put its systems and programs into interesting, involving and profitable use in a variety of Corporate and Retail venues. Home Market The Corporate Events/Home Market Group has recently begun preparations to market programs, similar to those offered on the Network, to the home consumer market via the Internet and enhanced distribution systems being introduced by telephone companies and cable system operators. The home market programs are intended to provide multi-player interactive games through home computers and televisions with access to third party services such as gateway services, corporate and commercial World Wide Web sites, and interactive cable systems. The Company has recently entered into a contract with AOL Canada which is intended to lead to providing AOL Canada with a selection of Canadian oriented interactive game content for use by subscribers of this gateway service. AOL Canada has approximately 200,000 subscribers. The Company has also entered into agreements, together with Communications, to provide interactive game content for "tsn.ca", the World Wide Web site of TSN The Sports Network, the leading sports television specialty service in Canada, Discovery Channel exn.net (Canada) and to provide interactive game content for Bell Canada's broadband interactive television trials in London, Ontario and Repentigny, Quebec. Consumer trials are expected to be launched later in January 1998. The Company is also providing interactive game content for N.B. Tel's internet service, called VIBE. 9 The Company's games are currently being utilized by VIBE subscribers. The Company has also entered into an agreement with Videoway Communications ("Videoway"), a cable service provider in Canada, pursuant to which the Company is providing a selection of interactive games for use by Videoway's cable subscribers. Communications has considerable experience in providing interactive entertainment programming to the home market through its affiliation with GTE MainStreet, America OnLine, GEnie, and others. Communication's sizable catalogue of interactive games, exclusive licenses for the delivery of major league interactive sports, over twelve years of continuous development, programming, and broadcasting of IATV programs leads the Company to believe that both Communications and the Company are well positioned for the future in this market. Sales and Marketing The marketing of the Network in Canada is conducted by the Company's direct sales force and through a regional sublicensee. This sublicensee, in turn, is expected to market the system to end-users, primarily Group Subscribers. A sublicense agreement exists for the Province of British Columbia. The sublicensee receives a commission based solely upon its ability to market the Network within its exclusive territory. During the year ended August 31, 1997, commissions of Cdn$190,107 (US$136,915) were paid to the British Columbia sublicensee. The sublicensee is responsible for marketing the Network to end-user establishments in its assigned territory in a manner consistent with the Company's policies and directives. The sublicense agreement is generally for a ten-year term and provides for the payment of a one-time sublicense fee and for the payment of commissions by the Company based upon Company Group Subscriber revenues derived from the sublicensee's exclusive region. In areas where the Company does not have an exclusive sublicensee, the Company markets the Network directly. At present, Communications has distribution arrangements with gateway services, systems which operate in conjunction with home personal computers through telephone lines. These services currently have in excess of 15,070,000 subscribers worldwide, of which America OnLine (AOL) has approximately 10 million worldwide, and AOL Canada has approximately 200,000 in Canada. As of the end of the 1997 Fiscal Year, the Company had only one direct agreement or arrangement with any provider of gateway services. The Company's revenues will include the Canadian portion of revenues received by Communications from other gateway services. Education Communications has been active for several years in bringing interactive systems and services to the education field. Through its subsidiary LearnStar Corp. ("LearnStar"), Communications developed LearnStar, a system and curriculum software for distance learning and in-class use. LearnStar's products and services were introduced to the education market in the United States in early 1995 and has been licensed to approximately 170 schools to date. LearnStar's products and services are targeted at schools and teachers who are seeking an 10 educational tool to increase student interest in learning via interactive competitions in the classroom. The system enables a school to evaluate the academic proficiency of the students, while creating an enjoyable environment in which students seem more apt to participate. Using similar technology to that used by the Network, the LearnStar interactive learning system can conduct academic competitions, collect data for surveys and provides local, regional and national testing capabilities. All of these products and services can be utilized within a single classroom, at one distinct site, or at multiple schools throughout the country, all with instantaneous feedback. The Company has continued to investigate market opportunities for LearnStar in Canada. Management believes the education market could become a growth area for the Company in the coming years. Following the acquisition of the Magic Lantern Group in October 1996, the Company determined that plans for the introduction of LearnStar in Canada should be developed in concert with Magic and this process is presently underway. LearnStar has granted to the Company the exclusive license to market its products and services for educational applications throughout Canada. Other Markets Communications has created a wholly-owned subsidiary called IWN, Inc. ("IWN") which is developing interactive gaming applications. IWN's initial focus is on pari-mutuel wagering, with planned expansion into other gaming venues. The Company intends to periodically review IWN's development with Communications to clarify how the Company could benefit when interactive gaming begins in Canada. The Company has not invested any funds in the gaming application development project, has not evaluated the interactive gaming market in Canada, and has made no commitments or plans to expand into lotteries, casinos, and pari-mutuel betting. Dependency Upon NTN Communications, Inc. All programming for the Network is furnished by Communications and is supplied through independent transmission companies. In addition, Communications is the Company's sole supplier of selected components of Network subscriber systems including Playmakers. The Company has no equity interest in Communications and the long term viability of the Company's Network business is dependent upon the continued availability of broadcast services originating at Communications' Broadcast Center. If Communications ceases operations or terminates broadcast services, the Company believes, but cannot assure, that services of the nature, quantity, and quality currently provided by Communications would become available from others. Any interruption in broadcast services would result in an interruption in those broadcast services normally delivered to Group Subscriber. Other Company services would continue, including the availability of interactive programs and games. The Company has not formulated plans for action which would be taken should Communications cease operations or alter the availability or terms of continued availability of broadcast services. Accordingly, the Company is substantially dependent upon the continued existence of Communications. Based upon its Annual Report on Form 10-K for its fiscal year ended December 31, 1996, Communications reported a net income (loss) of approximately US$(22,952,000), US$(3,948,000) and US$707,000 for the years ended December 31, 1996, 1995 and 1994, respectively. According to its latest Quarterly Report on Forms 10-Q, Communications reported a net loss of approximately US$9,709,000 for the nine months ended September 30, 1997, and had shareholders' equity of US$4,344,000 and a working capital deficiency of US$5,838,000 at September 30, 1997. 11 Competition The Company currently operates in a number of markets. The traditional core businesses focus on the Hospitality industry, to which the Company markets the Network as a revenue generating marketing tool; and the broader corporate market, to which the Company offers its technology and programs as an effective medium with which to deliver interactive training and testing programs, and as a compelling information and entertainment medium for corporate events and trade shows. During the 1996 Fiscal Year, the Hospitality Group became aware of a new entertainment system attempting to enter the Hospitality market. Called Sports Active, this system offers only two programs, a football game and a trivia game. The football game, for which players are charged a per game fee, can be played by only two customers at a time, is based on prerecorded game simulations between non-professional "generic" football teams, and lasts approximately 30 minutes. The trivia game is a variation of a CD-Rom based game released to the retail market approximately one year ago. While it is visually entertaining, it requires audio and the Company believes this is a significant drawback in the restaurant environment in which it is being marketed. The Company does not believe this will be a significant competitive entry. The Company has not experienced the impact of any direct competition in its corporate market to date. The Company defines "direct competition" as other providers of products or services which offer similar features and benefits to customers. The Company is not aware of other companies marketing interactive television services of a comparable nature, within its client base or target groups, in any manner which competes with the Company. NTNIN tries to position its products and services so they are not directly comparable to any products or services available elsewhere. Magic Lantern Group The Magic Lantern Group of companies operates in five principal markets. Magic Lantern Communications Ltd. markets and distributes an exclusively licensed library of educational video titles to schools, school boards, and Ministries of Education across Canada. Compared to the total business volumes of the 28 members of the Canadian Media Producers and Distributors Association of Canada trade association, it is believed Magic has approximately a 20% share of the grades K-12 market, making it the dominant player in this, Magic's primary market. Magic's exclusive distribution rights enable it to not compete for the sale of specific titles, but for a share of the available media buying budget within each educational jurisdiction. Several years ago, Magic began accumulating digital delivery rights for the titles it distributes, and approximately 75% of all titles in its library include such rights. It is believed that this extensive library of titles with digital delivery rights will favorably position Magic as distribution technologies and delivery systems migrate to digital formats - a process which is already underway in Canada. Custom Video provides video dubbing and conversion services, primarily in the Southern Ontario market. Dozens of competitors exist in this area, and Custom Video's market share is unknown. Approximately 45-50% of Custom Video's current business is from Magic and its subsidiary, BCLC. The remainder is from a growing number of repeat commercial clients which rely on Custom Video to provide timely delivery of quality duplications at competitive prices, and from a small amount of walk-in business traffic. In the past twelve months, Custom Video has upgraded and increased its capacity in order to ensure it satisfies the steady increase in demand for its services. 12 B.C. Learning Connection has traditionally operated under an exclusive arrangement with the British Columbia Ministry of Education to provide marketing and fulfilment services for educational videos in the B.C. school system. The Company is presently negotiating to extend the term of this arrangement. Sonoptic Technologies Inc., located in Saint John, New Brunswick, operates a digital video facility which converts analog video to digital video formats suitable for distribution through the Internet, as well as through broadband distribution networks being established by telephone and cable companies in Canada and elsewhere. This is a relatively new type of business and, while there are numerous "low-end" service providers entering the market in North America, there are no clear leaders or dominant players which have emerged. Sonoptic has been granted preferential supplier status by NBTel, the provincial telephone company in New Brunswick, for the conversion of video materials which will be delivered on its broadband network, now being introduced in the province. Sonoptic is also positioning itself as the premier source for digital video consulting and conversion services within the key markets which are expected to emerge in the next two to three years. Viewer Services, a new joint venture company 50% owned by Magic, was created to assume the inbound telemarketing and product fulfilment business previously operated by TVOntario, the provincial educational television broadcaster in Ontario. Viewer Services began operations in November 1996 and focuses on assuming and building the fulfilment services associated with TVOntario programming. It has expanded its base of broadcast clients and now provides similar services for VISION TV and the Knowledge Network. In either of these regards, it has no direct competition. Interlynx Multimedia The Company, effective as of September 1, 1997, acquired 51% of the shares of Interlynx Multimedia, Inc. of Toronto ("Interlynx"). The acquisition was paid for with a combination of cash and issuance of shares. Interlynx is a leader in designing and developing educational and corporate multimedia, programming for CD-ROMs and Web Sites and animation and 3-D rendering. Their sales are targeted for both local and international markets. The acquisition is designed to bolster the Company's production capabilities and assist in the development of high-speed broadband contracts. Interlynx also owns 60% of Interlynx International, Inc., the marketing and sales arm of Interlynx responsible for the international distribution of all CD-ROM products, licensing and partnerships in other countries. Employees The Company has 99 employees in the 8 subsidiaries, consisting of 10 executives, 19 salespersons, 30 persons involved in technical and warehouse services, 12 involved in graphic development, 12 clerical staff, 7 in marketing and 9 individuals involved in finance and administration. During the 1997 Fiscal Year, the Company anticipates hiring an additional 5 persons in various capacities to assist in the Company's growth and development. Employee relationships are solid and the Company believes its planned staff to be adequate for its anticipated needs. 13 Item 2. Properties. In November 1994, the Company acquired an approximately 25,000 square foot parcel of land in Etobicoke, Ontario, Canada, on which a 12,500 square foot free-standing, one story building was previously erected. The Company presently utilizes this building as its principal place of business. The Company owns the Etobicoke property and building free of any liens, the purchase mortgage for the property having been paid in full and satisfied on October 2, 1995. Magic owns three office units, comprising an aggregate 8,000 square feet of office space, in a building located in Oakville, Ontario, Canada. These properties, which collectively serve as Magic's principal executive offices, are pledged as security for a demand instalment loan, from the Royal Bank of Canada, with an outstanding principal amount of Cdn$641,000 (US$461,649) as of August 31, 1997. Magic and its subsidiaries also lease (or are negotiating leases for) additional properties as follows:
Lease Square Expiration Location Purpose Feet Date Annual Rent -------- ------- ---- ---- ----------- Saint John, New Brunswick Offices 2,342 06/30/00 Cdn$35,130 US$25,670 Langley, British Columbia Offices 1,048 12/31/97 8,400 6,138 Oakville, Ontario Offices and warehouse 4,000 12/01/98 15,970 11,742 Vancouver, British Columbia Offices and warehouse 8,451 08/31/00 78,171 57,119
