-----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, LfGySUmJqt5wx6T1Vy1RfljQkRkZxSc8abkVuD63GWsWiKetCoKSmMJn0XwM3+RR IcpXK/qW18/zI6UT+ZbaYA== 0000891618-96-001826.txt : 19970924 0000891618-96-001826.hdr.sgml : 19970924 ACCESSION NUMBER: 0000891618-96-001826 CONFORMED SUBMISSION TYPE: PRE 14A PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 19960913 FILED AS OF DATE: 19960814 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: SANCTUARY WOODS MULTIMEDIA CORP CENTRAL INDEX KEY: 0000900748 STANDARD INDUSTRIAL CLASSIFICATION: 3651 IRS NUMBER: 752444109 FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: PRE 14A SEC ACT: SEC FILE NUMBER: 000-21510 FILM NUMBER: 96614197 BUSINESS ADDRESS: STREET 1: 1825 SOUTH GRANT ST STREET 2: STE 410 CITY: SAN MATEO STATE: CA ZIP: 94402 MAIL ADDRESS: STREET 1: 1825 S GRANT ST CITY: SAN MATEO STATE: CA ZIP: 94402 PRE 14A 1 PRELIMINARY PROXY MATERIALS 1 SANCTUARY WOODS MULTIMEDIA CORPORATION 1825 S. GRANT STREET SAN MATEO, CALIFORNIA 94402 -------------------- NOTICE OF ANNUAL MEETING OF SHAREHOLDERS TO BE HELD ON SEPTEMBER 13, 1996 -------------------- TO THE SHAREHOLDERS: NOTICE IS HEREBY GIVEN that the Annual Meeting of Shareholders of Sanctuary Woods Multimedia Corporation (the Company), a British Columbia corporation (the Company) will be held on September 13, 1996 at 10:00 a.m., Pacific time, at for the following purposes: 1. To receive and consider the financial statements of the Company for the fiscal year ended December 31, 1995 and for the three month period from January 1, 1996 to March 31, 1996 and the Auditor's Report thereon. 2. To fix the number of directors for the ensuing year (Proposal One). 3. To elect three (3) directors of the Company to hold office until the 1997 Annual Meeting of Shareholders or until their successors have been duly elected and qualified (Proposal Two). 4. To approve the appointment of Deloitte & Touche, certified and chartered accountants, as independent auditors of the Company for the fiscal year ending March 31, 1997 and to authorize the Board of Directors to fix the remuneration to be paid to the auditors (Proposal Three). 5. To approve amendments of the Company's 1995 Stock Option Plan to (a) increase the number of shares of Common Stock reserved for issuance thereunder by 2,030,000 shares from 1,970,000 shares to 4,000,000 shares and (b) to change the formula for granting options to Directors (Proposal Four). 6. To approve, as a special resolution, the consolidation of the Company's share capital on the basis of one (1) new share for each three (3) existing shares and to approve an increase to the Company's authorized capital (Proposal Five). 7. To approve, as a special resolution, an amendment to the Company's Articles of Incorporation authorizing a class of preferred stock with preferences, limitations and relative rights as determined by the Board of Directors (Proposal Six). 8. To transact such other business as may properly be brought before the meeting and any adjournment(s) thereof. 2 Pursuant to the Articles of the Company, the Board of Directors has fixed August 1, 1996 as the record date for the determination of such shareholders entitled to notice of and to vote at the Meeting and all adjournments thereof, and only shareholders of record at the close of business on that date are entitled to such notice and to vote at the Meeting. Accompanying this Notice of Meeting is a Proxy Statement and Information Circular and Proxy with Notes to Proxy. We hope that you will use this opportunity to take an active part in the affairs of the Company by voting on the business to come before the Meeting by executing and returning the enclosed Proxy. Whether or not you expect to attend the meeting in person, please date and sign the accompanying Proxy and return it promptly in the envelope enclosed for that purpose. If you receive more than one Proxy because you own shares registered under different names or addresses, each Proxy should be completed and returned. The enclosed Proxy is solicited by Management and the Board of Directors of the Company and you may amend it, if you so desire, by striking out the names listed therein and inserting in the space provided the name of the person you wish to represent you at the Meeting. By Order of the Board of Directors San Mateo, California August ___, 1996 Jeremy Salesin Secretary -2- 3 - - - -------------------------------------------------------------------------------- YOUR VOTE IS IMPORTANT IN ORDER TO ASSURE YOUR REPRESENTATION AT THE MEETING, YOU ARE REQUESTED TO COMPLETE, SIGN AND DATE THE ENCLOSED PROXY CARD AS PROMPTLY AS POSSIBLE AND RETURN IT IN THE ENCLOSED ENVELOPE. - - - -------------------------------------------------------------------------------- SANCTUARY WOODS MULTIMEDIA CORPORATION 1825 GRANT STREET SAN MATEO, CALIFORNIA 94402 ----------------- PROXY STATEMENT AND INFORMATION CIRCULAR ----------------- INFORMATION CONCERNING SOLICITATION AND VOTING GENERAL INFORMATION The enclosed Proxy and Information Circular (the Proxy Statement) is furnished in connection with the solicitation of Proxies by Management and the Board of Directors of Sanctuary Woods Multimedia Corporation (the "Company") for use at the Annual Meeting of Shareholders to be held at on September 13, 1996 at 10:00 a.m. Pacific time, and at any adjournment(s) thereof, for the purposes set forth herein and in the accompanying Notice of Annual Meeting of Shareholders. The Company's principal office is located at 1858 S. Grant Street, San Mateo, California and its telephone number is (415)286-6000. These proxy solicitation materials were mailed on or about August , 1996 to all shareholders entitled to vote at the meeting. All information contained herein is as of August 1, 1996 unless otherwise noted. REVOCABILITY OF PROXIES Any proxy given pursuant to this solicitation may be revoked by the person giving it at any time before its use by delivering to the Secretary of the Company a written notice of revocation at any time up to and including the last business day preceding the day of the Meeting or, if adjourned, any reconvening thereof, or to the Chairman of the Meeting on the day of the Meeting prior to its commencement or, if adjourned, any reconvening thereof, or in any other manner provided by law. A revocation of a proxy does not affect any manner on which a vote has been taken before revocation. VOTING; QUORUM; AND SOLICITATION Shareholders of record at the close of business on August 1, 1996 (the "Record Date") are entitled to notice of and to vote at the meeting and at any adjournment(s) thereof. At the Record Date, 26,786,163 shares of the Company's Common Shares were issued and outstanding, including 4,000,000 Performance Shares. See Note 6 to the "Security Ownership of Certain Beneficial Owners and Management" table. Shareholders unable to attend the Meeting in person should read the notes accompanying the enclosed Proxy and complete and return the Proxy to the Company's Registrar and Transfer Agent within the time required by, and to the location set out in, the notes to the Proxy. You may amend the enclosed Proxy, if you wish, by striking out the 4 names listed therein and inserting in the space provided the name of the person you wish to represent you as proxy at the meeting. The persons named in the enclosed form of Proxy are directors or officers of the Company and will, if authorized by proxy, vote the shares represented thereby on any poll, and where a choice with respect to any matter to be acted upon has been specified in the form of a Proxy, the shares will be voted in accordance with the specification so made. If no such specification is made, the shares will be voted for each of the nominees named herein as directors and for Proposals 1, 2 and 4 through 6. If for any reason, which the Management and the Board of Directors do not expect, a nominee is unable or unwilling to serve, the holders of such Proxies may use their discretion to vote for a substitute proposed by Management. The enclosed form of Proxy confers discretionary authority upon the person appointed thereunder with respect to amendments or variations of matters identified in the Notice of Meeting and with respect to other matters which may properly come before the Meeting. At the time of printing this Proxy Statement, Management of the Company knows of no such amendment, variation or other matter which is expected to come before the Meeting. On all matters which may come before the Meeting, shareholders will be entitled to one vote for each share held of record. In the election of directors, shareholders do not have cumulative voting rights. Approval of each proposal other than Proposals 5 and 6 requires the affirmative votes of a majority of the Common Shares represented and voting at the Meeting. Proposals 5 and 6 require the affirmative votes of not less than 75% of the Common Shares so represented and voting at the Meeting. The presence in person of two persons entitled to vote as members or by proxy not less than 10% of the issued and outstanding Common Shares constitutes a quorum for the transaction of business at the Meeting. The cost of this solicitation will be borne by the Company. DEADLINE FOR RECEIPT OF SHAREHOLDER PROPOSALS The Company currently intends to hold its 1997 Annual Meeting of shareholders in September 1997 and to mail proxy statements relating to such meeting in August 1997. Proposals of shareholders of the Company that are intended to be presented by such shareholders at such Annual Meeting must be received by the Company no later than April __, 1997 and must otherwise be in compliance with applicable laws and regulations in order to be considered for inclusion in the proxy statement and form of proxy relating to that meeting. -2- 5 PROPOSAL ONE FIXING THE NUMBER OF DIRECTORS FOR THE ENSUING YEAR AND PROPOSAL TWO ELECTION OF DIRECTORS NOMINEES Management is seeking shareholder approval of an ordinary resolution setting the number of directors at three (3) for the ensuing year. A board of three (3) directors is to be elected at the meeting. Unless otherwise instructed, the proxy holders will vote the proxies received by them for the election of the three nominees named below, each of whom are presently directors of the Company. Each nominee has consented to be named a nominee in this Proxy Statement and to continue to serve as a director if elected. Should any nominee become unable or decline to serve as a director, the proxies will be voted in the discretion of the holder of such Proxies for other nominees in lieu of those unwilling or unable to serve. The Company is not aware of any reason that any nominee will be unable or will decline to serve as a director. Each director elected at this Annual Meeting will serve until the next Annual Meeting of Shareholders or until such director's successor has been elected and qualified. There are no arrangements or understandings between any director or executive officer and any other person pursuant to which he or she is or was to be selected as a director or officer of the Company. The names of the nominees and certain information about them, are set forth below:
COMMON SHARES NAME OF NOMINEE AGE PRINCIPAL OCCUPATION DIRECTOR SINCE HELD(1) - - - ------------------------------ --- --------------------------- -------------- ------------- N. John Campbell(2)(3)........ 42 Chairman and President of May 1994 90,000 CWC Capital Ltd. Charlotte J. Walker........... 41 Chairman, President and Chief February 1995 1,120,278 Executive Officer of the Company Grant N. Russell(2)(3) 43 Chief Technology Officer May 1994 90,000 and Vice Chairman of Advanced Gravis Computer Technology Ltd.