Item 3. Legal Proceedings. Set forth below is a description of material pending litigation to which the Company is a party. (a) On June 12, 1992, the Company, together with Communications and NTNIN, commenced a lawsuit against Interactive Network, Inc. ("Interactive") and its president, David Lockton, in the Federal Court of Canada, Trial Division, in Montreal, Quebec, under the title NTN Communications, Inc., NTN Sports, Inc. and NTN Canada, Inc. v. David Lockton and Interactive Network, Inc. (the "Company Action"). The Company Action seeks a declaration of non-infringement with respect to Canadian Patent No. 1,274,903 held by Interactive (the "Interactive Patent") and to establish that the Company, Communications and NTNIN have properly done business in Canada since the fall of 1986. The basis for the Company's claim in the Company Action is that the systems used by the Company to produce interactive programming are not within the scope of the claims of the Interactive Patent. The Company thereafter amended its complaint to include a claim of invalidity of the Interactive Patent based upon untrue and materially misleading claims made by Interactive in its petition for the Interactive Patent. Except for the aforementioned pleadings, no proceedings or discovery have been undertaken in the Company Action. (b) Subsequent to the commencement of the Company Action, and on June 18, 1992, 14 Interactive commenced a lawsuit against the Company, Communications and NTNIN in the Federal Court of Canada, Trial Division, Montreal, Quebec, under the titled Interactive Network, Inc. v. NTN Communications, Inc., NTN Sports, Inc. and NTN Canada, Inc. (the "Interactive Action"). The Interactive Action alleges that Interactive granted Communications the right to use the Interactive Patent, which right Communications then improperly licensed to the Company and NTNIN. Interactive alleges that the license agreement between Communications and the Company and NTNIN infringes upon the Interactive Patent. The Interactive Action seeks a declaration of the validity of the Interactive Patent, an injunction restraining the Company from further infringement, and either damages (in an unspecified amount) or an accounting of profits derived from certain games used in Canada. Except for the aforementioned pleadings, no proceedings or discovery have been undertaken in the Interactive Actions. Management believes that the licenses granted to the Company by Communications are valid and that the patent infringement claims underlying the Interactive Action will ultimately be proven to be unfounded. The Company intends to vigorously defend its position in the Interactive Action and to prosecute its position in the Company Action; however, there can be no assurance that any or all of these actions will be decided in favor of the Company. The Company believes, based in part upon the advice of outside, independent counsel, that the costs of defending and prosecuting these actions will not have a material adverse effect upon the Company's financial position. In its Quarterly Report on Form 10-Q, for the quarter ended September 30, 1996, Communications stated that "[w]ith the courts [sic] assistance, [Communications] and [Interactive] have been able to reach a resolution of all pending disputes in the United States and have agreed to private arbitration regarding any future licensing, copyright or infringement issues which may arise between the parties." The disputes referred to in the Communications Form 10-Q involved litigation in the United States involving allegations similar to the allegations underlying the Company Action and Interactive Action. In the Communication Form 10-Q, Communications also noted that "no substantive action has been taken in the furtherance of" the Company Action or Interactive Action. The Company and its property are not a party or subject to any other material pending legal proceedings, other than ordinary routine litigation incidental to its business. To the knowledge of the Company no proceedings of a material nature have been or are contemplated against the Company. Item 4. Submission of Matters to a Vote of Security Holders. The Company did not submit any matters to a vote of its security holders during the quarter ended August 31, 1997. 15 PART II Item 5. Market Price for the Registrant's Common Equity and Related Stockholder Matters. Market Information The common stock of the Company, par value $.0467 per share (the "Common Stock"), is traded in the over-the-counter market and is quoted on the Nasdaq SmallCap Market ("Nasdaq"), under the symbol "NTNC." Set forth below is the range of high and low bid prices for shares of Common Stock for each full quarterly period within the Company's two most recent fiscal years, as derived from reports furnished by the National Association of Securities Dealers, Inc., as adjusted to give retroactive effect to the Company's three-for-two (3:2) stock split made effective August 15, 1996. The information reflects inter-dealer prices, without retail mark-ups, mark-downs or commissions and may not necessarily represent actual transactions. Bid Prices -------------------------------- Quarters Ended High Low - -------------- ---- --- November 30, 1995........................ US$4-5/12 3-1/4 February 29, 1996........................ 5-1/12 3-1/12 May 31, 1996............................. 6-1/2 4-7/12 August 31, 1996.......................... 7-1/8 4-1/4 November 30, 1996........................ 8 4-7/8 February 28, 1997........................ 5-1/4 3-7/8 May 31, 1997............................. 4-5/8 2-7/8 August 31, 1997.......................... 6-5/8 3-7/16 Holders As of the close of business on August 31, 1997, there were 379 holders of record of Common Stock. The Company believes that there are approximately 600 beneficial holders of Common Stock. Dividends Since its inception in 1987, the Company has not paid any cash dividends on its Common Stock. However, the Company has, in the past, declared certain stock dividends and stock splits. The Company intends to retain earnings, if any, to finance operations and, therefore, does not expect to declare or pay any cash dividends on the Common Stock in the foreseeable future. Item 6. Selected Financial Data. The following table sets forth a summary of selected financial information regarding the Company and its subsidiaries, consolidated, for each of the 16 five fiscal years ended August 31, 1997. For the convenience of the reader, the selected financial information is also given in U.S. dollars, converted at the Noon Buying Rate in effect at the end of the period to which the amount relates. (For applicable Noon Buying Rates, see "Exchange Rates" preceding Item 1 above.) In the 1997 Fiscal Year, depreciation expense has been reclassified and is no longer included in cost of sales. Previous years' comparatives have been restated to be consistent. Statement of Operations Data (Canadian Dollars):
Year Ended August 31, ----------------------------------------------------------------------------------- 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- Operating revenues........... Cdn$10,351,689 Cdn$6,318,251 Cdn$4,559,382 Cdn$3,147,980 Cdn$2,770,479 Cost of sales................ 3,395,898 2,223,916 1,701,629 1,244,462 1,268,250 Gross profit................. 6,955,791 4,094,335 2,857,753 1,903,518 1,502,229 Net income................... 609,387 541,059 357,535 75,694 55,811 Net income per share......... .23 .23 .17 .05 .07 Weighted average number of shares outstanding.......... 2,694,734 2,392,548 2,146,226 1,517,348 779,097 - --------------------------------------------------------------------------------------------------------------------
Balance Sheet Data (Canadian Dollars):
August 31, ----------------------------------------------------------------------------------- 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- Total assets................. Cdn$14,287,602 Cdn$9,883,093 Cdn$8,352,670 Cdn$3,575,115 Cdn$3,043,832 Long-term obligations........ 2,185,249 -0 - -0- -0 - 18,804 Shareholders' equity......... 9,488,648 8,877,434 7,536,411 2,338,277 2,148,719 Statement of Operations Data (United States Dollars):
Year Ended August 31, ----------------------------------------------------------------------------------- 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- Operating revenues........... US$7,455,304 US$4,616,917 US$3,394,418 US$2,295,785 US$2,097,576 Cost of sales................ 2,445,731 1,830,963 1,266,847 907,571 960,214 Gross profit................. 5,009,573 2,785,954 2,127,571 1,388,214 1,137,363 Net income................... 438,882 395,366 266,182 55,203 42,255 Net income per share......... .16 .17 .12 .04 .05 Weighted average number of shares outstanding.......... 2,694,734 2,392,548 2,146,226 1,517,348 779,097
Balance Sheet Data (United States Dollars):
August 31, ----------------------------------------------------------------------------------- 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- Total assets................. US$10,289,955 US$7,221,844 US$6,218,486 US$2,607,289 US$2,304,537 Long-term obligations........ 1,573,820 -0- -0- -0- 14,237 Shareholders' equity......... 6,833,740 6,486,981 5,610,788 1,705,278 1,626,831 - --------------------------------------------------------------------------------------------------------------------
No cash dividends have been declared for any of the fiscal years presented above. 17 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. Introduction The financial statements of the Company and the information contained in this Management's Discussion and Analysis of Financial Condition and Results of Operations are expressed in Canadian dollars. For the convenience of the reader, in this Management's Discussion and Analysis, certain financial amounts are also given in U.S. dollars, converted at the Noon Buying Rate in effect at the end of the period to which the amount relates, or the exchange rate on the date specified herein. (For applicable Noon Buying Rates, see "Exchange Rates" preceding Item 1 above.) As the Noon Buying Rate fluctuates daily, financial comparisons between periods expressed in U.S. dollars do not accurately reflect the true difference in the Company's financial position or results of operations between periods. Accordingly, the comparisons between periods presented below, both in dollar amounts and as percentages from prior periods, are expressed in Canadian dollars only. Results of Operations Year Ended August 31, 1997 Compared to Year Ended August 31, 1996 Revenues. Revenues from program content services for the 1997 Fiscal Year were Cdn$3,932,912 (US$2,832,490), compared to Cdn$3,520,814 (US$2,572,754) for the Company's fiscal year ended August 31, 1996 (the "1996 Fiscal Year"), an increase of Cdn$412,098 or 11.7%. This increase is primarily the result of an increase in the average number of sites outstanding in 1997 when compared to the average number of sites outstanding in 1996. Revenues from equipment rental were Cdn$1,642,305 (US$1,182,791), compared to Cdn$959,153 (US$700,879) for the 1996 Fiscal Year, an increase of Cdn$683,152 or 71.2%. This increase is primarily the result of an increase in the average number of rental systems outstanding in 1997 when compared to the average number of rental systems outstanding in 1996. Revenues from event programming for the 1997 Fiscal Year were Cdn$434,965 (US$313,263), compared to Cdn$409,722 (US$299,395) for the 1996 Fiscal Year, an increase of Cdn$25,243 or 6.2%. This increase is due primarily to increased initiatives in this area in 1997. Revenues from maintenance services were Cdn$539,349 (US$388,440) for the 1997 Fiscal Year, compared to Cdn$476,533 (US$348,216) for the 1996 Fiscal Year, an increase of Cdn$62,816 or 13.2%. This increase is primarily the result of an increase in the average number of systems and rental Playmakers outstanding in 1997 when compared to the average number outstanding in 1996. Revenues from equipment sales, which were Cdn$144,748 (US$104,248), remained relatively constant when compared to Cdn$148,330 (US$108,389) for the 1996 Fiscal Year, a decrease of Cdn$3,582 or 2.4%. This decrease is reflective of the Company's initiatives in introducing a rental equipment program over 2 years ago. Revenues from ad sponsorship were Cdn$246,090 (US$177,234) for the 1997 Fiscal Year, compared to Cdn$198,989 (US$145,407) for the 1996 Fiscal Year, an increase of Cdn$47,101 or 23.7%. This increase is primarily the result of increased initiatives in this area. Revenues from video sales and video dubbing, as earned by the Magic Lantern Group, were 18 Cdn$2,277,768 (US$1,640,452) and Cdn$399,082 (US$287,420) respectively, for the 1997 Fiscal Year, the first year of ownership by the Company. Other revenues, as earned by NTNIN and NTN Canada Inc., which consist primarily of revenue from internet services and interest income, were Cdn$595,168 (US$428,641), compared to Cdn$604,710 (US$441,878) for the 1996 Fiscal Year, a decrease of Cdn$9,542 or 1.6%. Other revenues, as earned by the Magic Lantern Group, consist primarily of revenue from video conversion services. Revenues in this area were Cdn$139,302 (US$100,326) for the 1997 Fiscal Year, the first year of ownership by the Company. As a result of the foregoing, the Company's total revenues were Cdn$10,351,689 (US$7,455,304), compared to Cdn$6,318,251 (US$4,616,917) for the 1996 Fiscal Year, an increase of Cdn$4,033,438 or 63.8%. Excluding total revenues from the Magic Lantern Group of Cdn$2,816,152 (US$2,028,197), revenues were Cdn$7,535,537 (US$5,427,106) for the 1997 Fiscal Year, compared to revenues of Cdn$6,318,251 (US$4,616,917) from the 1996 Fiscal Year, an increase of Cdn$1,217,286 or 19.3%. Cost of Sales. Commissions for the 1997 Fiscal Year were Cdn$1,757,922 (US$1,266,058), compared to Cdn$1,549,729 (US$1,132,429) for the 1996 Fiscal Year, an increase of Cdn$208,193 or 13.4%. This increase is primarily the result of an increase in the average number of sites outstanding in 1997 compared to the average number outstanding in 1996. Since the amount the Company is billed by Communications is a direct function of the number of sites, an increase in the number of average sites outstanding in 1997 would result in higher commissions payable to Communications in 1997, than the level experienced in 1996. As a percentage of the Company's total revenues, such costs decreased to 17.0% for the 1997 Fiscal Year from 24.5% for the 1996 Fiscal Year. This decrease is primarily the result of an increase in sales which are not commissionable, including sales made by the Company's direct sales force who do not receive commission, and revenues from the Magic Lantern Group for the year. Equipment costs were Cdn$258,701 (US$186,317), compared to Cdn$298,243 (US$217,934) for the 1996 Fiscal Year, a decrease of Cdn$39,542 or 13.2%. As a percentage of the Company's total revenues, such costs decreased to 2.5% for the 1997 Fiscal Year from 4.7% for the 1996 Fiscal Year. This decrease, both in total amount and as a percentage of total revenue, is primarily the result of a decreased level of equipment sales, in 1997 when compared to the level of equipment sales in 1996, resulting from the continued success of the rental program. Video and video dubbing costs, originating from the Magic Lantern Group, were Cdn$797,636 (US$574,459) and Cdn$212,072 (US$152,735), for the 1997 Fiscal Year. As a percentage of the Company's total revenues, these costs were 7.7% and 2.0%. Other costs, originating from activities of NTNIN, were Cdn$359,886 (US$259,190), compared to Cdn$375,944 (US$274,712) for the 1996 Fiscal Year, a decrease of Cdn$16,058 or 4.3%. As a percentage of the Company's total revenues, such costs decreased to 3.5% for the 1997 Fiscal Year from 6.0% for the 1996 Fiscal Year. Other costs, originating from the activities of the Magic Lantern Group, were Cdn$9,681 (US$6,972) for the 1997 Fiscal Year, which were 0.1% of the Company's total revenues. As a result of the foregoing, the Company's total cost of sales was Cdn$3,395,898 19 (US$2,445,731), compared to Cdn$2,223,916 (US$1,625,076) for the 1996 Fiscal Year, an increase of Cdn$1,171,982 or 52.7%. Excluding the Magic Lantern Group's cost of sales of Cdn$1,019,389 (US$734,166), cost of sales were Cdn$2,376,509 (US$1,711,566) in the 1997 Fiscal Year, compared to Cdn$2,223,916 (US$1,625,076) in the prior year, an increase of $152,593 or 6.9%. Total gross margins improved to 67.2% in the 1997 Fiscal Year from 64.8% in the 1996 Fiscal Year, and excluding the Magic Lantern Group, the gross margin improved to 68.5% in the 1997 Fiscal Year. Expenses. Selling, general and administrative expenses for the 1997 Fiscal Year were Cdn$4,786,519 (US$3,447,259), compared to Cdn$2,642,853 (US$1,931,204) for the 1996 Fiscal Year, an increase of Cdn$2,143,666 or 81.1%. These expenses for the 1997 Fiscal Year, excluding those of the Magic Lantern Group of Cdn$1,394,541 (US$1,004,351), totaled Cdn$3,391,978 (US$2,442,908), compared to Cdn$2,642,853 (US$1,931,204) for the 1996 Fiscal Year, an increase of Cdn$749,125 or 28.3%. As a percentage of the Company's total revenues, total selling, general and administrative expenses increased to 46.2% for the 1997 Fiscal Year from 41.8% for the 1996 Fiscal Year. This increase in percentage is primarily the result of the addition of staff and rising salaries in 1997, when compared to 1996. Bad debts expense was Cdn$48,284 (US$34,774), compared to Cdn$54,990 (US$40,183) for the 1996 Fiscal Year, a decrease of Cdn$6,706 or 12.2%. As a percentage of the Company's total revenues, such costs decreased to 0.5% for the 1997 Fiscal Year from 0.9% for the 1996 Fiscal Year. This decrease is primarily the result of an overall improvement in the management of the Company's accounts receivable. Interest and bank charges for the 1997 Fiscal Year were Cdn$109,834 (US$79,103), compared to Cdn$8,657 (US$6,326) for the 1996 Fiscal Year, an increase of Cdn$101,177 or 1168.7%. As a percentage of the Company's total revenues, such costs increased to 1.1% for the 1997 Fiscal Year from 0.1% for the 1996 Fiscal Year. This increase is the result of the increased debt load assumed upon the Magic Lantern Group Acquisition. Depreciation and amortization for the 1997 Fiscal Year were Cdn$952,145 (US$685,736), compared to Cdn$383,776 (US$280,436) for the 1996 Fiscal Year, an increase of Cdn$568,369 or 148.1%. As a percentage of the Company's total revenues, such costs increased to 9.2% for the 1997 Fiscal Year from 6.1% for the 1996 Fiscal Year. This increase is the result of both depreciation on the increased amount of rental equipment in the field, attributable to an increased number of average rental sites outstanding in 1997, and amortization of goodwill associated with the purchase of the Magic Lantern Group. Income Taxes. Provision for income taxes was Cdn$433,900 (US$312,495) for the 1997 Fiscal Year, compared to Cdn$463,000 (US$338,327) for the 1996 Fiscal Year, a decrease of Cdn$29,100 or 6.3%. The provision for taxes is lower in 1997 when compared to the 1996 provision due to a lower level of taxable income experienced in 1997. Net Income. As a result of all of the above, the Company's net income for the 1997 Fiscal Year was Cdn$609,387 (US$438,882), compared to Cdn$541,059 (US$395,366) for the 1996 Fiscal Year, an increase of Cdn$68,328 or 12.6%. This represents a decrease in net income as a percentage of total revenues to 5.9% in the 1997 Fiscal Year from 8.6% in the 1996 Fiscal Year. 20 Year Ended August 31, 1996 Compared to Year Ended August 31, 1995 Revenues. Revenues from program content services for the 1996 Fiscal Year were Cdn$3,520,814 (US$2,572,754), compared to Cdn$2,772,319 (US$2,063,966) for the Company's fiscal year ended August 31, 1995 (the "1995 Fiscal Year"), an increase of Cdn$748,495 or 27%. This increase was primarily the result of a net increase of 100 Network locations during the year. Revenues from equipment rental were Cdn$959,153 (US$700,879), compared to Cdn$517,950 (US$385,609) for the 1995 Fiscal Year, an increase of Cdn$441,203 or 85.2%. This increase was primarily the result of an increase in the number of rental systems and an increase in the number of Playmakers per system installed in Group Subscriber locations. Revenues