(1) Calculated in accordance with United States regulations. See "Security Ownership of Certain Beneficial Owners and Management" at page 17. (2) Member of the Audit Committee. (3) Member of the Compensation Committee. Except as set forth below, each of the directors has been engaged in his or her principal occupation set forth above during the past five years. There is no family relationship between any director or executive officer of the Company. -3- 6 N. John Campbell became a director of the Company on May 17, 1994. Mr. Campbell has been Chairman and President of CWC Capital Ltd., an investment banking firm, since May 1989. From January 1989 to May 1989, Mr. Campbell was Vice President and Director of Research of Pemberton Securities. Mr. Campbell has served on the Board of Directors of Advanced Gravis Computer Technology Ltd. ( Advanced Gravis), a computer peripherals company since July 1992 and is a member of the Compensation Committee of the Board of Directors of Advanced Gravis. Charlotte J. Walker has served as a director of the Company's since February 1995. In January 1996, Ms. Walker was appointed to the position of President and Chief Executive Officer of the Company. From September 1993 to January 1996, Ms. Walker served as a Managing Director of Bear Stearns & Co. Inc., an investment bank. From March 1990 to September 1993, Ms. Walker was employed by Martin Simpson & Company, Inc., an investment banking firm, serving in various capacities including Managing Director, Chief Executive Officer, Senior Managing Director and General Manager. Grant N. Russell became a director of the Company on May 17, 1994. Mr. Russell served as President of Advanced Gravis beginning April 1984, a member of its Board of Directors since December 1994 and is currently a member of the Compensation Committee of its Board of Directors. MANAGEMENT RECOMMENDS THAT SHAREHOLDERS VOTE FOR THE ORDINARY RESOLUTION SETTING THE NUMBER OF DIRECTORS AND FOR THE NOMINEES LISTED ABOVE BOARD MEETINGS AND COMMITTEES The Board of Directors of the Company held a total of 9 meetings during the fiscal year ended December 31, 1995 and held 11 additional meetings in the three month period ended March 31, 1996. No director serving during such fiscal year or such three month period attended fewer than 75% of the aggregate of all meetings of the Board of Directors and the committees of the Board upon which such director served during such periods. The Board of Directors has two committees, the Audit Committee and the Compensation Committee. The Audit Committee of the Board of Directors which consisted of Messrs. Campbell, Russell and Walker, held one meeting during the last fiscal year. Ms. Walker resigned from this Committee on January 13, 1996, in order to take a more active role in the affairs of the Company and ultimately became the post of President and Chief Executive Officer. The Audit Committee is responsible for certain financial affairs of the Company and its subsidiaries, including selection of the Company's independent auditors, the review of the adequacy of internal controls and reporting and the performance of any other duties or functions deemed appropriate by the Board of Directors. The Compensation Committee of the Board of Directors which consisted of Messrs. Campbell, Russell, Beninger and Walker held one meeting during the last fiscal year. Ms. Walker resigned from this Committee on January 13, 1996, in order to take the post of President and Chief Executive Officer. The Compensation Committee is responsible for the matters discussed under the heading Report of the Compensation Committee. The Board of Directors has no nominating committee or any committee performing such functions. -4- 7 DIRECTOR COMPENSATION The Company's directors are not paid any cash compensation for their services in their capacity as directors; however, they are reimbursed for reasonable expenses incurred in attending meetings of the Board of Directors. Upon commencement of service as a director and upon each anniversary date thereafter, each non-employee director receives an option to purchase 25,000 shares of Common Stock. In addition, non-employee directors annually receive an option to purchase 10,000 additional shares of Common Stock for each committee of the Board upon which they serve. The Company is proposing a change to this structure to provide directors with grants of options to purchase 50,000 shares of Common Stock, 25,000 of which will vest based upon attendance at meetings. In addition, the Company is proposing to grant options to purchase 2,500 shares to each director which serves on a committee of the Board of Directors. See "Proposal Four." -5- 8 PROPOSAL THREE RATIFICATION OF APPOINTMENT OF INDEPENDENT AUDITORS The Board of Directors has selected Deloitte & Touche, certified public accountants to continue to serve as the Company's independent auditors, to audit the financial statements of the Company for the fiscal year commencing on April 1, 1996, and recommends that shareholders vote for ratification of such appointment. Deloitte & Touche, certified public and chartered accountants, were first appointed on May 17, 1994 and served as the Company's independent auditors for the fiscal year ended December 31, 1995 and, following the Company's decision to change the Company's fiscal year end to March 31, for the fiscal year ended March 31, 1996. A representative of Deloitte & Touche is expected to attend the Meeting with the opportunity to make a statement if they desire to do so and are expected to be available to respond to shareholders questions. On May 17, 1994, the Company terminated Chambers, Phillips & Co. as independent auditors for the Company. Chambers, Phillips & Co.'s reports on the consolidated financial statements of the Company for 1992 and 1993 did not contain an adverse opinion or a disclaimer of opinion and the reports were not qualified or modified as to uncertainty, audit scope, or accounting principles. The decision to change accountants was approved by the Company's board of directors. During the fiscal years 1992 and 1993 and subsequent interim period (through May 17, 1994), there were no disagreements with Chambers, Phillips & Co. on any matter of accounting principles or practice, financial statement disclosure, or auditing scope or procedure, which, if not resolved to the satisfaction of Chambers, Phillips & Co., would have caused Chambers, Phillips & Co. to make a reference to the subject matter of the disagreement in connection with its report. During the fiscal years 1992 and 1993 and subsequent interim period (through May 17, 1994), there did not occur any kind of event listed in paragraphs (a)(1)(v)(A) through (D) of Regulation S-K, Item 304. Effective May 17, 1994, the Company engaged Deloitte & Touche (Canada) as independent auditors to audit the Company's financial statements for 1994. On April 11, 1994 the Company engaged Deloitte & Touche (Canada) as independent auditors to audit the financial statements of Magic Quest, Inc. for 1991, 1992 and 1993, pursuant to the Company's acquisition of Magic Quest, Inc. Deloitte & Touche LLP (United States) issued its independent auditors' report, which included a going concern uncertainty paragraph, dated May 6, 1994, on such Magic Quest, Inc. financial statements. Other than described above, during the fiscal years 1992 and 1993 and the subsequent interim period through May 17, 1994, neither the Company nor any person acting on behalf of the Company consulted Deloitte & Touche regarding (i) either: the application of accounting principles to a specified transaction, either completed or proposed; or the type of audit opinion that might be rendered on the Company's financial statements; or (ii) any matter that was either the subject of a disagreement (as defined in paragraph (a)(1)(iv) of Regulation S K, Item 304 and the related instructions) or a reportable event (as described in paragraph (a)(1)(v) of Regulation S-K, Item 304. MANAGEMENT RECOMMENDS THAT SHAREHOLDERS VOTE FOR RATIFICATION OF THE APPOINTMENT OF DELOITTE & TOUCHE AS INDEPENDENT AUDITORS FOR THE COMPANY. -6- 9 PROPOSAL FOUR AMENDMENT OF THE SANCTUARY WOODS MULTIMEDIA CORPORATION 1995 STOCK OPTION PLAN GENERAL The 1995 Stock Option Plan (the Plan ) was approved by the shareholders and became effective May 25, 1995. The Plan provides for the grant to employees of the Company including officers and employee directors of incentive stock options within the meaning of Section 422 of the Internal Revenue Code of 1986, as amended (the Code ) and for the grant of nonstatutory stock options to employees, non-employee directors and consultants of the Company. The Plan is administered by a committee comprised of members of the Board. There are currently 1,970,000 shares of Common Stock reserved for issuance under the Plan. As of July 15, 1996, options to purchase 1,639,000 shares were outstanding under the Plan and 331,000 shares remained available for future grants. Options to purchase 418,500 shares were outstanding based upon grants prior to adoption of the Plan. PROPOSAL At the Annual Meeting, the shareholders are being requested to approve an amendment to the Plan as follows: (i) to increase the number of shares reserved for issuance thereunder by 2,030,000 shares for an aggregate of 4,000,000 shares reserved for issuance thereunder which if fully vested and exercised would represent 13% of the total number of Common Shares outstanding based upon the number of shares outstanding at the record date. The amendment to increase the number of shares reserved under the Plan is proposed in order to give the Board of Directors greater flexibility to grant stock options. The Company believes that granting stock options motivates high levels of performance and provides an effective means of recognizing employee contributions to the success of the Company. The Company believes that this policy is of great value in recruiting and retaining highly qualified technical and other key personnel who are in great demand as well as providing reward and incentive to current employees. The Board of Directors believes that the ability to grant options will be important to the future success of the Company by allowing it to accomplish these objectives. (ii) To change the formula for granting Director's options to (A) a grant of options to purchase 50,000 shares of Common Stock, 25,000 of which will vest over the twelve month term of the position, plus 25,000 based upon participation in meetings of the Board of Directors and (B) a grant of options to purchase 2,500 shares of Common Stock for each committee upon which the Director serves. If this proposal is approved and Proposal Five (Proposal to Effect a One-for-Three Share Consolidation) is approved, each of the numbers of shares described above will be decreased by a factor of three. SUMMARY OF THE PLAN Certain features of the Plan are outlined below. Administration. The Plan is administered by a committee comprised of members of the Board (the Administrator ). Subject to the provisions of the Plan and to the instructions of the Board of Directors, the Administrator has the power to construe and interpret the Plan and all option agreements entered into under the Plan, to define the terms used in the Plan, to prescribe, amend and rescind rules and regulations relating to the administration of the Plan, and to make any other determinations necessary or advisable for the administration of the Plan. -7- 10 Eligibility and Terms of Options. The Plan provides that nonstatutory stock options may be granted to non-employee directors, employees and consultants. Incentive stock options may be granted only to employees including officers and employee directors. An optionee who has been granted an option may, if he or she is otherwise eligible, be granted additional options. A person, if eligible, may hold both Incentive Stock Options and Non-Qualified Options, but each such Option must be specifically identified as such. With respect to any optionee who owns stock possessing more than 10% of the voting power of all classes of stock of the Company (a 10% Shareholder ), the exercise price of any incentive stock option granted must equal at least 110% of the fair market value on the grant date and the maximum term of the option must not exceed five years. At present, each non-employee member of the Board of Directors is entitled annually, as of the date he or she commences service as a director and as of each anniversary date thereafter, to an option grant to purchase 25,000 shares of Common Stock. A non-employee director is further entitled annually to an additional option grant to purchase 10,000 shares of Common stock for each Board committee on which he/she serves. The Board of Directors proposes to change this provision to provide for yearly option grants of 50,000 shares, 25,000 of which would vest over the 12-month period of the position, 25,000 of which would vest based upon participation in Board of Directors meetings. An additional 2,500 shares shall be granted for each committee on which the Director serves. The exercise price for each such option granted to a director shall be, in the case of an Incentive Stock Option, equal to 100% of the fair market value of the shares covered by the option on the date of the grant, and in the case of a Non-Qualified Option, equal to the applicable percentage (i.e., 85%, 90%, or 100% of the fair market value of the covered shares on the date of the grant) as determined in accordance with the rules and regulations of the Vancouver Stock Exchange. Non-employee directors are not eligible for discretionary option grants under the Plan. The aggregate number of shares of Common Stock which may be reserved for issuance to any one individual upon exercise of options granted under the Plan shall in no event exceed 5% of the Company's total issued shares of Common Stock at the applicable date of grant. The aggregate number of shares of Common Stock which may be reserved for issuance to insiders or issued to insiders in any 12 month period shall in no event exceed 10% of the Company's issued shares of Common Stock during that period. Terms and Conditions of Options. Each option granted under the Plan is evidenced by a written stock option agreement between the optionee and the Company and is subject to the following terms and conditions: (iii) Exercise Price. The agreement specifies the exercise price of options to purchase shares of Common Stock at the time the options are granted. However, the exercise price of an incentive stock option must not be less than 100% (110% if issued to a 10% Shareholder) of the fair market value of the Common Stock on the date the option is granted. The exercise price of a nonstatutory option may not be less than the applicable discount percent determined in accordance with the rules and regulations of the Vancouver Stock Exchange. The market value of a share of the Company's Common Stock on August 1, 1996 was $0.65 Cdn. The fair market value per share of Common Stock shall be determined by the Committee in accordance with the following provisions: a. If the Common Stock is traded on the Nasdaq Small Cap Market or the Nasdaq National Market System, the fair market value shall be the closing selling price per share on the date in question, as such price is reported by the National Association of Securities Dealers through the Nasdaq Small Cap Market or the Nasdaq National Market System, whichever is applicable. If there -8- 11 is no reported closing selling price for the Common Stock on the date in question, then the closing selling price on the last preceding date for which such quotation exists shall be determinative of fair market value. b. If the Common Stock is not at the time listed or admitted to trading on the Nasdaq Small Cap Market or the Nasdaq National Market System but is traded on the Vancouver Stock Exchange, the fair market value shall be the closing selling price per share on the date in question on such exchange. If there is no reported closing selling price for the Common Stock on the date in question, then the closing selling price on the last preceding date for which such quotation exists shall be determinative of fair market value. c. If the Common Stock is not at the time traded on the Nasdaq Small Cap Market, the Nasdaq National Market System or the Vancouver Stock Exchange, but is listed or admitted to trading on another national stock exchange, then the fair market value shall be the closing selling price per share on the date in question on the exchange determined by the Committee to be the primary market for the Common Stock, as such price is officially quoted in the composite tape of transactions on such exchange. If there is no reported sale of Common Stock on such exchange on the date in question, then the fair market value shall be the closing selling price on the exchange on the last preceding date for which such quotation exists. d. If the Common Stock is not at the time listed or admitted to trading on any national stock exchange and is not traded on the Nasdaq Small Cap Market or the Nasdaq National Market System, the fair market value on the date in question shall be determined in good faith by the Committee. (iv) Exercise of the Option. Each stock option agreement will specify the term of the option and the date when the option is to become exercisable. An option is exercised by giving written notice of exercise to the Company, specifying the number of full shares of Common Stock to be purchased and by tendering full payment of the purchase price to the Company. If an Optionee does not purchase all the shares which the Optionee is entitled to purchase, the Optionee's right to purchase the remaining shares continues until the expiration of such option. (v) Form of Consideration. The consideration to be paid for the shares of Common Stock issued upon exercise of an option shall be determined by the Administrator and is set forth in the option agreement. Such form of consideration may vary for each option, and may consist entirely of cash, check, promissory note, other shares of the Company's Common Stock, any combination thereof, or any other legally permissible form of consideration as may be provided in the option agreement. (vi) Termination of Employment. If an Optionee ceases to be employed by the Company or a subsidiary (or, in the case of a Non-Qualified Option, ceases to serve as a non-employee director, independent contractor or employee) for any reason other than death or for cause, such Optionee's option or options shall expire thirty days thereafter, and during such thirty-day period shall be exercisable to the extent exercisable on the date the Optionee ceased to be employed by the Company or a subsidiary (or ceased to serve as a non-employee director or independent contractor, if applicable). The Committee, in its discretion, may exercise the time for an employee to exercise options beyond this thirty-day period. -9- 12 If an Optionee dies while employed by the Company or a subsidiary (or in the case of a Non-Qualified Option, while serving as a non-employee director, independent contractor or employee), the person or persons to whom the Optionee's rights under an Option shall pass by will or the laws of descent and distribution may exercise such option within one year of the Optionee's death as to those shares with respect to which the option was exercisable on the date of death. In the event an optionee's continuous status as an employee or consultant terminates for cause or by order of the Superintendent of Brokers for B.C., B.C. Securities Commission, Vancouver Stock Exchange or any securities regulatory body having jurisdiction to so order, such Optionee's option or options shall immediately expire on the date of notice by the Company of such termination. Cause for termination shall include the optionee's: (i) breach of fiduciary obligation to the Company, any of its subsidiaries or affiliates, or any customer, client or supplier of any of them; (ii) commission of any act or omission to perform any act which results or may, in the reasonable view of the Board of Directors, tend to result in serious adverse consequences to the Company, any of its subsidiaries or affiliates, or any client or supplier of any of them; (iii) gross neglect of duty; (iv) insubordination; (v) failure to follow the instructions of any of his or her supervisors or superiors; (vi) performance of an illegal act related