from event programming for the 1996 Fiscal Year were Cdn$409,722 (US$299,395), compared to Cdn$373,477 (US$278,050) for the 1995 Fiscal Year, an increase of Cdn$36,245 or 9.7%. This increase was primarily the result of sales efforts leading to a greater number of higher revenue-producing events. Revenues from maintenance services were Cdn$476,533 (US$348,216), compared to Cdn$381,008 (US$283,657) for the 1995 Fiscal Year, an increase of Cdn$95,525 or 25.1%. This increase was primarily the result of an increase in the number of systems and rental Playmakers installed in Group Subscriber locations. Revenues from equipment sales were Cdn$148,330 (US$108,389), compared to Cdn$215,152 (US$160,179) for the 1995 Fiscal Year, a decrease of Cdn$66,822 or 31.1%. This decrease was primarily the result of a majority of Group Subscribers preferring the system rental program which was begun two years earlier, as evidenced by the increase in revenues from equipment rental. Ad sponsorship revenues increased to Cdn$198,989 (US$145,407) in Fiscal Year 1996 from Cdn$18,414 (US$13,709) in the prior year, an increase of Cdn$180,575 or 980.6%. this increase was primarily due to increased advertising and sponsorship revenues from a larger number of advertisers. Other revenues, consisting primarily of interest income and revenues from internet services, were Cdn$604,710 (US$441,878), compared to Cdn$281,062 (US$209,248) for the 1995 Fiscal Year, an increase of Cdn$323,648 or 115.2%. This increase is primarily the result of increased revenues from internet services, which were new in 1996. As a result of the foregoing, the Company's total revenues were Cdn$6,318,251 (US$4,616,917), compared to Cdn$4,559,382 (US$3,394,418) for the 1995 Fiscal Year, an increase of Cdn$1,758,869 or 38.6%. Cost of Sales. Commissions for the 1996 Fiscal Year were Cdn$1,549,729 (US$1,132,429), compared to Cdn$1,340,196 (US$997,764) for the 1995 Fiscal Year, an increase of Cdn$209,533 or 15.6%. As a percentage of the Company's total revenues, such costs decreased to 24.5% for the 1996 Fiscal Year from 29.4% for the 1995 Fiscal Year. This decrease is primarily the result of an increase in sales which are not commissionable, including sales made by the Company's direct sales force who do not receive commission. Equipment costs were Cdn$298,243 (US$217,934), compared to Cdn$198,344 (US$147,665) 21 for the 1995 Fiscal Year, an increase of Cdn$99,899 or 50.4%. As a percentage of the Company's total revenues, such costs increased to 4.7% for the 1996 Fiscal Year from 4.4% for the 1995 Fiscal Year. This increase, both in total amount and as a percentage of total revenue, is primarily the result of increased refurbishing costs related to equipment at Group Subscriber locations. Other costs were Cdn$375,944 (US$274,712), compared to Cdn$163,089 (US$121,418) for the 1995 Fiscal Year, an increase of Cdn$212,855 or 130.5%. As a percentage of the Company's total revenues, such costs increased to 6.0% for the 1996 Fiscal Year from 3.6% for the 1995 Fiscal Year. This increase is primarily the result of costs associated with advertising and sponsorships and event programming which were new in the 1996 Fiscal Year. As a result of the foregoing, the Company's total costs of sales were Cdn$2,223,916 (US$1,625,076), compared to Cdn$1,701,629 (US$1,266,847) for the 1995 Fiscal Year, an increase of Cdn$522,287 or 30.7%, and total gross margins improved to 64.8% in the 1996 Fiscal Year from 62.7% in the 1995 Fiscal Year. Expenses. Selling, general and administrative expenses for the 1996 Fiscal Year were Cdn$2,642,853 (US$1,931,204), compared to Cdn$2,043,369 (US$1,521,269) for the 1995 Fiscal Year, an increase of Cdn$599,484 or 29.3%. As a percentage of the Company's total revenues, such expenses decreased to 41.8% for the 1996 Fiscal Year from 44.8% for the 1995 Fiscal Year. This decrease in percentage is primarily the result of improved utilization of staff and resources, as well as the Company's existing physical premises having the capacity to serve it without additional cost as revenues increased. Bad debts expense was Cdn$54,990 (US$40,183), compared to Cdn$57,653 (US$42,922) for the 1995 Fiscal Year, a decrease of Cdn$2,663 or 4.6%. As a percentage of the Company's total revenues, such costs decreased to 0.9% for the 1996 Fiscal Year from 1.3% for the 1995 Fiscal Year. This decrease is primarily the result of an overall improvement in the management of the Company's accounts receivable. Interest and bank charges for the 1996 Fiscal Year were Cdn$8,657 (US$6,326), compared to Cdn$28,311 (US$21,077) for the 1995 Fiscal Year, an decrease of Cdn$19,654 or 69.4%. As a percentage of the Company's total revenues, such costs decreased to 0.14% for the 1996 Fiscal Year from 0.62% for the 1995 Fiscal Year. This decrease is primarily the result of the full payment of a mortgage on the Company's building in October 1995. Depreciation and amortization for the 1996 Fiscal Year were Cdn$383,776 (US$280,436), compared to Cdn$231,785 (US$172,562) for the 1995 Fiscal Year, an increase of Cdn$151,991 or 65.6%. As a percentage of the Company's total revenues, such costs increased to 6.1% for the 1996 Fiscal Year from 5.1% for the 1995 Fiscal Year. Income Taxes. Provision for income taxes were Cdn$463,000 (US$338,327) for the 1996 Fiscal Year, compared to Cdn$139,100 (US$103,559) for the 1995 Fiscal Year, an increase of Cdn$323,900 or 232.9%. The provision for taxes is higher in 1996 when compared to the 1995 provision due to a higher level of taxable income experienced in 1996. Net Income. As a result of all of the above, the Company's net income for the 1996 Fiscal Year was Cdn$541,059 (US$395,366), compared to Cdn$357,535 (US$266,182) for the 1995 Fiscal Year, an increase of Cdn$183,524 or 51.3%. This represents an increase in net income as a percentage of total 22 revenues to 8.6% in the 1996 Fiscal Year from 7.8% in the 1995 Fiscal Year. Liquidity and Capital Resources At August 31, 1997, the Company had working capital of Cdn$3,499,862 (US$2,520,606), a decrease of Cdn$2,586,294 from working capital of Cdn$6,086,156 (US$4,447,319) at August 31, 1996. This decrease is primarily due to the increased debt load assumed on the acquisition of the Magic Lantern Group. For the 1997 Fiscal Year, the Company had a net increase in cash flow of Cdn$643,908 (US$463,744), an increase from its net decrease in cash flow of Cdn$1,320,251 (US$964,743) for the 1996 Fiscal Year. Net positive cash flow for the 1995 Fiscal Year was Cdn$1,486,036 (US$1,106,340). The increase in net cash flow for the 1997 Fiscal Year was primarily due to cash provided from operations. Cash provided by operating activities for the 1997 Fiscal Year was Cdn$3,814,770 (US$2,747,404), an increase of Cdn$4,168,913 from cash used by operating activities for the 1996 Fiscal Year. The major factors contributing to this increase from the 1996 Fiscal Year include: an increase in net income before depreciation and amortization of Cdn$636,697 (US$458,550); a decrease in short-term investments of Cdn$1,872,137 (US$1,348,316); a decrease in inventory of Cdn$180,134 (US$129,733), due to an increased level of inventory converted to rental equipment during the year; a decrease in prepaid expenses of Cdn$253,487 (US$182,562); and increases in accounts payable and accrued liabilities and income taxes payable of Cdn$92,744 (US$66,794) and Cdn$108,197 (US$77,924) respectively, due mainly to expanding operations, higher debt load, and higher effective tax rates in 1997, respectively. These sources of operating cash were mitigated by the use of cash resulting from the increase in accounts receivable of Cdn$286,008 (US$205,983), which resulted from increased sales levels in 1997. Cash used by operations for the 1996 Fiscal Year decreased by Cdn$1,626,179 from the cash used in operations in the 1995 Fiscal Year, primarily due to an increase in net income before depreciation and amortization of Cdn$335,515 (US$245,170), as well as increases in accounts payable and accrued liabilities of Cdn$251,329 (US$183,653) resulting from growth in the Company's operations. Income taxes payable increased Cdn$162,294 (US$118,593) from the prior year as a result of increased taxable income. These sources of operating cash were offset by the use of cash in increasing short-term investments by Cdn$1,525,770 (US$1,114,921). Also, inventory increased by Cdn$75,915 (US$55,473), as required to service the increase in Group Subscriber locations, prepaid expenses increased by Cdn$11,732 (US$8,573), and accounts receivable increased by Cdn$99,184 (US$72,476) in the 1996 Fiscal Year, primarily due to increased sales levels. Cash used in investing activities in both the 1997 Fiscal Year and 1996 Fiscal Year was Cdn$3,092,057 (US$2,226,905) and Cdn$1,521,849 (US$1,112,056), respectively. Cash used in the 1997 Fiscal Year was greater than in the prior fiscal year primarily due to the Company's purchase of the Magic Lantern Group totaling Cdn$1,644,497 (US$1,184,369), the investment in Viewer Services of Cdn$38,305 (US$27,587) by Magic and the purchase of certain of the business assets and the resulting goodwill of Image Media by Magic for Cdn$590,000 (US$424,919). The above uses of cash were somewhat offset by the decrease in notes receivable in the 1997 Fiscal Year of Cdn$221,510 (US$159,532). Cash used in financing activities in the 1997 Fiscal Year was Cdn$78,805 (US$56,755) which decreased by Cdn$634,546 from the amount provided by financing activities of Cdn$555,741 23 (US$406,095) in the 1996 Fiscal Year. This decrease was primarily due to the fact that in the 1996 Fiscal Year, the Company received net proceeds of Cdn$799,964 (US$584,555) on the issuance of 385,386 shares of its Common Stock compared to only Cdn$1,827 (US$1,316) of net proceeds received on 375 shares issued in the 1997 Fiscal Year. The Company believes that its working capital position provides the required liquidity on both a short and long term basis and that its will not require external financing for its operating activities during the 1998 Fiscal Year, as based upon the Company's present plans for the 1998 Fiscal Year. However, any changes in such plans may require the Company to seek outside financing. No arrangements are presently in place for outside financing should the need arise. Inflation The rate of inflation has had little impact on the Company's operations or financial position during the three fiscal years ended August 31, 1997, and inflation is not expected to have a significant impact on the Company's operations or financial position during the 1998 Fiscal Year. The Company pays a number of its suppliers, including its licensor and principal supplier, Communications, in US dollars. Therefore, fluctuations in the value of the Canadian dollar against the US dollar will have an impact on gross profit as well as the net income of the Company. If the value of the Canadian dollar falls against the US dollar, the cost of sales of the Company will increase thereby reducing the Company's gross profit and net income. Conversely, if the value of the Canadian dollar rises against the US dollar, gross profit and net income will increase. Item 8. Financial Statements and Supplementary Data. Set forth below is a list of the consolidated financial statements of the Company being furnished in this Annual Report on Form 10-K pursuant to the instructions to Item 8 to Form 10-K and their respective locations herein. Financial Statement Location* - ------------------- -------- Report of Independent Auditors........................................ F - 1 Consolidated Balance Sheets........................................... F - 2 Consolidated Statements of Operations and Retained Earnings (Deficit). F - 3 Consolidated Statements of Cash Flows................................. F - 4 Notes to Consolidated Financial Statements............................ F - 5 - ---------- * Page F-1 follows page 38 to this Annual Report on Form 10-K. Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosures. None. 24 PART III Item 10. Directors and Executive Officers of the Registrant. Director Name Age Principal Positions with the Company Since - ---- --- ------------------------------------ ----- Peter Rona 51 President, Chief Executive Officer, 1987 Principal Financial and Accounting Officer and Chairman of the Board of Directors of the Company Douglas R. Connolly 44 President of Magic Lantern Communications 1996 Ltd.; Director of the Company Daniel C. Downs 58 Director of the Company 1993 James R. Newell 40 Director of the Company 1994 James Thompson 55 Director of the Company 1997 Dale G. Smith 48 Director of the Company 1993 Adrian P. Towning 53 Director of the Company 1994 Mark Truman 42 Acting Secretary of the Company N/A Peter Rona has been the President, Chief Executive Officer, Principal Financial and Accounting Officer and a director of the Company since September 1, 1987. He has been President of NTN Interactive Network, Inc. (formerly, NTN Sports, Inc. until 1993) from 1985 to 1991 and February 1993 to present. Mr. Rona has also been the President, sole director and sole shareholder of Anor Management, Ltd., a personal holding company since 1987. Douglas Connolly has been the President and a director of Magic Lantern Communications Ltd. (and its predecessor corporation) since 1985. On October 2, 1996, the Company acquired all of the outstanding stock of Magic. Mr. Connolly also has been President, director and a principal shareholder of Connolly-Daw Holdings Inc. (since 1987) and 1199846 Ontario Ltd. (since September 1996), two personal holding companies. Daniel C. Downs has been Executive Vice-President (1983 to April 1994), Chief Operating Officer (1983 to October 1996), President (April 1994 to March 1997) and a Director (1985 to June 1997) of NTN Communications, Inc., a developer and distributor of interactive programs. Under a License Agreement, dated March 23, 1990 (the "License Agreement"), between Communications and NTNIN, the Company, through NTNIN, holds the exclusive license to market the products and programs of Communications throughout Canada through December 31, 2015. Mr. Downs was an independent marketing consultant from 1981 to 1983, during which time he also worked on the development of the interactive game QB1. From 1979 to 1981, he served as Executive Vice-President and General Manager of Hollywood Park Race Course. From 1974 to 1979, he served as Executive and General Manager for the Southern California Racing Association at Los Alamitos Race Course. James R. Newell is the Senior Vice President of Finance and Chief Financial Officer (October 1993 to present) of NetStar Communications Inc. (formerly, Labatt Communications Inc.), a company 25 involved in broadcast operations. Mr. Newell was the Assistant Treasurer (1986 to 1987), Treasurer (1987 to 1989) and Vice President of Finance and Chief Financial Officer (1989 to October 1993) of Gandalf Technologies Inc., a manufacturer of data communications products. He was an auditor with KPMG (formerly, Peat Marwick Mitchell), an international firm of chartered accountants from 1980 to 1986. Mr. Newell is currently a director of The Discovery Channel (since March 1995). James Thompson is the President (since January 1997) of Netstar Communications, Inc. (formerly Labatt Communications, Inc.), President (since June 1994) of TSN The Sports Network ("TSN"), a cable network providing sports, news and entertainment programming throughout Canada and an affiliate of Netstar. Mr. Thompson also served as General Manager (July 1988 to January 1997), Vice-President (July 1988 to June 1994), Vice-President of Programming (January 1986 to July 1988) and Program Director (July 1985 to January 1986) of TSN. Prior to joining TSN, Mr. Thompson was employed for over twenty years by the Canadian Broadcasting Corporation, serving in positions of increasing responsibility up to the level of Executive Producer. Dale G. Smith has been an officer and part owner of Montebello Farms Inc., the world's second largest breeders of Straight Egyptian Arabian Horses, since 1990. From 1988 to 1990, he was the President of Oden Capital Corporation, a privately owned venture capital company. From 1969 to 1988, he was a member of Deloitte & Touche, chartered accountants, having been elected a partner in 1980. Adrian P. Towning is a private, independent investor in several companies involved in the communications industry. As a result of his investments, he has served as a director of some of these companies, including Medical Communications Corporation ("MCC") (1994 to July 1996). On May 14, 1996, MCC filed a petition under Chapter 7 of the United States Bankruptcy Code and the Bankruptcy Court appointed a Trustee of MCC on July 11, 1996. On July 16, 1996, MCC was dissolved. From 1983 to 1989, he established and managed Anglo- Massachusetts Investments Incorporated, with offices in Boston and London, which was involved in providing financial advice to Europeans. Mark Truman has been the Controller of the Company since December of 1994. Pursuant to a Designation Agreement, dated as of October 4, 1994, among the Company, NTNIN and NetStar, the Company has granted NetStar the right to designate one-third (1/3) of the members of the Company's Board of Directors so long as NetStar is the owner of at least 20% and not greater than 50% of the outstanding Common Stock. Should NetStar's ownership be at least 10% and less than 20% of the outstanding Common Stock, NetStar would be entitled to designate one-sixth (1/6) of the members of the Company's Board. Further, should NetStar's ownership exceed 50% of the outstanding Common Stock, NetStar shall be entitled to designate one-half (1/2) of the members of the Company's Board. In accordance with the terms of the Designation Agreement, James R. Newell and James Thompson have been designated by NetStar as directors of the Company. Item 11. Executive Compensation. Summary Compensation Table The following table sets forth information concerning the compensation paid or accrued by the Company during the three years ended August 31, 1997 to those individuals who served as Chief 26 Executive Officer of the Company during the 1997 Fiscal Year and all other executive officers of the Company or any of its subsidiaries at August 31, 1997 who received total annual salary and bonuses in excess of $100,000 during the 1997 Fiscal Year (collectively, the "Named Executive Officers").