in any manner to his or her employment by and/or duties to the Company; (vii) conviction for any crime or act involving moral turpitude; (viii) unauthorized use or disclosure of confidential information or trade secrets of the Company or any of its subsidiaries or affiliates; or (ix) breach of any of the Company's rules, policies or procedures. (vii) Termination of Options. Excluding options issued to 10% Shareholders, options granted under the Option Plan expire on such date as the Administrator may determine, but not later than ten years from the date of grant. No option may be exercised by any person after the expiration of its term. (viii) Nontransferability of Options. An option is nontransferable by the optionee, other than by will or the laws of descent and distribution, and is exercisable during the optionee's lifetime only by the optionee. (ix) Other Provisions. The stock option agreement may contain such other terms, provisions and conditions not inconsistent with the Plan as may be determined by the Administrator. Amendment and Termination of the Plan. The Board may at any time amend, alter, suspend or terminate the Plan. However, except in certain circumstances pertaining to changes in capitalization of the Company, the Board of Directors may not, without approval of the shareholders, adopt any amendment or modification of the plan or any option granted under the Plan which would (i) change the designation of the class of persons entitled to receive options; (ii) materially increase the total number of shares for which options may be granted under the Plan; (iii) extend the term of the Plan or the maximum option period thereunder; or (iv) decrease the minimum exercise price, subject to adjustment as provided in the Plan upon certain significant corporate events. The specific provisions of the Plan governing the grant of options to non-employee members of the Board of Directors shall not be amended more than once every six months, except to comply with required changes in the Code or regulations thereunder. Further, the Plan may not, without shareholder approval, be amended in any manner that would cause Incentive Stock Options issued under it to fail to meet the requirements of incentive stock options under Section 422 of the Code. Amendments to the Plan are subject to the approval of the Vancouver Stock Exchange and, if an individual participating in the Plan is an insider (as that term is defined in the Securities Act, S.B.C. 1985, c.83 as amended) of the Company, by shareholders of the Company. -10- 13 CERTAIN U.S. FEDERAL TAX INFORMATION Options granted under the Option Plan may be either incentive stock options, as defined in Section 422 of the Code, or nonstatutory options. An optionee who is granted an incentive stock option will not recognize taxable income either at the time the option is granted or upon its exercise, although the exercise may subject the optionee to the alternative minimum tax. Upon the sale or exchange of the shares more than two years after grant of the option and one year after exercising the option, any gain or loss will be treated as long-term capital gain or loss. If these holding periods are not satisfied, the optionee will recognize ordinary income at the time of sale or exchange equal to the difference between the exercise price and the lower of (i) the fair market value of the shares at the date of the option exercise or (ii) the sale price of the shares. A different rule for measuring ordinary income upon such a premature disposition may apply if the optionee is also an officer, director, or 10% Shareholder of the Company. The Company will be entitled to a deduction in the same amount as the ordinary income recognized by the optionee. Any gain or loss recognized on such a premature disposition of the shares in excess of the amount treated as ordinary income will be characterized as long-term or short-term capital gain or loss, depending on the holding period. All other options which do not qualify as incentive stock options are referred to as nonstatutory options. An optionee will not recognize any taxable income at the time he is granted a nonstatutory option. However, upon its exercise, the optionee will recognize taxable income generally measured as the excess of the then fair market value of the shares purchased over the purchase price. Any taxable income recognized in connection with an option exercise by an optionee who is also an employee of the Company will be subject to tax withholding by the Company. Upon resale of such shares by the optionee, any difference between the sales price and the optionee's purchase price, to the extent not recognized as taxable income as described above, will be treated as long-term or short-term capital gain or loss, depending on the holding period. The Company will be entitled to a tax deduction in the same amount as the ordinary income recognized by the optionee with respect to shares acquired upon exercise of a nonstatutory option. THE FOREGOING IS ONLY A SUMMARY OF THE EFFECT OF UNITED STATES FEDERAL INCOME TAXATION UPON THE OPTIONEE AND THE COMPANY WITH RESPECT TO THE GRANT AND EXERCISE OF OPTIONS UNDER THE OPTION PLAN; IT DOES NOT PURPORT TO BE COMPLETE, AND IT DOES NOT DISCUSS THE TAX CONSEQUENCES OF THE OPTIONEE'S DEATH OR THE INCOME TAX LAWS OF ANY MUNICIPALITY, STATE OR OTHER COUNTRY IN WHICH AN OPTIONEE MAY RESIDE. AMENDED AND NEW PLAN BENEFITS With the exception of option grants to the non-employee members of the Board of Directors which shall be granted pursuant to the express terms and conditions of the Plan, the proposed Plan provides the Committee with absolute discretion to determine the persons who will receive options under the Plan, the number of options to be granted and the terms of those options. Accordingly, it is impossible to determine the benefits that will be received or would have been received had the Plan been in effect during the Company's prior fiscal year by the Chief Executive Officer, the four most highly compensated officers other than the Chief Executive Officer, all executive officers as a group, and all employees, including current officers who are not executive officers as a group. -11- 14 REQUIRED VOTE The affirmative vote of the holders of a majority of the Common Stock present or represented at the Annual Meeting is required to approve and ratify the amendment to the Option Plan. THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR THE AMENDMENT OF THE OPTION PLAN PURSUANT TO THE FOLLOWING RESOLUTION "IT IS HEREBY RESOLVED THAT: 1. the proposed amendment to the Company's Stock Option Plan (the "Stock Option Plan") to be dated September 13, 1996 be adopted and approved; 2. the Company be authorized to grant stock options pursuant and subject to the terms and conditions of the Stock Option Plan entitling the option holders to purchase up to 4,000,000 common shares of the Company; 3. the Stock Option Plan be amended to provide for annual automatic grants to Directors of 50,000 options, 25,000 of which shall vest over the 12-month period of the position, 25,000 of which shall vest based on attendance at each Board of Directors meeting, plus 2,500 options per Committee on which the Director serves, 4. the existing stock options previously granted by the Company entitling the option holders to purchase up to common shares of the Company be ratified and confirmed; 5. the board of directors, by resolution, be authorized to make such amendments to the Stock Option Plan, from time to time, as may, in its discretion, be considered appropriate, provided always that such amendments be subject to the approval of all applicable regulatory authorities; and 6. any Director or Senior Officer of the Company be and he is hereby authorized and directed to perform all such acts, deeds and things and execute, under the seal of the Company if applicable, all such documents and other writings as may be required to give effect to the true intent of this resolution." -12- 15 PROPOSAL FIVE AUTHORIZATION OF THE BOARD TO AMEND THE COMPANY'S ARTICLES OF INCORPORATION TO EFFECT A ONE-FOR-THREE SHARE CONSOLIDATION OF THE COMPANY'S COMMON STOCK AND TO INCREASE THE AUTHORIZED SHARE CAPITAL The Company's stockholders are being asked to act upon a proposal that the authorized capital of the Company be consolidated on the basis of one (1) new common share without par value for every three (3) existing common shares without par value and thereafter the Company's authorized capital be increased to 50,000,000 shares of Common Stock and accordingly, the following special resolutions are proposed: "RESOLVED, as a Special Resolution, THAT: 1. all of the 50,000,000 common shares without par value, both unissued and fully paid issued, be consolidated on the basis of one new common share without par value for every three common shares without par value before consolidation. 2. the authorized capital be increased to 50,000,000 common shares without par value; AND THAT paragraph 2 of the Memorandum of the Company be altered to read as follows: '2. The authorized capital of the Company consists of 50,000,000 Common shares without par value.'" PURPOSES AND EFFECTS OF THE SHARE CONSOLIDATION The Board of Directors has proposed the one-for-three share consolidation because the Board believes that the share consolidation would increase the marketability of the Company's Common Stock and result in an increase in the market price of the Common Stock. The Company's stock was recently delisted from the Nasdaq Stock Market in part because the market price of the Company's stock did not meet the requirements for continued listing on the Nasdaq Stock Market, including a requirement that the trading price remain above $1.00 per share. Although the impact on the market price of shares of Common Stock cannot be predicted with certainty, it is likely that the share consolidation would initially result in the market price of each share of Common Stock being approximately three times the price previously prevailing, and that the aggregate market price of all shares of Common Stock held by a particular stockholder should remain approximately the same. The Common Stock is listed for trading on Vancouver Stock Exchange only. On the Record Date, the reported closing price of the Common Stock on Vancouver Stock Exchange was $0.65 Cdn. per share. Proportionate voting rights and other rights of stockholders would not be altered by the share consolidation. In addition, the number of shares of Common Stock subject to outstanding options granted pursuant to the Company's employee and director stock option and stock purchase plans (collectively, the Plans), and the number of shares of Common Stock reserved for issuance under the Plans, would be decreased by a factor of three, and the exercise price of outstanding options would be multiplied by three. -13- 16 The proposed share consolidation would not change the stockholders' equity or interest in the Company, and the book value of the number of shares outstanding immediately after the applicable share consolidation would be equal to the book value of the number of shares outstanding immediately prior to the share consolidation. Following the effective date, on which the amendments to the Articles of Incorporation effecting the share consolidation would be effected, the number of shares of Common Stock outstanding immediately prior to the share consolidation (26,786,163 shares as of the Record Date) would be consolidated into 8,928,721 shares, and the number of authorized and unissued shares of Common Stock would be 33,333,333 assuming that no additional shares of Common Stock are issued by the Company after the Record Date. Stockholders of record as of the close of business on the Effective Date would receive instructions to return their stock certificates to the Company's transfer agent which would return a new stock certificate representing one share of Common Stock for each three shares surrendered. The Company will not issue any fractional shares but will issue checks for any fractional interests. TAX CONSEQUENCES The Company has been advised by tax counsel that, under existing U.S. federal income tax laws and regulations, the receipt of fewer shares of the Company's Common Stock in the share consolidation will not constitute taxable income or gain or loss to shareholders; the cost or other tax basis of each share of Common Stock held by a stockholder immediately prior to the share consolidation will be allocated equally among the corresponding number of shares held immediately after the consolidation and the holding period for each of the post-consolidated shares will be equal to the most recently acquired of the three shares which were consolidated. The laws of jurisdictions other than the United States (including state and foreign jurisdictions) may impose income taxes on the receipt by a stockholder of shares of Common Stock resulting from the share consolidation. Stockholders are urged to consult their own tax advisors. THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR PROPOSAL FIVE TO AUTHORIZE THE BOARD TO AMEND THE COMPANY'S MEMORANDUM TO EFFECT A ONE-FOR-THREE SHARE CONSOLIDATION AND TO INCREASE THE AUTHORIZED SHARE CAPITAL. -14- 17 PROPOSAL SIX AMENDMENT OF THE COMPANY'S ARTICLES TO PROVIDE FOR A CLASS OF PREFERRED SHARES Shareholder approval is being sought for the following special resolution which authorizes the Company to create a new class of shares (the "Preferred Shares") without par value, to create, define and attach to the Preferred shares as a class, special rights and restrictions, and to alter the Articles of the Company accordingly. These matters require approval by special resolution (being at least 75% of the shares voted at the Meeting) by the operation of the Company Act (British Columbia). "RESOLVED, AS A SPECIAL RESOLUTION, THAT: 1. the authorized capital of the Company be increased by creating 5,000,000 Preferred shares without par value: 2. the Memorandum of the Company be altered by deleting paragraph 2 thereof and in its place substituting the following: "2. The authorized capital of the Company consists of 55,000,000 shares divided into: (a) 50,000,000 Common Shares without par value: and (b) 5,000,000 Preferred Shares without par value having attached thereto the special rights and restrictions set out in the Articles of the Company.", a copy of the Memorandum as altered being attached as Schedule "A" hereto; 3. there be created, defined and attached to the Preferred shares as a class the special rights and restrictions set out in Schedule "B" hereto. 4. the Articles of the Company be altered by the addition thereto of Part 27 attached as Schedule "B" hereto. REASONS FOR AND POSSIBLE EFFECTS OF THE PROPOSED AMENDMENT The Board of Directors believes that the proposed authorization of Preferred Stock is desirable to enhance the Company's flexibility in connection with possible future actions, such as financings, corporate mergers, acquisitions of property, use in employee benefit plans and for other general corporate purposes. Having such authorized capital stock available for issuance in the future would give the Company greater flexibility and would allow shares of Preferred Stock to be issued without the expense and delay of a special stockholders' meeting. Elimination of the delay occasioned by the necessity of obtaining stockholder approval will better enable the Company to engage in financing transactions and acquisitions that take full advantage of changing market conditions. The Company is not presently engaged in any negotiations concerning the issuance of any shares of the Preferred Stock, nor are there any present arrangements, understandings or plans concerning the issuance of such shares. -15- 18 It is not possible to state the precise effect of the authorization of the Preferred Stock upon the rights of holders of Common Stock until the Board of Directors determines the respective preferences, limitations and relative rights of the holders of one or more series of Preferred Stock. However, such effect might include, among other things: (i) reduction of the amount otherwise available for payment of dividends on Common Stock, to the extent dividends are payable on any issued shares of Preferred Stock, and restrictions on dividends on Common Stock if dividends on Preferred Stock are in arrears; (ii) dilution of the voting power of Common Stock to the extent that the Preferred Stock has rights to vote with shares of Common Stock; and (iii) the holders of Common Stock not being entitled to share the Company's assets upon liquidation until satisfaction of any liquidation preference granted to the Preferred Stock. Stockholders of Common Stock will not have preemptive rights to purchase additional shares of Common Stock or to purchase shares of Preferred Stock. ANTI-TAKEOVER EFFECT OF THE PROPOSED AMENDMENT Although the Board of Directors has no present intention of doing so, it could issue shares of preferred Stock that could, depending on the terms of such series, make more difficult or discourage an attempt to obtain control of the Company by means of a merger, tender offer, proxy contest or other means. Under certain circumstances such shares could be used to create voting impediments or to deter persons seeking to effect a takeover or otherwise gain control of the Company. Also, additional shares of Common Stock or shares of Preferred Stock could be publicly or privately sold to purchasers who might side with the Board of Directors in opposing such action. In addition, the Board of Directors could authorize holders of Preferred Stock to vote as a class, on any merger, sale or exchange of assets or any other extraordinary corporate action. The existence of the additional authorized shares of Common Stock and the authorization of shares of Preferred Stock could have the effect of discouraging an attempt by any person or entity, through the acquisition of a substantial number of shares of Common Stock, to acquire control of the Company with a view to imposing a merger, sale of all or any part of the Company's assets or a similar transaction, since the issuance of the additional shares of Common Stock or Preferred Stock could be used to dilute the stock ownership of a takeover bidder. In addition, the Board of Directors may issue, without stockholder action, Common Stock, or warrants or other rights to acquire such stock, with terms designed to protect against certain takeovers, including partial takeovers and front-end loaded, two-step takeovers and freeze-outs and to control stockholder acquisitions, should the Board of Directors consider the action of such entity or person not to be in the best interest of the Company and its stockholders. To the extent that potential takeovers are thereby discouraged, stockholders may not have the opportunity to dispose of all or a part of their stock at a price that may be higher than that prevailing in the market. The proposed amendments to the Company's Articles are not part of a plan by the Board of Directors to adopt a series of anti-takeover measures. The Board of Directors does not presently intend to propose any additional measure designed to discourage any unfair or unnegotiated takeovers apart from those amendments proposed in this Proxy Statement and those measures that previously have been adopted, but reserves the right to propose and adopt additional measure if the Board of Directors determines that such measures are in the best interests of the Company and its stockholders. The affirmative vote of a 75% majority of the outstanding shares of Common Stock will be required to approve Proposal Five. If the proposed amendment is approved by the stockholders, such amendment will become effective upon filing of the special resolution with the British Columbia Register of Companies. THE BOARD OF DIRECTORS RECOMMENDS VOTE FOR PROPOSAL SIX. -16- 19 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth as of Record Date certain information regarding the beneficial ownership of the Company's Common Stock buy (i) each person (including any group as that term is used in Section 13(d)(3) of the Securities Exchange Act of 1934, as amended) known by the Company to be the beneficial owner of more than 5% of the Company's voting securities, (ii) each director, (iii) each of the Company's executive officers named in the Summary Compensation Table appearing herein, and (iv) all of the Company's directors and executive officers as a group.