Long-Term Compensation ------------ Annual Compensation Awards ------------------------------------------ ------------ Securities Year Ended Other Annual Underlying Name and Principal Position August 31, Salary Bonus Compensation Options --------------------------- ---------- ------ ----- ------------ ------- Peter Rona, President and 1997 US$119,103 US$34,030 $-0- 25,000 Chief Executive Officer 1996 115,090 10,961 3,483 37,500 1995 111,674 11,167 -0- 75,000
During the three year period ended August 31, 1994, the Company did not grant any restricted stock awards or stock appreciation rights, nor did the Company have any long-term incentive plan. Additionally, all of the Company's group life, health, hospitalization, medical reimbursement or relocation plans, if any, do not discriminate in scope, terms or operation, in favor of the Named Executive Officers and are generally available to all salaried employees. Further, no Named Executive Officer received, in any of the periods specified in the Summary Compensation Table, perquisites and other personal benefits, securities or property in an aggregate amount in excess of the lesser of $50,000 or 10% of the total salary and bonus reported for the Named Executive Officer in the fiscal year in which such benefits were received, and no single type of perquisite or other personal benefits exceeded 25% of the total perquisites and other benefits reported for the Named Executive Officer in the applicable fiscal year. Option Grants Table The following table sets forth (a) the number of shares underlying options granted to each Named Executive Officer during the 1997 Fiscal Year, (b) the percentage the grant represents of the total number of options granted to all Company employees during the 1997 Fiscal Year, (c) the per share exercise price of each option, (d) the expiration date of each option, and (e) the potential realized value of each option based on: (i) the assumption of a five (5%) percent annualized compounded appreciation of the market price of the Common Stock from the date of the grant of the subject option to the end of the option term, and (ii) the assumption of a ten (10%) percent annualized compounded appreciation of the market price of the Common Stock from the date of the grant of the subject option to the end of the option term.
Percentage of Potential Realizable Value at Total Options Assumed Rates of Stock Price Number of Shares Granted to Appreciation for Option Term Underlying Employees in Exercise Expiration ------------------------------ Name Options Granted Fiscal Year Price Date 5% 10% - ---- --------------- ----------- ----- ---- -- --- Peter Rona 25,000 30.0% US$4.875 11/25/01 US$33,672 US$74,406
Options Exercised and Remaining Outstanding 27 Set forth in the table below is information, with respect to each of the Named Executive Officers, as to the (a) number of shares acquired during the 1997 Fiscal Year upon each exercise of options granted to such individuals, (b) the aggregate value realized upon each such exercise (i.e., the difference between the market value of the shares at exercise and their exercise price), (iii) the total number of unexercised options held on August 31, 1997, separately identified between those exercisable and those not exercisable, and (iv) the aggregate value of in-the-money, unexercised options held on August 31, 1997, separately identified between those exercisable and those not exercisable.
Value of Unexercised Number of Unexercised Options In-the-Money Options at Shares At August 31, 1997 August 31, 1997 Acquired on ----------------------------- ---------------------------- Name Exercise Value Realized Exercisable Unexercisable Exercisable Unexercisable - ---- -------- -------------- ----------- ------------- ----------- ------------- Peter Rona -0- -0- 167,500 -0- US$162,600 -0-
Director's Remuneration Each director not otherwise a full time employee of the Company is eligible to receive Cdn$500 for each meeting of the Board of Directors or committee thereof which they attend, along with the reimbursement of their reasonable expenses incurred on the Company's behalf. The NetStar designees on the Company's Board have declined such compensation in the 1997 Fiscal Year and in previous fiscal years. On April 7, 1997, the following directors were awarded five-year options to purchase 1,500 shares of Common Stock each, at $3.875 per share: Daniel C. Downs, Dale G. Smith and Adrian P. Towning. Employment Contracts with Named Executive Officers As of September 1, 1997, NTNIN extended by two years its employment agreement (the "Rona Employment Agreement") with Peter Rona, its President and Chief Executive Officer, originally dated as of September 1, 1994. Mr. Rona is also the President, Chief Executive Officer, Chief Financial and Accounting Officer and Chairman of the Board of Directors of the Company. NTNIN's obligations under the Rona Employment Agreement have been guaranteed by the Company. Mr. Rona does not receive any compensation from the Company other than pursuant to the Rona Employment Agreement. The Rona Employment Agreement provides for an initial base compensation of Cdn$165,375 with annual increases to be subject to review by the Board of Directors, but in no event less than the proportional increase in the Consumer Price Index as published by Statistics Canada, plus a bonus equal to a percentage of the annual base compensation paid to Mr. Rona determined by reference to the excess of NTNIN's actual net income before taxes over specified amounts set forth in the Rona Employment Agreement. The Rona Employment Agreement further provides for the granting to Mr. Rona of stock options at the discretion of the Board of Directors. The Board awarded Mr. Rona stock options to purchase 25,000 shares of Common Stock as of November 26, 1996. In all other respects, the basic provisions of the Rona Employment Agreement remains the same. 28 Magic has entered into two separate Employment Agreements, each dated October 1, 1996, with Douglas Connolly and Wendy Connolly. These Employment Agreements each have two year terms commencing on September 1, 1997 and terminating on August 31, 1999, and pursuant to which Mr. and Ms. Connolly shall receive annual base salaries of Cdn$125,000 (US$90,025 at August 31, 1997) and Cdn$70,000 (US$50,414), respectively, together with automotive expenses of Cdn$12,000 (US$8,624) and Cdn$8,400 (US$6,050), respectively. There is a provision in each Employment Agreement for a cost-of-living adjustment to their base salaries for the second year of the term. In addition, under their respective Employment Agreements, Mr. and Ms. Connolly shall each be entitled to a bonus, not to exceed Cdn$50,000 (US$36,010) and Cdn$28,000(US$20,166), respectively (subject to a cost-of living adjustment for the second year of their respective terms), to be based upon the actual net income before taxes, if any, of Magic during each year of the terms of the Employment Agreements. The D. Connolly Employment Agreement further provides for Mr. Connolly to serve as President and Chief Operating Officer of Magic during its term. NTNIN has entered into an Employment Agreement, dated August 15, 1997, with Don Pagnutti. This employment agreement has a two-year term, commencing on September 15, 1997 and terminating on September 14, 1999, with a revolving term to be reviewed annually at the anniversary of the commencement date. The agreement provides for an initial base compensation of $Cdn137,500 with annual reviews, together with automobile expenses of Cdn$9,000 plus a bonus equal to a percentage of the annual base compensation paid to Mr. Pagnutti determined by reference to the excess of NTNIN's actual net income before taxes over specified amounts set forth in the agreement. This agreement further provides for the granting to Mr. Pagnutti of stock options at the discretion of the Board of Directors. This agreement also provides for Mr. Pagnutti to serve as Executive Vice President and Chief Operating Officer of NTNIN during its term. Neither the Company or NTNIN has any other employment agreement in effect with any other executive employee. Compensation Committee Interlocks and Insider Participation The Company's Audit and Compensation Committee currently consists of James Newell and Dale G. Smith. Neither Messrs. Newell or Smith are officers or employees of the Company, and have not served in such capacities in the past. No executive officer of the Company served as a director or member of the compensation committee (or group performing similar functions) of another entity, one of whose executive officers served on the Audit and Compensation Committee or as a director of the Company. Item 12. Security Ownership of Certain Beneficial Owners and Management. Set forth in the table below is information concerning the ownership, as of the close of business on August 31, 1997, of the Common Stock by each person who is known to the Company to be the beneficial owner of more than five (5%) percent of the Common Stock, the Company's directors and Named Executive Officers, and all directors and executive officers as a group. 29 Amount and Nature of Percent of Name and Address Beneficial Ownership Class (1) - ---------------- -------------------- --------- NetStar Enterprises Inc. (2).............. 1,578,091 (3) 51.0% James R. Newell (4)....................... 1,578,091 (5) 51.0 James Thompson (4)........................ 1,578,091 (5) 51.0 Peter Rona (6)............................ 360,357 (7) 12.9 Anor Management Ltd. (8).................. 192,857 (8) 7.3 Douglas Connolly.......................... 38,158 (9) 0.1 Adrian P. Towning......................... 5,250 (10) 0.0 Daniel C. Downs........................... 750 (10) 0.0 Dale G. Smith............................. 750 (10) 0.0 All directors and executive officers as a group (7 persons).................... 1,983,356 (11) 57.8% (1) Unless otherwise indicated, the Company believes that all persons named in the table have sole voting and investment power with respect to all shares of Common Stock beneficially owned by them. A person is deemed to be the beneficial owner of securities which may be acquired by such person within 60 days from the date on which beneficial ownership is to be determined, upon the exercise of options, warrants or convertible securities. Each beneficial owner's percentage ownership is determined by assuming that options, warrants and convertible securities that are held by such person (but not those held by any other person) and which are exercisable within such 60 day period, have been exercised. (2) The address for NetStar Enterprises Inc. (formerly, Labatt Communications Inc.) ("NetStar") is 2225 Sheppard Avenue East - Suite 100, North York, Ontario, Canada M2J 5C2. (3) Includes (a) 925,787 shares held of record by NetStar and (b) 651,914 shares (subject to adjustment) issuable upon exercise of an option (the "NetStar Option") granted pursuant to a Stock Purchase Agreement, dated as of October 4, 1994 (the "NetStar Agreement"), between the Company and NetStar. The NetStar Agreement also grants NetStar the right (the "NetStar Ownership Maintenance Right"), exercisable in the event the Company seeks to issue additional shares of Common Stock or any options, warrants, shares of preferred stock or other rights entitling the holder thereof to acquire Common Stock, to purchase from the Company such additional shares of Common Stock so as to permit NetStar to maintain the its then percentage ownership of outstanding Common Stock. The NetStar Option expires on April 4, 1998. The NetStar Ownership Maintenance Right is exercisable as long as NetStar owns any shares of Common Stock. (4) The address for Messrs. Newell and Thompson is c/o NetStar Communications Inc., 2225 Sheppard Avenue East - Suite 100, North York, Ontario, Canada M2J 5C2. (5) Includes the 1,578,091 shares of Common Stock beneficially owned by NetStar, of which Mr. Newell is Senor Vice President of Finance and Chief Financial Officer and Mr. Thompson is President and Chief Operating Officer. (6) The address for Mr. Rona is c/o NTN Canada, Inc., 14 Meteor Drive, Etobicoke, Ontario, 30 Canada M9W 1A4. (7) Includes (a) 192,857 shares of Common Stock issuable upon conversion of the 900,000 shares of Convertible Preferred Stock held of record by Anor Management, Ltd. ("Anor") and (b) 167,500 shares issuable upon exercise of options granted to Mr. Rona which are currently exercisable. Mr. Rona is the President, sole director and sole shareholder of Anor. (8) The address for Anor is c/o Peter Rona, NTN Canada, Inc., 14 Meteor Drive, Etobicoke, Ontario, Canada M9W 1A4. Includes 192,857 shares of Common Stock issuable upon conversion of the 900,000 shares of Convertible Preferred Stock held of record by Anor. The 900,000 shares of Convertible Preferred Stock have the equivalent voting power to 192,857 shares of Common Stock. (9) Represents the first payment of stock in lieu of cash based upon two promissory notes controlled by Mr. Connolly. The stock certificate representing the 38,158 shares of Common Stock are beneficially owned by 1199846 Ontario, Ltd., of which Mr. Connolly is the President. The remaining stock payments due under the promissory notes are not due within the next 60 days. (10) Includes 750 shares of common stock issuable upon exercise of options, which vested on 4/29/97, granted to each of Messrs. Towning, Downs and Smith. Does not include an additional 750 shares of Common Stock issuable upon exercise of options granted to each of Messrs. Towning, Downs and Smith, which are not exercisable within the next 60 days. (11) Includes 968,521 shares issuable upon conversion of the Convertible Preferred Stock and the exercise of the options and rights referred to in notes (5) and (7) above. Item 13. Certain Relationships and Related Transactions. Set forth below is a description of certain transactions between the Company and its directors, executive officers, beneficial owners of five percent or more of the outstanding Common Stock, or member of the immediate family of any of the foregoing persons, as well as certain business relationships between the Company and its directors, which occurred or existed during the 1997 Fiscal Year. (a) During the 1997 Fiscal Year, both pursuant to the License Agreement and otherwise, the Company paid Communications an aggregate Cdn$1,757,922 (US$1,266,058) as commissions. Under the License Agreement, the Company, through NTNIN, holds the exclusive license to market the products and programs of Communications throughout Canada through December 31. 2015. Daniel C. Downs, a director of the Company, is a former President, Chief Operating Officer of Communications. (b) On October 2, 1996, pursuant to a Stock Purchase Agreement, dated October 1, 1996 (the "Magic Lantern Purchase Agreement"), the Company, through NTNIN, acquired all of the outstanding stock of Magic. As consideration for the purchase of such stock the Company delivered Cdn$200,000 (US$146,800 on October 1, 1996) and a Non-Negotiable Promissory Note (the "Connolly-Daw Note") in the principal amount of Cdn$703,133 31 (US$516,099) to Connolly-Daw Holdings Inc.