BENEFICIAL OWNERSHIP(1) NUMBER PERCENT OF NAME AND ADDRESS OF SHARES TOTAL - - - --------------------------------------------------------------------------- --------- ---------- State of Wisconsin Investment Board (2).................................... 2,145,000 8.0% Lake Terrace 121 East Wilson Street P.O. Box 7842 Madison, WI 53707 The Travelers Indemnity Company (3)........................................ 3,350,000 12.5% 388 Greenwich Street, 36th Floor New York, NY 10013 Scudder Development Fund (4)............................................... 1,068,000 4.0% 345 Park Avenue, 26th Floor New York, NY 10154 Brian J. Beninger (5)(6)................................................... 2,001,000 7.5% 1006 Government Street Victoria, B.C., Canada V8W 1X7 Charlotte J. Walker (6)(7)................................................. 1,120,278 4.1% N. John Campbell (8)....................................................... 90,000 * Grant N. Russell (9)....................................................... 90,000 * A. Renee Courington (6)(10)................................................ 592,143 2.2% Jeremy Salesin (11)........................................................ 75,100 * Scott A. Walchek (12)...................................................... -- -- Paul Salzinger (13)........................................................ 37,500 * Allen M. Barr (14)......................................................... 87,500 * All directors and executive officers as a group (7 persons) (15)........... 2,213,521 8.3%
- - - --------------------- * Less than 1% (1) Beneficial ownership is determined in accordance with the rules and regulations of the SEC and generally includes voting or investment power with respect to securities. Options to purchase shares of Common Stock -17- 20 which are currently exercisable or will become exercisable within 60 days of August 1, 1996 (the Record Date), are deemed to be outstanding for purposes of computing the percentage of the shares held by an individual but are not outstanding for purposes of computing the percentage of any other person. Except as indicated otherwise in the footnotes below, and subject to community property laws where applicable, the persons named in the table above have sole voting and investment power with respect to all shares of Common Stock shown as beneficially owned by them. (2) As reported on a Schedule 13G filed with the SEC in March 1996. (3) As reported on Schedule 13G filed with the SEC in July 1996. (4) As reported on a Schedule 13G filed with the SEC in March 1996. (5) Includes 101,000 shares directly owned by Mr. Beninger and 50,000 shares held directly by C. Antoinette Beninger, his spouse, as separate property. Also includes 1,800,000 Performance Shares ("Performance Shares"), 800,000 of which are owned by Mr. Beninger and 1,000,000 of which are owned by Mrs. Beninger. Also includes 50,000 shares subject to outstanding options held by Mr. Beninger exercisable within 60 days of the Record Date. (6) Performance Shares are shares of Common Stock which are held in escrow pending release upon the attainment by the Company of certain performance criteria (see discussion in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Company's Report as Form 10-k for the fiscal year ended December 31, 1996). Holders of Performance Shares are entitled to vote such shares pending their release from escrow. Under U.S. generally accepted accounting principles, the Performance shares are not included in the calculation of earnings (loss) per share until such time as the Company achieves positive earnings per share. (7) Includes 345,000 shares subject to outstanding options held by Ms. Walker which are exercisable within 60 days of the Record Date and 600,000 Performance Shares. (8) Includes 90,000 shares subject to outstanding options held by Mr. Campbell which are exercisable within 60 days of the Record Date. (9) Includes 90,000 shares subject to outstanding options held by Mr. Russell which are exercisable within 60 days of the Record Date. (10) Includes 96,250 shares subject to outstanding options, 62,500 shares subject to a warrant held by Ms. Courington which are exercisable within 60 days of the Record Date and 327,500 Performance Shares. (11) Includes 75,100 shares subject to outstanding options held by Mr. Salesin which are exercisable within 60 days of the Record Date. (12) Mr. Walchek has resigned as an executive officer and director of the Company. (13) Includes 37,500 shares subject to outstanding options held by Mr. Salzinger which are exercisable within 60 days of the Record Date. Mr. Salzinger has resigned as an executive officer of the Company. (14) Includes 87,500 shares subject to options exercisable within 60 days of the Record Date. (15) Includes an aggregate of 871,350 shares subject to outstanding options and warrants which are exercisable within 60 days of the Record Date (see footnotes 5 through 14 above) and 2,927,500 Performance Shares . -18- 21 EXECUTIVE OFFICERS
Name of Executive Officer Age Principal Occupation - - - ----------------------------------- --- ----------------------------------------------------------- Charlotte J. Walker................ 41 Chairman, President, Chief Executive Officer, Chief Financial Officer and Director A. Renee Courington................ 33 Senior Vice President Jeremy R. Salesin.................. 32 Vice President, Business Affairs, General Counsel and Secretary Suzie O'Hair........................ 37 Vice President, Marketing
Charlotte J. Walker. Please see Proposal Two - Election of Directors for a description of Ms. Walkers' background. A. Renee Courington joined the Company in May 1993 and was appointed Vice President of the Education Division in November 1, 1994 responsible for all education products produced by the Company. In April 1996 she was appointed Senior Vice President of the Company. From December 1992 until joining the Company, Ms. Courington was Director of Marketing Communications for Raster Ops Corporation and was responsible for marketing high end graphics and color products. From May 1990 to December 1992, Ms. Courington was Director of Product Marketing for Macromedia Corporation, and from May 1989 to May 1990, Director of Marketing for Ragtime USA. Jeremy R. Salesin joined the Company in April 1994, and has served as General Counsel since November 1994, Secretary since May 1995 and Vice President, Business Affairs since October 1995. From October 1990 until joining the Company, Mr. Salesin practiced law with the San Francisco office of the law firm of Graham and James. Suzie O'Hair joined the Company in September 1994 as Director of Marketing for the Education Division. Ms. O'Hair was promoted to Vice President, Marketing in April 1996. Prior to joining the Company, Ms. O'Hair was President of the marketing firm Hi-Lo communications, Inc. and was formerly Partner, then President, of HL&S Partners, and independent marketing firm serving primarily high technology companies. The Company knows of no arrangement or understanding between any executive officer and any other person(s) pursuant to which he was selected as an officer. Each person chosen to become an executive officer has consented to be named in response to this Item. -19- 22 EXECUTIVE COMPENSATION SUMMARY COMPENSATION The following table shows, as to the Chief Executive Officer and each of the other four most highly compensated executive officers, information concerning compensation awarded to, earned by or paid for services to the Company in all capacities during the fiscal years ended December 31, 1995, 1994 and 1993. On May 6, 1996 the Company changed its fiscal year end to March 31, beginning March 31, 1996. Accordingly, the table below shows such compensation information for the twelve-month period ended March 31, 1996. SUMMARY COMPENSATION TABLE
LONG-TERM ANNUAL COMPENSATION COMPENSATION -------------------------------------------- AWARDS NAME AND PRINCIPAL POSITION FISCAL YEAR ENDED SALARY BONUS($) OPTIONS(#) - - - ------------------------------------- ----------------- -------- -------- ------------ Charlotte J. Walker(1)............... March 31, 1996 $ 27,000 $ -- 420,000 President, Chairman and December 31, 1995 -- -- -- Chief Executive Officer December 31, 1994 -- -- -- December 31, 1993 -- -- -- A. Renee Courington................. March 31, 1996 111,530 -- 62,500 Vice President, Kids Division December 31, 1995 116,430 -- 62,500 December 31, 1994 99,000 -- -- December 31, 1993 58,000 -- -- Jeremy R. Salesin.................... March 31, 1996 102,000 -- 90,000 Vice President, Business Affairs December 31, 1995 100,580 -- 90,000 and General Counsel December 31, 1994 -- -- -- FORMER OFFICERS Scott A. Walchek(1) March 31, 1996 170,160 -- 350,000 President, Chief Executive Officer December 31, 1995 164,000 -- 350,000 and Director December 31, 1994 140,200 6,300 -- December 31, 1993 85,000 6,800 250,000 Paul Salzinger(2).................... March 31, 1996 137,700 -- 130,000 Vice President, Sales December 31, 1995 132,900 -- 30,000 December 31, 1994 75,000 -- -- December 31, 1993 -- -- -- Allen M. Barr(3)..................... March 31, 1996 112,200 -- 100,000 Chief Financial Officer December 31, 1995 116,000 -- 100,000 December 31, 1994 71,020 -- -- December 31, 1993 -- -- --
- - - ---------------------------- (1) Mr. Walchek resigned effective January 19, 1996. Ms. Charlotte Walker accepted the position of President and Chief Executive Officer of the Company effective January 19, 1996. (2) Mr. Barr resigned effective May 15, 1996. (3) Mr. Salzinger resigned effective July 15, 1996. -20- 23 STOCK OPTION GRANTS AND EXERCISES The following table shows, as to the individuals named in the Summary Compensation Table above, information concerning stock options granted during the fiscal year ended March 31, 1996. OPTION GRANTS IN THE FISCAL YEAR ENDED MARCH 31, 1996(1)
INDIVIDUAL GRANTS ------------------------------------------------------------ POTENTIAL REALIZABLE VALUE NUMBER OF % OF TOTAL OF ASSUMED ANNUAL RATES OF SECURITIES OPTIONS STOCK PRICE APPRECIATION UNDERLYING GRANTED TO EXERCISE FOR OPTION TERM(5) OPTIONS EMPLOYEES IN PRICE EXPIRATION --------------------------- NAME GRANTED(#)(2) FISCAL YEAR(3) ($/SH)(4) DATE 5%($) 10%($) - - - ----------------------------------- ------------- -------------- --------- ---------- ---------- ---------- Charlotte J. Walker(4)............. 20,000 1.5% $5.75 8/11/00 31,772 70,209 100,000 7.4% 2.50 12/15/00 69,070 152,628 300,000 22.1% 0.875 2/20/01 72,524 166,259 A. Renee Courington(4)............. 12,500 1.0% 5.75 8/11/00 19,858 43,880 50,000 3.7% 6.125 8/18/00 84,611 186,969 Jeremy R. Salesin(4)............... 75,000 5.5% 5.75 8/11/00 119,146 263,282 15,000 1.1% 6.125 8/18/00 25,383 56,091 FORMER OFFICERS Scott A. Walchek(6)................ 100,000 7.4% 5.75 8/11/00(5) 158,862 351,041 250,000 18.4% 6.125 8/18/00(5) 423,056 934,843 Paul Salzinger(4).................. 30,000 2.2% 4.06 11/22/00 33,650 75,350 100,000 7.4% 1.375 01/16/01 37,990 83,445 Allen M. Barr...................... 50,000 3.7% 5.75 8/11/00 79,430 175,522 50,000 3.7% 6.125 8/18/00 84,611 186,989