("Connolly-Daw") and a Non-Negotiable Promissory Note (the "1199846 Note") in the principal amount of Cdn$546,867 (US$401,400) to 1199846 Ontario Ltd ("1199846"). The Connolly Note requires principal payments of Cdn$78,133 (US$57,350), Cdn$312,500 (US$229,375) and Cdn$312,500 (US$229,375) on August 31, 1998, 1999, and 2000, respectively. In lieu of such cash payments, the Company has the option to tender payment to Connolly-Daw, and Connolly-Daw has the option to demand payment, in the form of 12,276, 49,097 and 49,096 shares of Common Stock (collectively, the "Connolly-Daw Shares"), respectively. The 1199846 Note requires principal payments of Cdn$312,500 (US$229,375) and Cdn$234,367 (US$172,025) on August 31, 1997 and 1998, respectively. In lieu of such cash payments, the Company has the option to tender payment to 1199846, and 1199846 has the option to demand payment, in the form of 49,097 and 36,821 shares of Common Stock (collectively, the "1199846 Shares"), respectively. Also pursuant to the Magic Lantern Purchase Agreement, Connolly-Daw, NTNIN and the Company entered into an Option Agreement, dated October 1, 1996, and 1199846, NTNIN and the Company entered into an Option Agreement, dated October 1, 1996 (together, the "Option Agreements"). Under the terms of the Option Agreements, in the event that either Magic or Mr. Connolly chooses not to extend the term of the D. Connolly Employment Agreement beyond its initial term expiring on August 31, 1999, on or after September 1, 1999 and on or before September 30, 1999, Connolly-Daw and 1199846 shall each have the right to cause the Company to purchase any of the Connolly-Daw Shares or 1199846 Shares, as the case may be, then held by Connolly-Daw or 1199846 at a price equal to 90% of the market value (as defined in the Option Agreements) of such shares (Connolly-Daw having been granted the right in this event to cause acceleration of the September 1, 2000 payment under the Connolly-Daw Note to August 31, 1999) and the Company shall have the right to cause the Connolly-Daw and 1199846 to sell to the Company any of the Connolly-Daw Shares or 1199846 Shares, as the case may be, then held by Connolly-Daw or 1199846 at a price equal to 110% of the market value (as defined in the Option Agreements) of such shares (Connolly-Daw having been granted the right in this event to cause acceleration of the September 1, 2000 payment under the Connolly-Daw Note to August 31, 1999). Douglas Connolly, a director of the Company and President of Magic, is the President and a principal shareholder of both Connolly-Daw and 1199846. On September 5, 1997, the Company issued 38,158 shares of the Common Stock of the Company and Cdn$65,000 to 1199846 in lieu of the August 31, 1997 payment pursuant to the 1199846 Note. (c) At the time of the Company's acquisition of Magic, Connolly-Daw was indebted to Magic in the amount of Cdn$160,000 (US$117,440 on October 1, 1996). This indebtedness is represented by a Promissory Note, dated October 1, 1996 (the "Magic Lantern Note"), in the principal amount of such indebtedness. The Magic Lantern Note is due on demand and bears interest, at a specified bank prime rate, payable monthly. (d) The Company purchased 51% of the outstanding shares of Interlynx Multimedia, Inc. effective September 1, 1997. Cross reference is made to Item 1, page 16 in this Form 10-K for further information on Interlynx Multimedia, Inc. 32 PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K. (a) The following financial statements and supplementary financial information are filed as part of this Annual Report on Form 10-K: Financial Documents Location* - ------------------- -------- 1. Financial Statements of the Company Report of Independent Auditors........................ F - 1 Consolidated Balance Sheets........................... F - 2 Consolidated Statements of Operations................. F - 3 Consolidated Statement of Cash Flows.................. F - 4 Notes to Consolidated Financial Statements............ F - 5 - ---------- * Page F-1 follows page 38 to this Annual Report on Form 10-K. There are no financial statement schedules either applicable or required to be filed by the Company in this Annual Report on Form 10-K pursuant to the instructions to Item 14 of Form 10-K. (b) The Company did not file any Current Reports on Form 8-K during its fourth fiscal quarter ended August 31, 1997. (c) The following list sets forth the applicable exhibits (numbered in accordance with Item 601 of Regulation S-K) required to be filed with this Annual Report on Form 10-K: 33 Exhibit Number Title - ------ ----- 2.1 Stock Purchase Agreement, dated October 1, 1996, among Connolly-Daw Holdings Inc., 1199846 Ontario Ltd., Douglas Connolly, Wendy Connolly and NTN Interactive Network Inc., minus Schedules thereto.+ 3.1 Certificate of Incorporation, as amended to date. 3.2 By-Laws, as amended to date. 4.1 Specimen Stock Certificate. 10.1 License Agreement, dated March 23, 1990, between NTN Communications, Inc. and NTN Interactive Network Inc.+ 10.2 Stock Purchase Agreement, dated as of October 4, 1994, between NTN Canada and NetStar Enterprises Inc. (formerly, Labatt Communications Inc.).+ 10.3 Option, dated as of October 4, 1994, registered in the name of NetStar Enterprises Inc. (formerly, Labatt Communications Inc).+ 10.4 Designation Agreement, dated as of October 4, 1994, among NTN Canada, Inc., NTN Interactive Network Inc. and NetStar Enterprises Inc. (formerly Labatt Communications Inc.).+ 10.5 Registration Rights Agreement, dated as of October 4, 1994, between NTN Canada and NetStar Enterprises Inc. (formerly, Labatt Communications Inc.).+ 10.6 Promissory Note of NTN Interactive Network Inc. registered in the name of Connolly-Daw Holdings, Inc.+ 10.7 Promissory Note of NTN Interactive Network Inc., registered in the name of 1199846 Ontario Ltd.+ 10.8 Option Agreement, dated October 1, 1996, among Connolly-Daw Holdings Inc., NTN Interactive Network Inc. and NTN Canada, Inc.+ 10.9 Option Agreement, dated October 1, 1996, among 1199846 Ontario Ltd., NTN Interactive Network Inc. and NTN Canada, Inc.+ 10.10 Registration Rights Agreement, dated October 1, 1996, among NTN Canada, Inc., Connolly-Daw Holdings Inc. and 1199846 Ontario Ltd.+ 10.11 Employment Agreement, dated as of August 31, 1994, between NTN Interactive Network Inc. and Peter Rona. + 10.12 Management Agreement, dated October 1, 1996, between Magic Lantern Communications Ltd. and Connolly-Daw Holdings Inc. + 10.13 Employment Agreement, dated October 1, 1996, between Magic Lantern Communications Ltd. and Douglas Connolly. + 10.14 Employment Agreement, dated October 1, 1996, between Magic Lantern Communications Ltd. and Wendy Connolly. + 22 List of Subsidiaries. 23 Business Sector Data 27 Financial Data Schedule. + Incorporated by reference. See Exhibit Index. 34 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. NTN CANADA, INC. Date: November 27, 1997 By: /s/ Peter Rona ------------------------------------- Peter Rona, President Pursuant to the requirements of the Securities Exchange Act of 1934, this report on has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. Signature Capacity Date --------- -------- ---- /s/ Peter Rona President, Chief Executive Officer, November 27, 1997 Principal Financial and Accounting Officer, Chairman of the Board and Director - ------------------------- Peter Rona /s/ Douglas Connolly Director November 27, 1997 - ------------------------- Douglas Connolly /s/ Daniel C. Downs Director November 27, 1997 - ------------------------- Daniel C. Downs /s/ James Newell Director November 27, 1997 - ------------------------- James Newell /s/ James Thompson Director November 27, 1997 - ------------------------- James Thompson /s/ Dale G. Smith Director November 27, 1997 - ------------------------- Dale G. Smith /s/ Adrian P. Towning Director November 27, 1997 - ------------------------- Adrian P. Towning 35 2.1 Stock Purchase Agreement, dated October 1, 1996, among Connolly-Daw Holdings Inc., 1199846 Ontario Ltd., Douglas Connolly, Wendy Connolly and NTN Interactive Network Inc., minus Schedules thereto +1, Exh. 10.1 3.1 Articles of Incorporation, as amended to date..................p. 59 3.2 By-Laws, as amended to date....................................p. 62 4.1 Specimen Stock Certificate.....................................p. 71 10.1 License Agreement, dated March 23, 1990, between NTN Communications, Inc. and NTN Interactive Network Inc. .+2, Exh. 10.9 10.2 Stock Purchase Agreement, dated as of October 4, 1994, between NTN Canada and NetStar Enterprises Inc. (formerly, Labatt Communications Inc.) ..............................+3, Exh. A 10.3 Option, dated as of October 4, 1994, registered in the name of NetStar Enterprises Inc. (formerly, Labatt Communications Inc) .....................................................+3, Exh. B 10.4 Designation Agreement, dated as of October 4, 1994, among NTN Canada, Inc., NTN Interactive Network Inc. and NetStar Enterprises Inc. (formerly Labatt Communications Inc.)....+3, Exh. C 10.5 Registration Rights Agreement, dated as of October 4, 1994, between NTN Canada and NetStar Enterprises Inc. (formerly, Labatt Communications Inc.) ..............................+3, Exh. D 10.6 Promissory Note of NTN Interactive Network Inc. registered in the name of Connolly-Daw Holdings, Inc..............+1, Exh. 10.2 10.7 Promissory Note of NTN Interactive Network Inc., registered in the name of 1199846 Ontario Ltd. ...................+1, Exh. 10.3 10.8 Option Agreement, dated October 1, 1996, among Connolly-Daw Holdings Inc., NTN Interactive Network Inc. and NTN Canada, Inc. ..................................................+1, Exh. 10.5 10.9 Option Agreement, dated October 1, 1996, among 1199846 Ontario Ltd., NTN Interactive Network Inc. and NTN Canada, Inc. ..................................................+1, Exh. 10.6 10.10 Registration Rights Agreement, dated October 1, 1996, among NTN Canada, Inc., Connolly-Daw Holdings Inc. and 1199846 Ontario Ltd. ..........................................+1, Exh. 10.4 10.11 Employment Agreement, dated as of August 31, 1994, between NTN Interactive Network Inc. and Peter Rona...........+4, Exh. 10.11 10.12 Management Agreement, dated October 1, 1996, between Magic Lantern Communications Ltd. and Connolly-Daw Holdings Inc. .................................................+4, Exh. 10.12 10.13 Employment Agreement, dated October 1, 1996, between Magic Lantern Communications Ltd. and Douglas Connolly .....+4, Exh. 10.13 10.14 Employment Agreement, dated October 1, 1996, between Magic Lantern Communications Ltd. and Wendy Connolly .+4, Exh. 10.14 22 List of Subsidiaries..........................................p. 110 23 Business Sector Data..........................................p. 111 27 Financial Data Schedule...........................................++ - -------- +1 All Exhibits so indicated are incorporated herein by reference to the exhibit listed above in the Company's Current Report on Form 8-K (Date of Report: October 2, 1996) (File No. 0-18066), filed on October 17, 1996. +2 All Exhibits so indicated are incorporated herein by reference to the exhibit listed above in the Annual Report on Form 10-K of NTN Communications, Inc., for its fiscal year ended 36 December 31, 1990) (File No. 2-91761-C), filed on April 1, 1991. +3 All Exhibits so indicated are incorporated herein by reference to the exhibit listed above in the Company's Current Report on Form 8-K (Date of Report: October 4, 1994) (File No. 0-18066), filed on October 18, 1994. +4 All Exhibits so indicated are incorporated herein by reference to the exhibit listed above in the Company's Annual Report on Form 10-K (Date of Report: November 27, 1996) (File No. 0-18066), filed on December 16, 1996. ++ Filed electronically pursuant to Item 401 of Regulation S-T. 37 REPORT OF INDEPENDENT AUDITORS To the Board of Directors and Shareholders of NTN Canada Inc. We have audited the accompanying consolidated balance sheets of NTN Canada Inc. as at August 31, 1997 and 1996 and the related consolidated statements of operations and retained earnings (deficit) and cash flows for each of the years in the three-year period ended August 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We did not audit the consolidated financial statements of Magic Lantern Communications Ltd., a wholly-owned subsidiary, acquired in 1997, which statements reflect total assets constituting 27% in 1997, and total revenues constituting 29% in 1997 of the related consolidated totals. Those financial statements were audited by other auditors whose report has been furnished to us and, our opinion, insofar as it relates to data included for Magic Lantern Communications Ltd., is based solely on the report of other auditors. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits and the report of other auditors provide a reasonable basis for our opinion. In our opinion, based on our audits and the report of other auditors, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of NTN Canada Inc. at August 31, 1997 and 1996 and the consolidated results of its operations and its cash flows for each of the years in the three-year period ended August 31, 1997 in conformity with accounting principles generally accepted in the United States. /s/ Ernst & Young LLP Thornhill, Canada, October 31, 1997. Chartered Accountants F-1 NTN Canada Inc. CONSOLIDATED BALANCE SHEETS [Expressed in Canadian dollars] As at August 31 1997 1996 $ $ - ------------------------------------------------------------------------------- ASSETS Current Cash and cash equivalents 2,421,797 1,777,889 Short-term investments [note 4] 1,705,014 3,577,151 Accounts receivable - trade [net of allowance for doubtful accounts of $51,000; 1996 - $39,000] 1,547,395 563,601 Note receivable [note 5] -- 350,000 Inventory 624,828 631,171 Prepaid expenses 419,843 162,003 - -------------------------------------------------------------------------------- Total current assets 6,718,877 7,061,815 - -------------------------------------------------------------------------------- Investment in Viewer Services 5,758 -- Property and equipment, net [note 6] 4,754,173 2,447,937 License, net of accumulated amortization 225,046 237,549 Goodwill, net of accumulated amortization 2,273,748 135,792 - -------------------------------------------------------------------------------- Notes receivable [note 5] 310,000 -- - -------------------------------------------------------------------------------- 14,287,602 9,883,093 ================================================================================ LIABILITIES AND SHAREHOLDERS' EQUITY Current Bank indebtedness [note 7] 641,000 -- Accounts payable - trade 1,165,434 574,590 Accrued liabilities 455,110 141,061 Income taxes payable [note 8] 352,161 260,008 Current portion of long-term debt [note 9] 605,310 -- - -------------------------------------------------------------------------------- Total current liabilities 3,219,015 975,659 - -------------------------------------------------------------------------------- Long-term debt [note 9] 2,126,076 -- Less current portion (605,310) -- - -------------------------------------------------------------------------------- 1,520,766 -- - -------------------------------------------------------------------------------- Deferred income taxes [note 8] 59,173 30,000 - -------------------------------------------------------------------------------- Total liabilities 4,798,954 1,005,659 - -------------------------------------------------------------------------------- Commitments and contingent liability [notes 10 and 14] Shareholders' equity Share capital [note 11] 950,000 preferred shares 11,523 11,523 2,441,992 common shares [1996 - 2,441,617] 150,211 150,187 Capital in excess of par value 7,923,150 7,921,347 Retained earnings 1,403,764 794,377 - -------------------------------------------------------------------------------- Total shareholders' equity 9,488,648 8,877,434 - -------------------------------------------------------------------------------- 14,287,602 9,883,093 ================================================================================ See accompanying notes On behalf of the Board: Director Director F-2 NTN Canada Inc. CONSOLIDATED STATEMENTS OF OPERATIONS AND RETAINED EARNINGS (DEFICIT) [Expressed in Canadian dollars] Years ended August 31
1997 1996 1995 $ $ $ - -------------------------------------------------------------------------------------- REVENUE Program content services 3,932,912 3,520,814 2,772,319 Equipment rental 1,642,305 959,153 517,950 Event programming 434,965 409,722 373,477 Maintenance 539,349 476,533 381,008 Equipment sales 144,748 148,330 215,152 Ad sponsorship 246,090 198,989 18,414 Video sales 2,277,768 -- -- Video dubbing 399,082 -- -- Other 734,470 604,710 281,062 - -------------------------------------------------------------------------------------- 10,351,689 6,318,251 4,559,382 - -------------------------------------------------------------------------------------- COST OF SALES [does not include depreciation] Equipment 258,701 298,243 198,344 Commissions [note 10] 1,757,922 1,549,729 1,340,196 Video 797,636 -- -- Video dubbing 212,072 -- -- Other 369,567 375,944 163,089 - -------------------------------------------------------------------------------------- 3,395,898 2,223,916 1,701,629 - -------------------------------------------------------------------------------------- EXPENSES Selling, general and administrative 4,786,519 2,642,853 2,043,369 Bad debts 48,284 54,990 57,653 - -------------------------------------------------------------------------------------- 4,834,803 2,697,843 2,101,022 - -------------------------------------------------------------------------------------- Income before interest, depreciation and amortization, income taxes, loss from investment and minority interest 2,120,988 1,396,492 756,731 Interest and bank charges 109,834 8,657 28,311 Loss from investment in Viewer Services 32,547 -- -- Depreciation and amortization 952,145 383,776 231,785 - -------------------------------------------------------------------------------------- Income before income taxes and minority interest 1,026,462 1,004,059 496,635 Provision for income taxes [note 8] 433,900 463,000 139,100 - -------------------------------------------------------------------------------------- Income before minority interest 592,562 541,059 357,535 Minority interest 16,825 -- -- - -------------------------------------------------------------------------------------- Net income for the year 609,387 541,059 357,535 Retained earnings (deficit), beginning of year 794,377 253,318 (104,217) - -------------------------------------------------------------------------------------- Retained earnings, end of year 1,403,764 794,377 253,318 ====================================================================================== Earnings per share [note 13] Primary $ 0.23 $ 0.23 $ 0.17 Fully diluted $ 0.21 $ 0.22 -- ======================================================================================
See accompanying notes F-3 NTN Canada Inc. CONSOLIDATED STATEMENTS OF CASH FLOWS [Expressed in Canadian dollars] Years ended August 31
1997 1996 1995 $ $ $ - ------------------------------------------------------------------------------------------ OPERATING ACTIVITIES Net income for the year 609,387 541,059 357,535 Adjustments to reconcile net income to net cash provided by (used in) operating activities Depreciation and amortization 952,145 383,776 231,785 Deferred income taxes -- 20,000 2,100 Loss from investment in Viewer Services 32,547 -- -- Changes in assets and liabilities Decrease (increase) in short-term investments 1,872,137 (1,525,770) (2,051,381) Increase in accounts receivable (286,008) (99,184) (136,856) Decrease (increase) in inventory 180,134 (75,915) 34,318 Decrease (increase) in prepaid expenses 253,487 (11,732) (100,921) Increase (decrease) in accounts payable and accrued liabilities 92,744 251,329 (389,667) Increase in income taxes payable 108,197 162,294 72,765 - ------------------------------------------------------------------------------------------ Cash provided by (used in) operating activities 3,814,770 (354,143) (1,980,322) - ------------------------------------------------------------------------------------------ INVESTING ACTIVITIES Purchase of property and equipment (1,040,765) (1,171,849) (1,291,247) Acquisition of Magic Lantern Communications Ltd. [note 15] (1,644,497) -- -- Decrease (increase) in notes receivable [note 5] 221,510 (350,000) -- Investment in Viewer Services (38,305) -- -- Image Media Ltd. [note 15[c]] (590,000) -- -- Deposit -- -- 22,783 - ------------------------------------------------------------------------------------------ Cash used in investing activities (3,092,057) (1,521,849) (1,268,464) - ------------------------------------------------------------------------------------------ FINANCING ACTIVITIES Bank indebtedness (270,489) -- (350,000) Notes and loans payable 189,857 -- -- Mortgage payable -- (244,223) 244,223 Proceeds from sale of common shares, net of issuing costs -- -- 4,252,500 Proceeds from exercise of options and warrants 1,827 799,964 588,099 - ------------------------------------------------------------------------------------------ Cash provided by (used in) financing activities (78,805) 555,741 4,734,822 - ------------------------------------------------------------------------------------------ Net increase (decrease) in cash and cash equivalents during the year 643,908 (1,320,251) 1,486,036 Cash and cash equivalents, beginning of year 1,777,889 3,098,140 1,612,104 - ------------------------------------------------------------------------------------------ Cash and cash equivalents, end of year 2,421,797 1,777,889 3,098,140 ========================================================================================== Income taxes paid 343,608 277,334 81,764 ========================================================================================== Promissory notes issued in connection with acquisition of Magic 1,250,000 -- -- ==========================================================================================
See accompanying notes F-4 1. DESCRIPTION OF BUSINESS NTN Canada Inc. [the "Company"] was incorporated originally under the name Triosearch Inc. under the laws of the State of New York on May 12, 1986. On June 9, 1988, the Company changed its name to NTN Canada Inc. The Company is the holding company for NTN Interactive Network Inc. ["Interactive"] which is a wholly-owned operating company. Interactive is incorporated under the Canada Business Corporations Act and has signed with NTN Communications, Inc., an unrelated Delaware company, an agreement for exclusive representation of their interactive communications for all industry sectors in Canada. This interactive entertainment network allows viewers to participate actively in a variety of television programs, videotext services, trivia games, etc. Present subscribers to the Company's networks are hotels, restaurants, bars and university clubs. In addition, there are subscribers through a number of gateway services. Each subscriber either purchases the system hardware directly or leases it, or rents the system from Interactive. Interactive purchases the subscriber system from NTN Communications, Inc. and various other suppliers. Following the installation, each subscriber pays a monthly fee to Interactive for the program content and maintenance services, which range from $650 to $750. The monthly fees for rental systems range from approximately $255 to $290. On October 2, 1996, Interactive acquired, effective October 1, 1996, all of the outstanding stock of Magic Lantern Communications Ltd. ["Magic"], pursuant to which Magic became a wholly-owned subsidiary of Interactive [note 15]. Magic, which is involved in the marketing and distribution of educational video and media resources, conducts its operations directly and through its wholly-owned subsidiaries, 745695 Ontario Ltd. ["Custom Video"] and B.C. Learning Connection ["BCLC"], and its 75% ownership of Sonoptic Technologies Inc. ["STI"]. On October 10, 1996, Magic acquired 50% of the outstanding shares of 1113659 Ontario Ltd. ["Viewer Services"], a joint venture operated with International Tele-Film Enterprises Ltd. [note 15[b]]. 2. ECONOMIC DEPENDENCE Interactive is dependent upon NTN Communications, Inc. as its sole supplier for the transmission of program content to the Company's subscribers. In the event that NTN Communications, Inc., which operates under the going-concern assumption, terminates the transmission of program content, the Company believes, but cannot assure, that such services are likely to be continued by others. As of September 30, 1997, NTN Communications, Inc. had shareholders' equity of $4,344,000 and a working capital deficiency of $5,838,000 according to its unaudited balance sheet included in its quarterly report. NTN Communications, Inc. has reported a quarterly net loss for September 1997 of $1,134,000, a quarterly net loss for June 1997 of $2,228,000 and a quarterly net loss for March 1997 of $6,347,000. It reported a net loss for the year ended December 31, 1996 of $22,952,000. All such amounts are quoted in U. S. dollars [notes 10 and 12]. 3. SIGNIFICANT ACCOUNTING POLICIES Basis of presentation These consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. These consolidated financial statements have been expressed in Canadian dollars which is the currency of the country in which Interactive is incorporated and is the currency of its primary economic environment in which operations are conducted. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. Basis of consolidation These consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, Interactive and Magic. Viewer Services, the joint venture in which Magic has a 50% interest, has been recorded as an equity investment. 1 There are no differences between the carrying amount of the investment and the underlying equity in the net assets of Viewer Services. All significant intercompany transactions have been eliminated. Foreign exchange translation U.S. dollar accounts in these consolidated financial statements are translated into Canadian dollars on the following bases: [a] The assets and liabilities denominated in foreign currencies are translated at the exchange rate in effect at the consolidated balance sheet dates. [b] Revenue and expenses are translated at a rate approximating the rates of exchange prevailing on the dates of the transactions. [c] Gains and losses on translation of foreign currencies are included in operations. Revenues Revenue from the sale of program content services is recognized on a monthly basis beginning when the systems are installed on the purchasers' premises. The payment terms are on a monthly basis. Revenue from equipment rentals and maintenance is recognized on a monthly basis over the term of the contract. Revenue from event programming is recognized upon completion of the contract. Revenue from equipment sales is recognized upon the installation of the equipment. Revenue from video sales is recognized upon delivery of the goods sold. Revenue from video dubbing is recognized upon shipment of the video tapes. Revenue from advertising sponsorship is recognized on a monthly basis over the term of the contract. Cash and cash equivalents Cash and cash equivalents include cash, term deposits and government securities which mature in less than three months from the date of issue. The carrying value of term deposits and government securities approximates their fair values. Short-term investments Investments at August 31, 1997 and 1996 consist of money market funds, debt securities and marketable equity securities. The Company has adopted the provisions of Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" ["SFAS 115"]. Pursuant to the provisions of SFAS 115, the Company has classified its portfolio as "trading". Trading securities are bought and held principally for the purpose of selling them in the near term and are recorded at fair value. Unrealized gains and losses on trading securities are included in the determination of net income. The fair value of these securities represent current quoted market offer prices. Inventory Inventory consists of finished goods held for sale or rent, which are valued at the lower of cost, using the first-in, first-out method, and net realizable value. Property and equipment Property and equipment are stated at cost less accumulated depreciation. Equipment is depreciated using a declining balance rate of 20%. Computer equipment as well as masters and libraries are depreciated using a declining balance rate of 30%. 2 Automobiles are depreciated on a straight-line basis over 3 years, buildings and additions on a straight-line basis over 25 years, software on a straight-line basis over 3 years and rental equipment and leasehold improvements both on a straight-line basis over 5 years. On an ongoing basis, management reviews the valuation and depreciation of property and equipment, taking into consideration any events and circumstances which might have impaired the fair value. The Company assumes there is an impairment if the carrying amount is greater than the recoverable amount. The amount of impairment, if any, is measured based on projected discounted future cash flows, using a discount rate that reflects the Company's average cost of funds. License and goodwill The license is stated at cost less accumulated amortization. Amortization is provided over a 24-year period using the straight-line basis to 2016. Accumulated amortization amounted to $87,503 [1996 - $75,001]. Goodwill is stated at cost less accumulated amortization. Amortization is provided using the straight-line basis over a period varying from 10 to 20 years, depending on the transaction which generated the goodwill. Accumulated amortization amounted to $269,628 [1996 - $142,960]. On an ongoing basis, management reviews the valuation and amortization of the license and goodwill, taking into consideration any events and circumstances which might have impaired the fair value. The Company assumes there is an impairment if the carrying amount is greater than the recoverable amount. The amount of impairment, if any, is measured based on projected discounted future cash flows, using a discount rate that reflects the Company's average cost of funds. Income taxes The Company accounts for deferred income tax liabilities and assets based on the difference between the financial statement and the tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. Employee stock options The Company accounts for its stock option plans and its employee stock purchase plan in accordance with the provisions of the Accounting Principles Board's Opinion No. 25, "Accounting For Stock Issued to Employees" ["APB 25"]. Recent pronouncements The Financial Accounting Standards Board has issued Statement of Financial Accounting Standards No. 130, "Comprehensive Income" ["SFAS 130"], and No. 131 "Disclosures about Segments of an Enterprise and Related Information" ["SFAS 131"]. SFAS 130 and SFAS 131 will be effective for the Company's August 31, 1999 year end. The Company has not determined the impact, if any, of these pronouncements on its consolidated financial statements 3 4. SHORT-TERM INVESTMENTS Short-term investments consist of the following: 1997 1996 $ $ - -------------------------------------------------------------------------- Money market funds 236,668 1,182,328 - -------------------------------------------------------------------------- Debt securities U.S. treasury securities 574,645 402,823 Corporate debt securities 879,026 2,129,849 - -------------------------------------------------------------------------- Total debt securities 1,453,671 2,532,672 - -------------------------------------------------------------------------- Margin account 34,030 (137,849) Unrealized loss on margin account (19,355) -- - -------------------------------------------------------------------------- Net margin account 14,675 -- - -------------------------------------------------------------------------- 1,705,014 3,577,151 ========================================================================== All investments are held in United States dollars except for $1,992,860 of corporate debt securities held in Canadian dollars in 1996. At August 31, 1997, the Company held ten September 1997 Canadian dollar futures contracts as a hedge on the U.S. dollar denominated short-term investments. Each contract represents the right to purchase $100,000 Canadian at an exchange rate of 0.7334 and therefore short-term investments of US$733,400 were hedged at August 31, 1997. The unrealized loss on this hedge was $19,355 at August 31, 1997. 4 5. NOTES RECEIVABLE AND SUBSEQUENT EVENT Notes receivable consist of the following: 1997 1996 $ $ - ------------------------------------------------------------------------- Current Magic Lantern Communications Ltd. -- 350,000 ========================================================================= Long-term Connolly-Daw Holdings Inc. [note 15[c]] 160,000 -- Interlynx Multimedia Inc. 150,000 -- - ------------------------------------------------------------------------- 310,000 -- ========================================================================= The note receivable from Magic was eliminated upon consolidation resulting from the acquisition of Magic in 1997 [note 15[a]]. The unsecured note receivable from Connolly-Daw Holdings Inc. ["Connolly-Daw"] bears interest at the bank's prime rate, calculated and payable monthly, not in advance. The note is payable on demand, however, the Company does not intend to call the note within the next fiscal period. The President and Secretary of Connolly-Daw are the Controller and Chief Executive Officer of Magic. The note receivable from Interlynx Multimedia Inc. ["Interlynx"] is due June 30, 1999. The note bears interest at 6.5% per annum, calculated and payable monthly, not in advance. The note was made available to Interlynx as part of an arrangement concluded September 10, 1997, whereunder the Company acquired 51% of Interlynx and its subsidiary for a purchase price of $622,000 effective September 1, 1997. The purchase price was satisfied by $357,000 in cash and the issue of 55,209 shares with a value of $4.80. The acquisition will be accounted for as a purchase in fiscal 1998. The allocation of the purchase price has not been determined. 5 6. PROPERTY AND EQUIPMENT Property and equipment consist of the following:
1997 1996 ----------------------------------- -------------------------------- Net Net Accumulated book Accumulated book Cost depreciation value Cost depreciation value $ $ $ $ $ $ - ------------------------------------------------------------------------------------------------- Land 520,500 -- 520,500 238,500 -- 238,500 Buildings 1,069,828 67,012 1,002,816 355,371 24,634 330,737 Rental equipment 2,662,200 826,940 1,835,260 1,978,263 365,931 1,612,332 Equipment 1,088,875 220,728 868,147 316,592 130,218 186,374 Software 54,948 24,185 30,763 53,249 5,916 47,333 Automobiles 51,173 24,777 26,396 41,364 8,703 32,661 Computer equipment 284,694 73,534 211,160 -- -- -- Masters and libraries 268,729 63,509 205,220 -- -- -- Leasehold improvements 55,433 1,522 53,911 -- -- -- - ------------------------------------------------------------------------------------------------- 6,056,380 1,302,207 4,754,173 2,983,339 535,402 2,447,937 =================================================================================================