- - - ----------------- (1) On May 8, 1996, the Company changed its fiscal year from December 31 to March 31, beginning with the year ended March 31, 1996. Charlotte Walker also received a grant of 25,000 options on March 23, 1995. None of the other individuals named in the Summary Compensation Table received a stock option grant in the three-month period of January 1, 1995 to March 31, 1995. (2) These options generally vest over a three-year period from the date of grant as follows: 25% six months from the date of grant, 25% one year after the date of grant, 25% two years from the date of grant and 25% three years from the date of grant. (3) The Company granted options to purchase an aggregate of 420,500 shares of Common Stock to all employees other than executive officers and granted options to purchase an aggregate of 940,000 shares of Common Stock to all executive officers as a group ( 6 persons), during fiscal 1995. (4) All outstanding options were repriced to $0.875 on May 8, 1996. (5) This column sets forth hypothetical gains or option spreads for the options at the end of their respective five-year terms, as calculated in accordance with the rules of the SEC. Each gain is based on an arbitrarily assumed annualized rate of compound appreciation of the market price at the date of grant of 5% and 10% from the date the option was granted to the end of the option term. The 5% and 10% rates of appreciation are specified by the rules of the SEC and do not represent the Company's estimate or projection of future Common Stock prices. The Company does not necessarily agree that this method properly values an option. Actual gains, if any, on option exercises are dependent on the future performance of the Company's Common Stock and overall market conditions and the timing of option exercises, if any. All option grants shown in this table are presently at exercise prices significantly in excess of the current market price of the Company's Common Stock. 1995. (6) All of these options have terminated. -21- 24 The following table shows, as to the individuals named in the Summary Compensation Table above, information concerning stock options exercised during the fiscal year ended March 31, 1996 and unexercised options at March 31, 1996. None of such unexercised options were in-the-money at such date. Accordingly, the exercise value of such options was zero. AGGREGATED OPTION EXERCISES IN FISCAL YEAR ENDED MARCH 31, 1996 AND MARCH 31, 1996 OPTION VALUES
Number of Securities Underlying Shares Unexercised Options/ Acquired on Value SARs at March 31, 1996 (#)(2)(3) Exercise Realized -------------------------------- Name (#) ($)(1) Exercisable Unexercisable - - - ------------------------------------------------- ----------- --------- ----------- ------------- Charlotte J. Walker.............................. -- -- 245,000 200,000 A. Renee Courington.............................. -- -- 75,625 86,875 Jeremy R. Salesin................................ 15,000 66,143 27,700 97,300 FORMER OFFICERS Scott A. Walchek................................. 25,000 89,911 100,000 -- Paul Salzinger................................... -- -- 15,000 145,000 Allen M. Barr.................................... -- -- 75,000 125,000
- - - ------------------- (1) Calculated by determining the difference between the closing price of the Company's Common Stock on Nasdaq on the date of exercise and the exercise price of the options. (2) The Company has not granted any stock appreciation rights and its stock plans do not provide for the granting of such rights. (3) None of these options were in the money at March 31, 1996. -22- 25 EMPLOYMENT CONTRACTS AND TERMINATION OF EMPLOYMENT AND CHANGE-IN-CONTROL ARRANGEMENTS The Company entered into a year-to-year Management Services Agreement with Brian J. Beninger which commenced July 1, 1991, pursuant to which Mr. Beninger received a salary of CDN $5,000 per month for his services to the Company. Mr. Beninger resigned as Chairman effective May 15, 1996. Mr. Barr resigned effective May 15, 1996 and, pursuant to a letter agreement with the Company, was paid his salary until July 15, 1996. Mr. Salzinger resigned effective July 15, 1996. No severance payments were made to Mr. Salzinger. The Company entered into a letter Agreement with Scott A. Walchek in April 1993. Pursuant to this Agreement, as amended, Mr. Walchek received a salary of $13,333 per month for his services with the Company. Mr. Walchek resigned effective January 19, 1996. The Company entered into a severance agreement with Mr. Walchek pursuant to which the Company agreed to continue paying Mr. Walchek his salary for six months following his resignation, less payments to repay the Company for the full amount then owned by Mr. Walchek to the Company. The Company subsequently amended this agreement to reduce the amount payable by the Company. The Company entered into standard employment contracts with Ms. Walker, Mr. Salzinger, Mr. Barr, Ms. Courington and Mr. Salesin pursuant to which the salary levels of these executives were initially set. Subsequent salary increases have resulted in these executives being paid the amounts shown in the summary compensation table above. Ms. Courington, Ms. O'Hair and Mr. Salesin agreed to accept a 10% reduction in their salary effective January 1996 while the Company reorganized its operations. Mr. Courington and Mr. Salesin have entered into amendments to their employment agreements with the Company which call for severance payments in the event of a termination without cause if certain specified conditions are met. The amount of such severance payments will be equal to two month's of the individual's salary plus one month salary for each full year the individual was employed by the Company prior to termination. -23- 26 REPORT OF THE COMPENSATION COMMITTEE OF THE BOARD OF DIRECTORS The Compensation Committee of the Board of Directors at March 31, 1996 consisted of N. John Campbell, Grant N. Russell and Brian Beninger. Mr. Beninger subsequently resigned his position as Chairman and a Director of the Company. The Compensation Committee is responsible for reviewing the Company's compensation policies and practices and making recommendations to the Board with respect to compensation matters. COMPENSATION PHILOSOPHY The Company's executive compensation programs over the past fiscal year have been based upon the recognition that Sanctuary Woods is a young, growing company which is best served by executives who are prepared to accept lower levels of cash compensation in return for the potentially greater rewards which may become available if the Company proves successful. In addition, the adverse change in the Company's financial circumstances has resulted in a need to provide long-term incentives to management for improving the Company's results of operations. Therefore, the compensation programs are strongly oriented towards long term incentives which are designed to provide the Company's executives with substantial rewards based upon the Company's long term success. This approach has the further benefit of aligning the interest of the Company's executives with those of its shareholders. With these principles in mind, the Compensation Committee has set forth the following guidelines: 1. Provide a total compensation package that will attract talented individuals to the Company and provide them with motivation to excel in their performance with a view to building long term shareholder value; 2. Limit cash compensation to amounts which are reasonable but moderate in view of the Company's current stage of growth; and 3. Provide substantial long term incentive benefits which will reward long term commitment to the Company. COMPENSATION OF EXECUTIVE OFFICERS The Company currently provides each of its executive officers with an annual salary. Salaries are fixed by the Board of Directors after consultation with the Compensation Committee and with the Chief Executive Officer with respect to salary levels for other officers. Salary levels are reviewed at least annually and more often when circumstances warrant. Salary levels are generally fixed at the lower end of the range of comparable companies based upon information generally available to the Board of Directors. In light of the adverse change in the Company's financial circumstances, Ms. Courington, Ms. O'Hair, Mr. Barr and Mr. Salesin agreed to accept a 10% reduction in their pay in January 1996. The Company does not currently pay cash bonuses to its executives with the exception of the Vice President of Sales (see discussion below). The Compensation Committee believes that, during this stage of the Company's existence, it is more appropriate to award executives with stock options rather than cash bonuses. This practice is premised upon both the philosophy of establishing long term incentives for executive performance as well as recognition by the Compensation Committee of the importance of maximizing the availability of cash for investment in the growth of the Company's business. The Vice President of Sales receives a cash bonus which is based upon a corporate sales incentive policy adopted on July 1, 1994 and revised by the Company from time to time. This policy provides a sales incentive to all sales personnel based upon achievement of specified sales targets. Targets are fixed on a quarterly and annual basis for the Vice President of Sales by the President of the Company. -24- 27 STOCK OPTIONS Stock options are granted to executive officers and all other full time employees whose contributions are considered important to the long term success of the Company. All grants since the adoption of the Company's stock option plan at the 1995 Annual General Meeting have been made pursuant to the terms of that plan (summarized above in this proxy statement). Under applicable rules of the Vancouver Stock Exchange, all options granted by the Board of Directors to executive officers must be ratified on an annual basis by the shareholders at the annual general meeting of shareholders. Stock options have historically been granted by the Board of Directors on a case-by-case basis based upon the Board's evaluation of an individual's past contributions and potential future contributions to the Company. Stock options also are used to attract new management personnel to the Company and often are awarded upon an executive joining the Company with vesting periods designed to encourage the executive's retention. In granting stock options, the Board of Directors takes into consideration the fact that salary levels paid to its executive officers tend to be below industry averages. The Compensation Committee may in the future recommend adoption of other long term incentive programs designed to maximize management's long term commitment to the Company. OPTION REPRICING On June 4, 1996, stock options held by certain of the executive officers of the Company were repriced at the then-current fair market value. Prior to the repricing, the exercise prices of the stock options were well above the fair market value of the Common Shares and such stock options did not provide the intended long term incentive to the executive officers. The Board undertook this action in light of the Company's reorganization and subsequent downsizing and the recent reduction in the trading price of the Company's Common Stock and in consideration of the importance to the Company of retaining its employees by offering them appropriate equity incentives. The Board also considered the highly competitive environment for obtaining and retaining qualified employees and the overall benefit to the Company's stockholders from a highly motivated group of employees. COMPENSATION OF THE CHIEF EXECUTIVE OFFICER From August 18, 1994 to January 19, 1996, Scott A. Walchek served as Chief Executive Officer of the Company. Prior thereto, he had been the Company's President and Chief Operating Officer ( COO ). As COO, Mr. Walchek was paid salary at an annual rate of $120,000. His salary was raised to an annual rate of $160,000 upon his promotion to CEO. The Board of Directors deemed this increase in salary to be appropriate in light of the substantially greater duties and responsibilities which Mr. Walchek undertook as the Company's CEO. The Board considered Mr. Walchek's salary to be below industry averages but believed this lower salary level coupled with substantial option grants was the most appropriate