During the year, depreciation of property and equipment was $782,568 [1996 - $344,908; 1995 - $192,916]. 7. BANK INDEBTEDNESS Bank indebtedness consists of two demand loans as follows: [a] The Company has a demand operating loan facility with a maximum amount of $500,000 bearing interest at the bank's prime rate. The Company has not used this facility. The Bank's prime rate was 4.75% at August 31, 1997. [b] The Company also has a demand instalment loan which was initially established to acquire Magic's land and building and is due on demand from the Royal Bank of Canada. The debt bears interest at the bank's prime rate plus 0.5% [5.25% at August 31, 1997] and is repayable in monthly principal amounts of $1,500 plus interest. The weighted average interest rate for fiscal 1997 was 5.07%. Fair value of the demand instalment loan approximates carrying value of $641,000. Bank indebtedness is secured by a fixed debenture of $1,000,000, hypothecated to Magic's land and buildings, a guarantee and postponement of claim of $650,000 signed by Magic and a general security agreement covering all the assets of Interactive other than real property. 8. INCOME TAXES AND DEFERRED INCOME TAXES The provision for income taxes consists of the following: 1997 1996 1995 $ $ $ - ------------------------------------------------------------------------- Current Federal 282,000 216,800 89,259 Provincial 151,900 116,800 47,741 Foreign -- 109,400 -- - ------------------------------------------------------------------------- 433,900 443,000 137,000 - ------------------------------------------------------------------------- Deferred Federal -- 13,000 1,400 Provincial -- 7,000 700 - ------------------------------------------------------------------------- -- 20,000 2,100 - ------------------------------------------------------------------------- 6 433,900 463,000 139,100 ======================================================================== The difference between the provision for income taxes and the amount computed by applying the combined basic federal and provincial income tax rate of 44.6% [1996 - 44.6%; 1995 - 44.48%] to income before income taxes is as set out below:
1997 1996 1995 $ $ $ - ------------------------------------------------------------------------------------- Statutory rate applied to pre-tax income 472,318 448,011 220,903 Benefit of prior year's losses not previously recognized (87,086) (11,632) (83,680) Expenses not deductible for tax purposes 44,735 6,802 6,604 Other 3,933 19,819 (4,727) - ------------------------------------------------------------------------------------- 433,900 463,000 139,100 ===================================================================================== Deferred income taxes result substantially from timing differences related to fixed assets. Goodwill resulting from the purchase of Magic is not deductible for tax purposes. At October 1, 1996, Magic and its subsidiaries had aggregate operating losses of $676,000. The purchase price of Magic has not been allocated to the operating losses since a valuation allowance has been charged against the entire amount. 9. LONG-TERM DEBT Long-term debt consists of the following: 1997 1996 $ $ - ------------------------------------------------------------------------------- Loans payable Provincial Holdings Ltd. ["PHL"] [i] 750,000 -- Less unamortized discount (43,980) -- - ------------------------------------------------------------------------------- 706,020 -- Business Development Bank of Canada [ii] 144,000 -- Province of New Brunswick ["PNB"] [iii] 52,381 -- Atlantic Canada Opportunities Agency ["ACOA"] [iv] 51,010 -- - ------------------------------------------------------------------------------- 953,411 -- - ------------------------------------------------------------------------------- Notes payable Promissory notes - unsecured principal amount [note 15] 1,250,000 -- Less unamortized discount (146,685) -- - ------------------------------------------------------------------------------- 1,103,315 -- Lien notes [v] 69,350 -- - ------------------------------------------------------------------------------- 1,172,665 -- - ------------------------------------------------------------------------------- 2,126,076 -- ===============================================================================
[i] In June 1995, PHL advanced $750,000 to STI. This loan is secured by a demand promissory note signed by STI and bears interest at 6% per annum, compounded annually, commencing October 1995. Interest has been forgiven by PHL for the period from October 1, 1995 to September 30, 1998. The loan has been discounted to $706,020 at August 31, 1997 to reflect the interest-free period from September 1, 1997 to September 30, 1998. The carrying value of the loan approximates its fair value. Subsequent to September 1998, the loan will bear interest at 6.75% compounded annually. The loan is subject to an agreement dated March 15, 1995 which, inter alia, provides for repayment in full of principal plus interest at the earlier of [a] the commencement of redemption of shares pursuant to a redemption agreement [note 10[d]] or [b] September 30, 2002 subject to any extension agreed to, or [c] on any breach of STI's obligations under the loan agreement or any other agreement with PHL. 7 [ii] The Business Development Bank of Canada's loan bears interest at 9.75% and is repayable in monthly principal amounts of $4,000 plus interest. The interest rate is fixed until March 2000. The loan is secured by a charge over the assets of the Company. It is subject to priority and subordination agreements between the Company, the Business Development Bank of Canada and the Royal Bank of Canada [note 7]. The fair value of this loan at August 31, 1997 is $152,304. [iii] In June 1995, PNB advanced $100,000 to STI. The loan is subject to a loan agreement dated May 25, 1995 and is secured by a demand promissory note which bears interest at 9.7% per annum, calculated half period, not in advance. Subject to a forgiveness agreement outlined below, the principal plus interest is repayable at the earlier of [a] January 31, 1998 or earlier at the option of STI or [b] any breach of STI's obligations under the loan agreement. A forgiveness agreement dated May 24, 1995 provides that the principal plus interest may be forgiven in part or in whole, the amount dependent upon STI's number of full time employees the 1997 calendar year. An amount of $47,619 is included as forgiven in these consolidated financial statements, being a proportionate amount for the period from January to August 1997. No interest has been accrued on the balance of the advance as it is likely that future forgiveness will exceed any interest to be paid. The recorded loan approximates the fair value of the debt at August 31, 1997. [iv] ACOA advanced this unsecured non-interest bearing loan to STI in April 1995. The loan is repayable in fifteen equal quarterly instalments commencing April 2000. Fair value of the advance approximates carrying value. [v] The lien notes are secured by charges against certain capital assets held by Magic and are repayable in monthly blended payments of principal and interest. Interest rates on the lien notes vary between 13% and 15%. The carrying value of the lien notes approximates the fair value of the debt at August 31, 1997. Approximate annual principal payments required pursuant to these obligations are as follows: $ --------------------------------------------------------------------- 1998 38,058 1999 22,209 2000 24,328 --------------------------------------------------------------------- 84,595 Less deferred interest 15,245 --------------------------------------------------------------------- 69,350 ===================================================================== Approximate annual principal payments for long-term debt, exclusive of the above lien notes, are as follows: $ --------------------------------------------------------------------- 1998 673,000 1999 360,500 2000 367,301 2001 13,603 2002 and thereafter 763,603 ===================================================================== 10. COMMITMENTS [a] Commissions expense to NTN Communications, Inc. Commissions paid to NTN Communications, Inc. are recognized when the related revenues are earned at the rate of U.S. $2,100 per year per subscriber [note 12]. [b] Commissions expense Commissions expense to sub-licensees is recognized when the related revenues are earned and are calculated as follows: 8 [i] 30% of all fees received by Interactive under any Commercial User Agreement as then in effect if such agreement is executed through the efforts of the sub-licensee where the establishment subject to the Commercial User Agreement is located within the territory during the first term of any such agreement; [ii] 10% of all net fees received by Interactive from National Advertisers [sponsors] based on the number of Commercial User locations within the territory; and [iii] 5% of all net fees received by Interactive under any Residential User Agreement within the territory, which may only be solicited by Interactive directly. All commission payments are made to sub-licensees no later than the 15th of the month immediately following the month in which user fees and sponsor fees, from which said commissions are earned, are received and collected by Interactive. [c] Lease commitments The future minimum annual lease payments under operating leases are as follows: Vehicles $ --------------------------------------------------------------------- 1998 24,587 1999 18,678 --------------------------------------------------------------------- 43,265 ===================================================================== Office equipment $ --------------------------------------------------------------------- 1998 19,000 1999 9,000 2000 3,000 --------------------------------------------------------------------- 31,000 ===================================================================== Premises $ --------------------------------------------------------------------- 1998 125,000 1999 117,000 2000 107,000 --------------------------------------------------------------------- 349,000 ===================================================================== Operating lease expenses were $82,525 for 1997, $17,808 for 1996, and $26,629 for 1995. 9 [d] Redemption of shares of subsidiary STI, a subsidiary, has entered into a redemption agreement dated March 15, 1995 with its minority shareholder [25% of common shares held], PHL. Shares held by PHL may be redeemed by STI in minimum numbers of five after December 31, 1997 provided STI has repaid all indebtedness to PHL and PNB, or the PNB indebtedness has been forgiven, and must be redeemed in full on or before September 20, 2002. The redemption price is calculated at the higher of [a] the purchase price per share [$0.04], or [b] the purchase price per share plus the increase per share in retained earnings of the corporation to the date of redemption, calculated by adding back to the retained earnings, the pro rata share applicable to the number of shares being redeemed, of all interest paid or accrued on the loan by PHL and to the corporation in the amount of $750,000 and deducting therefrom the interest actually paid, pro rata to the number of shares being redeemed. As at August 31, 1997, the value of the shares, if redeemed, totalled a nominal amount. 11. SHARE CAPITAL AND WARRANTS [a] Authorized shares The Company's authorized share capital comprises 20,000,000 common shares with a par value of $0.062 [U.S. $0.0467] per share and 1,500,000 preferred shares with a par value of $0.014 [U.S. $0.010] per share. The preferred shares are voting and convertible, such that 4.67 preferred shares are exchanged for 1 common share, at the option of the holders. [b] Issued and outstanding shares As at August 31, 1997, 1996 and 1995, 950,000 preferred shares with a paid-up amount of $11,523 were issued and outstanding. Effective August 15, 1996, the Company elected a three for two common shares stock split. This share split has been applied retroactively to all common share data presented in these consolidated financial statements. Common shares issued and outstanding for accounting purposes are as follows: 10
Common shares ---------------------- Capital in excess Number Amount of par value Total # $ $ $ - -------------------------------------------------------------------------------------------- Issued and outstanding as at August 31, 1994 1,049,244 62,062 2,368,909 2,430,971 Issue of common shares through private placement [ii] 790,901 49,789 4,202,711 4,252,500 Exercise of 144,000 warrants [i] 216,000 13,722 574,377 588,099 - -------------------------------------------------------------------------------------------- Balance as at August 31, 1995 2,056,145 125,573 7,145,997 7,271,570 Issue of common shares through private placement [ii] 134,886 8,615 (8,615) -- Exercise of 167,000 warrants [i] 250,500 15,999 783,965 799,964 - -------------------------------------------------------------------------------------------- Balance as at August 31, 1996 2,441,617 150,187 7,921,347 8,071,534 Exercise of 375 stock options 375 24 1,803 1,827 - -------------------------------------------------------------------------------------------- Balance as at August 31, 1997 2,441,992 150,211 7,923,150 8,073,361 ============================================================================================
[i] In July 1993, 167,000 common shares and two separate warrant options were issued by a private placement for $646,802 [U.S. $501,000] [note 11 [c]]. [ii] On October 4, 1994, NetStar Communications, Inc. ["NetStar"], formerly Labatt Communications Inc., acquired a 35% equity interest [674,594 common shares] in the Company for U.S. $3,150,000. Additional common shares were issued to NetStar as follows: $ ------------------------------------------------------------------- August 31, 1995 116,307 March 31, 1996 22,617 August 31, 1996 112,269 =================================================================== These shares were issued in order to maintain NetStar's 35% equity position as the result of pre-existing warrants being exercised. NetStar also has the option, which expires April 1, 1998, to increase its equity interest to 51% at the then prevailing market price. 11 [c] Number of outstanding warrants Pursuant to a private offering in July 1993, the Company issued 167,000 "A" and 167,000 "B" warrants. All of the "A" warrants were exercised prior to August 31, 1995. All of the "B" warrants were exercised prior to July 30, 1996. [d] Long-Term Incentive Plan The Company has adopted a Long-Term Incentive Plan [the "Plan"] designed to compensate key employees of the Company for the performance of their corporate responsibilities. The benefits to employees under the Plan are dependent upon improvement in market value of the Company's common shares. The Plan offers selected key employees the opportunity to purchase common shares through the exercise of a non-qualified stock option. An option entitles the employee to purchase common shares from the Company at a price determined on the date the option is granted. The option price on the grant date is the average trading price of the stock over the five days prior to the grant date. The options vest over a two-year period from the grant date, 50% after one year and 50% at the end of the second year. The options must expire five years after the grant date. The Plan also provides that selected key employees may retrieve common shares as an award of Restricted Stock. Restricted Stock consists of common shares that are awarded subject to certain conditions, such as continued employment with the Company or an affiliate for a specified period. Up to 525,000 common shares may be issued under the Plan. 12 The following is a summary of outstanding stock options:
Exercise price Expiry date Total U.S. $ # - ----------------------------------------------------------------------------------------------------- Issued and outstanding as at August 31, 1994 58,929 Issued during year ended August 31, 1995 U.S.$5.33 October 5, 1999 75,000 U.S.$5.33 November 23, 1999 37,500 U.S.$4.33 April 4, 2000 15,000 - ----------------------------------------------------------------------------------------------------- Balance as at August 31, 1995 186,429 Issued during the year ended August 31, 1996 3.50 November 20, 2000 111,750 4.67 April 29, 2001 4,500 Expired during the year ended August 31, 1996 - ----------------------------------------------------------------------------------------------------- 5.83 March 1996 (21,429) Balance as at August 31, 1996 281,250 Issued during the year ended August 31, 1997 4.875 November 25, 2001 81,000 3.875 April 7, 2002 4,500 Forfeited during the year ended August 31, 1997 3.50 November 20, 2000 (3,375) Exercised during the year ended August 31, 1997 3.50 November 20, 2000 (375) - ----------------------------------------------------------------------------------------------------- Balance as at August 31, 1997 363,000 =====================================================================================================
Of the 363,000 outstanding stock options, 253,500 [1996 - 176,250] restricted common shares are issuable upon the exercise of the stock options outstanding in the above table. Non-restricted common shares are issuable for the remaining options outstanding. The fair value of options granted during 1997 was U.S. $2.56 [1996 - U.S.$1.34]. The Company accounts for its stock option plans and its employee stock purchase plan in accordance with the provisions of APB 25. Accordingly, because the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense has been recognized in the consolidated financial statements for these plans. Pro forma information regarding net income and earnings per share is required by FAS 123, and has been determined as if the Company had accounted for its employee stock options under the fair value method of that Statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for 1997 and 1996: risk-free interest rate of 3.0%; dividend yield of 0%; volatility factor of 0.522; and a weighted-average expected life of the options of 3 years. 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 the input of highly subjective assumptions including the expected stock price volatility. Because the Company's 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. 13 The Company's pro forma net income and earnings per share follows: 1997 1996 $ $ ------------------------------------------------------------------- Pro forma net income 428,657 459,463 =================================================================== Pro forma earnings per share Primary 0.16 0.19 Diluted 0.15 0.19 =================================================================== The pro forma net income reflects only options granted in 1997 and 1996. Therefore, the full impact of calculating compensation expense for options under FAS 123 is not reflected in the pro forma net income since compensation expense is reflected over the option vesting periods and compensation expense for options granted prior to September 1, 1995 is not considered. 12. AGREEMENTS WITH NTN COMMUNICATIONS, INC. Pursuant to an agreement dated March 23, 1990 and in consideration for the services granted to it, Interactive pays to NTN Communications, Inc. the amount of U.S. $2,100 per year per User Agreement executed by Interactive for every year of each User Agreement. Interactive also pays NTN Communications, Inc. a royalty fee equal to 25% of the net revenues as defined in the agreement derived from all services except for certain hospitality and Special Projects that existed at March 23, 1990; a royalty fee equal to the Production Quotation submitted by NTN Communications, Inc. plus 10% of the gross profit of Special Projects [special broadcasts for a non-continuous selective event]; and a one-time royalty fee equal to NTN Communications, Inc.'s production costs for any new programming developed by Interactive to be added to the existing programming schedule. The agreement expires on December 31, 2015. Total amounts expensed in the year under these agreements were $1,757,718 [1996 - - $1,339,263; 1995 - $1,082,634]. 13. EARNINGS PER SHARE Earnings per share were calculated based upon the weighted average number of common and equivalent shares and giving effect to the conversion of the preferred shares and settlement of the two promissory notes [note 15[a]] as follows: 1997 1996 1995 - -------------------------------------------------------------------------- # # # - -------------------------------------------------------------------------- Primary 2,694,734 2,392,548 2,146,226 Fully diluted 2,895,200 2,455,282 -- ========================================================================== 14. CONTINGENT LIABILITY On June 12, 1992, the Company filed a lawsuit against Interactive Network Inc. of Mountainview, California, U.S.A. and its president. The suit seeks a non-infringement with respect to a Canadian patent. On June 18, 1992, Interactive Network Inc. instituted proceedings against NTN Communications, Inc., NTN Interactive Network Inc. and the Company in the Federal Court of Canada and in the California Supreme Court claiming patent infringement. It is the opinion of the Company's management and its legal representatives that this patent infringement claim will be successfully defended. 14 15. BUSINESS ACQUISITIONS [a] Magic Lantern Communications Ltd. Effective October 1, 1996, the Company acquired 100% of Magic and its subsidiaries for a purchase price of $1,553,315 on a discounted basis. Magic is a Canadian corporation which distributes educational videos and provides related services. The acquisition was recorded using the purchase method of accounting and, accordingly, the purchase price has been allocated as set out below: $ -------------------------------------------------------------------------- Goodwill 2,219,623 Net assets purchased (575,126) Acquisition costs capitalized (91,182) -------------------------------------------------------------------------- Purchase price on a discounted basis 1,553,315 ========================================================================== The excess cost over tangible assets acquired of $2,219,623 was allocated to goodwill and will be amortized over twenty years. The purchase price was satisfied by $450,000 in cash and the issue of two non-interest bearing promissory notes with a maturity value of $1,250,000. The first promissory note of $703,133 is repayable by cash payments of $78,133 on August 31, 1998, $312,500 on August 31, 1999 and $312,500 on August 31, 2000. Notwithstanding the foregoing, the Company has the right to elect up until June 30, 1998 to issue common shares in lieu of the aforesaid payments as follows: 12,276 shares on August 31, 1998, 49,097 shares on August 31, 1999 and 49,096 shares on August 31, 2000. Should the Company not elect to deliver common shares, the noteholder has the right, exercisable between July 1, 1998 and July 31, 1998, to require the Company to issue the common shares as described. The August 31, 1999 and 2000 payments may be accelerated at the option of the noteholder if certain arrangements pursuant to an employment agreement with a shareholder of the noteholder [the "employee"] do not extend beyond September 1, 1998. The second promissory note of $546,867 is payable by cash payments of $312,500 on August 31, 1997 and $234,367 on August 31, 1998. Notwithstanding the foregoing, the Company has the right to elect up until June 30, 1997 to issue common shares in lieu of the aforesaid payments as follows: 49,097 shares on August 31, 1997 and 36,821 shares on August 31, 1998. The August 31, 1997 balance due of $312,500 was satisfied by the payment of $65,000 and the issuance of 38,158 common shares on September 5, 1997. Should the Company not elect to deliver common shares, the noteholder has the right, exercisable between July 1, 1997 and July 31, 1997 to require the Company to issue the common shares as described. Also pursuant to the share purchase agreement, the Company and noteholders have entered into separate option agreements which provide for the repurchase of the shares received by the noteholders under the terms of the notes, should the term of employment of the employee not be extended beyond August 31, 1999. The repurchase price will be 90% of the average closing price of the common shares during the 20 days prior to the exercise of a put option by the noteholders should the Company not wish to extend the term of employment. The repurchase price will be 110% of the average closing price of the common shares during the 20 days prior to the exercise of a call option by the Company should the employee not wish to extend the term of employment. The operating results of Magic are included in the Company's consolidated financial statements of operations and retained earnings (deficit) from the date of acquisition. The following unaudited pro forma information for the acquisition of Magic has been prepared as if this acquisition had occurred on September 1, 1995. The information is based on historical results of the separate companies and may not necessarily be indicative of the results that could have been achieved or of results which may occur in the future. The pro forma information includes the expense for amortization of goodwill resulting from this transaction but does not reflect any synergies or operating cost reductions that may be achieved from the combined operations. 15 Fiscal year ended August 31, 1996 $ -------------------------------------------------------------------------- Revenue 8,974,616 Income before amortization of goodwill 97,633 Loss after amortization of goodwill (12,076) Loss per share - fully diluted (0.01) ========================================================================== [b] Viewer Services Effective October 10, 1996, Magic acquired 500 of the 1000 shares of Viewer Services. This joint venture is operated with International Tele-Film Enterprises Ltd. The interest in the joint venture has been recognized in the consolidated financial statements using the equity method of accounting. [c] Image Media and Pilot Software Magic also entered into an agreement dated August 18, 1997 to acquire certain of the business assets of Image Media Ltd. and 802117 Ontario Inc., trading as Pilot Software. The agreement was completed on August 31, 1997. The total consideration, including transaction costs, amounted to $590,000 and has been allocated as follows: $ ---------------------------------------------------------------------- Equipment 481,000 Goodwill 45,000 Inventory 37,000 Sundry receivable 27,000 ---------------------------------------------------------------------- 590,000 ====================================================================== 16. SEGMENTED INFORMATION The Company operates in the interactive television entertainment and educational video distribution industries. Business segment information for the year ended August 31, 1997 is as follows: Interactive Educational television video entertainment distribution Total $ $ $ - -------------------------------------------------------------------------------- Total revenue 7,535,537 2,816,152 10,351,689 Operating income 863,750 162,712 1,026,462 Identifiable assets 3,893,824 3,452,415 7,346,239 Corporate assets 7,438,330 (496,967) 6,941,363 Capital expenditures 866,981 654,784 1,521,765 Depreciation and amortization 703,075 249,070 952,145 Loss from equity investment -- (32,547) (32,547) ================================================================================ Total revenue by industry segments is net of intersegment sales, which were immaterial. Operating income is equal to income before income taxes and minority interest, and includes deductions for items such as interest and depreciation. Identifiable assets by industry are those assets used in the Company's operations in each industry. Corporate assets are principally cash and cash equivalents, short-term investments and intangibles. The Company has a 50% interest in Viewer Services, whose operations are vertically integrated with the Company's operations in the educational video distribution segment. This investment is being accounted for on the equity basis. Equity in the net loss of Viewer Service was $32,547, while investment in the net assets of Viewer Services was $5,758. 16 Comparatives for previous years have not been presented due to the fact that 1997 was the first year that the educational video distribution segment was part of the Company's operations. 17. COMPARATIVE CONSOLIDATED FINANCIAL STATEMENTS The 1996 and 1995 comparative consolidated financial statements have been reclassified from statements previously presented to conform to the presentation of the 1997 consolidated financial statements. 18. RELATED PARTY TRANSACTIONS During the year, the Company had sales of $157,500 [1996 - $168,000] to and purchases of $100,000 [1996 - nil] from corporations controlled by a shareholder. 17 AUDITORS' REPORT To the Shareholder of Magic Lantern Communications Ltd. We have audited the consolidated balance sheet of Magic Lantern Communications Ltd. as at August 31, 1997 and the statements of income and deficit and changes in financial position for the eleven month period then ended. These consolidated financial statements are the responsibility of the company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform an audit to obtain reasonable assurance whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. In our opinion, except for the fact that comparative figures have not been presented, as outlined in Note 15, these consolidated financial statements present fairly, in all material respects, the financial position of the company as at August 31, 1997 and the results of its operations and the changes in its financial position for the eleven month period then ended in accordance with generally accepted accounting principles. /s/ Harendorf, Lebane, Moss HARENDORF, LEBANE, MOSS October 22nd, 1997 Chartered Accountants Toronto, Canada 18 EX-22 2 LIST OF SUBSIDIARIES Exhibit 22. List of Subsidiaries of NTN Canada, Inc. as at August 31, 1997 Name of Subsidiary (1) Jurisdiction of Incorporation - ---------------------- ----------------------------- B.C. Learning Connection, Inc. (2)..............................British Columbia Magic Lantern Communications Ltd (3)......................................Canada NTN Interactive Network Inc...............................................Canada 1113659 Ontario Ltd. (4).................................................Ontario 745695 Ontario Ltd. (5)..................................................Ontario Sonoptic Technologies Inc. (6)............................................Canada - ---------- (1) Unless otherwise indicated, all named entities are wholly-owned subsidiaries of NTN Canada, Inc. (2) Wholly-owned subsidiary of 745695 Ontario Ltd. (3) Wholly-owned subsidiary of NTN Interactive Network Inc. (4) Partially-owned (50%) equity investment of Magic Lantern Communications Ltd. (5) Wholly-owned subsidiary of Magic Lantern Communications Ltd. (6) Majority owned (75%) subsidiary of Magic Lantern Communications Ltd. 38 EX-23 3 BUSINESS SECTOR DATA Exhibit 23. Business Sector Data Business Sector Data for the years ended August 31:
Interactive TV Educational Video Entertainment Distribution Total ------------- ------------ ----- 1997 (Canadian dollars): Total revenues Cdn$7,535,537 Cdn$2,816,152 Cdn$10,351,689 Operating income 863,750 162,712 1,026,462 Net earnings 420,619 188,768 609,387 Total assets Cdn$11,332,154 Cdn$2,955,448 Cdn$14,287,602 Current liabilities 1,883,690 1,335,325 3,219,015 Total liabilities 2,491,657 2,307,297 4,798,954 1997 (United States dollars): Total revenues US$5,427,106 US$2,028,197 US$7,455,303 Operating income 622,074 117,185 739,259 Net earnings 302,931 135,951 438,882 Total assets US$8,161,436 US$2,128,519 US$10,289,955 Current liabilities 1,356,637 961,703 2,318,340 Total liabilities 1,794,495 1,661,719 3,456,214 1996 (Canadian dollars): Total revenues Cdn$6,318,251 -- Cdn$6,318,251 Operating income 1,004,059 -- 1,004,059 Net earnings 541,059 -- 541,059 Total assets Cdn$9,883,093 -- Cdn$9,883,093 Current liabilities 975,659 -- 975,659 Total liabilities 1,005,659 -- 1,005,659 1996 (United States dollars): Total revenues US$4,616,917 -- US$4,616,917 Operating income 733,693 -- 733,693 Net earnings 395,366 -- 395,366 Total assets US$7,221,844 -- US$7,221,844 Current liabilities 712,940 -- 712,940 Total liabilities 734,862 -- 734,862
EX-27 4 FINANCIAL DATA SCHEDULE
5 This schedule contains summary financial information extracted from the annual report on Form 10-K and is qualified in its entirety by reference to such financial statements. Canadian dollars 12-MOS AUG-31-1997 SEP-01-1996 AUG-31-1997 1.3885 2,421,797 1,705,014 1,598,395 51,000 624,828 6,718,877 6,056,380 1,302,207 14,287,602 3,219,015 0 0 11,523 150,211 9,326,914 14,287,602 2,422,516 10,351,689 3,395,898 5,771,211 0 48,284 109,834 1,026,462 433,900 609,387 0 0 0 609,387 0.23 0.21
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