compensation package for the Company's CEO at this stage of the Company's development. The Company granted Mr. Walchek an additional 350,000 options in 1995. At this time, the Compensation Committee has not established specific performance criteria to govern such incentive compensation. Charlotte J. Walker has served as President and Chief Executive Officer of the Company since January 19, 1996. As CEO, Ms. Walker's salary has been set at $162,000. Ms. Walker has also received stock option grants of 400,000 related to her acceptance of the position of President and Chief Executive Officer. The Board of Directors declared that salary and option level quite reasonable in light of Ms. Walker's extensive experience, and the difficulty in attracting a skilled CEO to lead the Company through a difficult reorganization required by its adverse operating results. -25- 28 THE COMPENSATION COMMITTEE N. John Campbell Grant N. Russell COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION The Compensation Committee of the Board currently consists of Messrs. Campbell and Russell, neither of whom is an officer or employee of the Company. No interlocking relationship exists between the Company's Board of Directors or Compensation Committee and the Board of Directors or compensation committee of any other company, nor has any such interlocking relationship existed during the past fiscal year. In March 1996, the Company completed a private placement of $1.5 million aggregate principal amount of secured debentures, all of which were converted to equity as of June 7, 1996 at a conversion price of $.50 per share. In connection with the issuance of these debentures, each purchaser of debentures receive a warrant to purchase 1.25 shares of the Company's Common Stock for each $1.00 principal amount of debentures purchased. Each warrant is exercisable for two years from the date of issuance at an exercise price of $.50 per share. Ms. Charlotte Walker and Ms. Renee Courington each purchased $50,000 principal amount of convertible debentures and each received the associated warrant to purchase 62,500 shares of the Company's Common Stock. Ms. Walker subsequently exercised such warrant in its entirety. Except as disclosed herein, since the commencement of the last completed fiscal year, no insider of the Company had any material interest, direct or indirect, or any transaction or any proposed transaction which has materially affected or would materially affect the Company or any of its subsidiaries. INDEBTEDNESS OF DIRECTORS, EXECUTIVE AND SENIOR OFFICERS As of December 31, 1996, Mr. Scott Walchek, the Company's former President and Chief Executive Officer owed the Company $24,500 under a loan made pursuant to the terms of his employment agreement. This loan was unsecured, does not bear interest and is due upon demand. In connection with Mr. Walchek's severance agreement, Mr. Walchek agreed to have the remaining balance of the loan repaid by deductions from the amount payable to him under his severance agreement. The Company subsequently renegotiated its severance agreement with Mr. Walchek to reduce the amount payable to Mr. Walchek, and in connection with this renegotiation wrote off a portion of this remaining balance. -26- 29 COMPANY STOCK PRICE PERFORMANCE The graph below compares the cumulative total return on investment (based on change in year-end stock price and assuming reinvestment of all dividends) assuming a $100 investment in the Common Stock of the Company, the Nasdaq Market Index and an industry index of companies contained in Standard Industrial Classification Code 7372 (the SIC Code Index ) for the period commencing December 31, 1991 and ended March 31, 1996. COMPARISON OF CUMULATIVE TOTAL RETURN AMONG SANCTUARY WOODS MULTIMEDIA CORPORATION, NASDAQ MARKET INDEX AND SIC CODE INDEX
DECEMBER 31, ------------------------------------- INDEX 1991 1992 1993 1994 1995 - - - ----- ---- ---- ---- ---- ---- Sanctuary Woods Multimedia Corporation 1.00 2.30 6.88 3.70 3.90 Nasdaq Market Index 1.00 1.01 1.21 1.27 1.65 SIC Code Index 1.00 1.09 1.16 1.52 2.29
Note: The Common Shares have been listed on the Vancouver Stock Exchange under the symbol SWD since December 11, 1991. The Company was delisted from The Nasdaq Stock Market on June 30, 1996. COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT Section 16(a) of the Securities Exchange Act of 1934 requires the Company's officers and directors, and persons who own more than ten percent of a registered class of the Company's equity securities, to file reports of ownership and changes in ownership with the Securities and Exchange Commission (the SEC ) and the National Association of Securities Dealers. Such officers, directors and ten-percent stockholders are also required by SEC rules to furnish the Company with copies of all forms which they file pursuant to Section 16(a). Based solely on its review of the copies of such forms received by, or written representations from certain reporting persons that no Forms 5 were required for such persons, the Company believes that certain reports required under Section 16(a) applicable to its officers, directors and ten-percent stockholders were late. In particular, the Company believes that one report on Form 4 for a set of transactions by Mr. Beninger was filed late, and that the Form 3 for Paul Salzinger was filed late. FINANCIAL AND OTHER INFORMATION The Company's consolidated financial statements for the three year period ended December 31, 1995 included in the Company's 1995 Annual Report on Form 10-k (Amendment No. 1) (the "Report on Form 10-k") and the discussion of the Company's Financial condition contained in Item 7 of the Report on Form 10-k, "Managements Discussion and Analysis of Financial Conditions and Results of Operations" are incorporated herein by reference. A copy of the Report on Form 10-K is being distributed to shareholders with these proxy materials. -27- 30 OTHER PROPOSED ACTION The Meeting is called for the purposes set forth in the notice thereof accompanying this Proxy Statement. Management is not aware of any matters to come before the Meeting other than those stated in this Proxy Statement. However, inasmuch as matters of which management is not now aware may come before the Meeting or any adjournment thereof, the Proxies confer discretionary authority with respect to acting thereon, and the person named in such Proxies intends to vote, act and consent in accordance with his or her best judgment with respect thereto. PERSONS MAKING THE SOLICITATION The accompanying Proxy is solicited by Management and by the Board of Directors of the Company. The Company will pay all expenses of the preparation, printing and mailing to the shareholders of the enclosed Proxy, accompanying notice and Proxy Statement. -28- 31 SCHEDULE "A" COMPANY ACT SANCTUARY WOODS MULTIMEDIA CORPORATION ALTERED MEMORANDUM (as altered by special resolution passed _______________, 1996) 1. The name of the Company is Sanctuary Woods Multimedia Corporation. 2. The authorized capital of the Company consists of 105,000,000 shares divided into: (a) 100,000,000 Common Shares without par value; and (b) 5,000,000 Preferred shares without par value having attached thereto the special rights and restrictions set out in the Articles of the Company." A-1 32 SCHEDULE "B" PART 27 SPECIAL RIGHTS AND RESTRICTIONS ATTACHED TO PREFERRED SHARES AS A CLASS The Preferred Shares as a class shall have attached to them the following special rights and restrictions: 27.1 The Preferred Shares may at any time and from time to time by issued in one or more series. The directors may from time to time, by resolution passed before the issue of any Preferred Shares of any particular series, alter the Memorandum of the Company to fix the number of Preferred Shares in, and to determine the designation of the Preferred Shares of, that series and alter the Memorandum and Articles to create, define and attach special rights and restrictions to the Preferred Shares of that series, including, but without in any way limiting or restricting the generality of the foregoing, the rate or amount of dividends, whether cumulative or non-cumulative, the dates, places and currencies of payment thereof, the consideration for, and the terms and conditions of, any purchase for cancellation or redemption thereof, including redemption after a fixed term or at a premium, conversion or exchange rights, the terms and conditions of any share purchase plan or sinking fund, the restrictions respecting payment of dividends on, or the repayment of capital in respect of, any other shares of the Company, and voting rights and restrictions; but no special right or restriction so created, defined or attached shall: (i) contravene the provisions of remaining articles of this Part or (ii) provide special rights of conversion into or exchange for any voting securities of the Company or any non-voting securities of the Company which may be convertible into or exchangeable for voting securities of the Company without obtaining the required approvals for such special rights of conversion or exchange for the stock exchanges on which the Company's shares are listed for trading at the time of creation of the special rights of conversion or exchange. 27.2 Holders of Preferred Shares shall be entitled, on the distribution of assets of the Company on the liquidation, dissolution or winding-up of the Company, whether voluntary or involuntary, or on any other distribution of assets of the Company among its members for the purpose of winding up its affairs, to receive, before any distribution shall be made to holders of Common Shares or any other shares of the Company ranking junior to the Preferred Shares with respect to repayment of capital, the amount paid up with respect to each Preferred share held by them, together with the fixed premium (if any) thereon, all accrued and unpaid cumulative dividends (if any and if preferential) thereon, which for such purpose shall be calculated as if such dividends were accruing on a day-to-day basis up to the date of such distribution, whether or not earned or declared, and all declared and unpaid non-cumulative dividends (if any and if preferentially thereon). After payment to holders of Preferred Shares of the amounts so payable to them, they shall not be entitled to share in any further distribution of the property or assets of the Company except as specifically provided in the special rights and restrictions attached to any particular series. 27.3 Except for such rights relating to the election of directors on a default in payment of dividends as may be attached to any series of the Preferred Shares by the directors, holders of Preferred Shares shall not be entitled as such to receive notice of, or to attend or vote at, any general meeting of members of the Company. 27.4 The Company may at any time or from time to time without the approval of the registered holders of the Preferred Shares: (i) increase the number of authorized Preferred Shares; B-1 33 (ii) create or issue shares of one or more other classes ranking on a parity with the Preferred Shares with respect to the payment of dividends or the distribution of assets in the event of the liquidation, dissolution or winding-up of the Company, whether voluntary or involuntary, or in the event of any other distribution of assets of the Company among its members for the purpose of winding up its affairs; or (iii) increase the number of authorized shares of any one or more of the such other classes of shares. B-2 34 REGISTERED AND NON-REGISTERED SHAREHOLDERS In accordance with national Policy Statement No. 41/Shareholder Communication (the "Policy"), and pursuant to the British Columbia Securities Act and Regulations: (a) a registered shareholder may elect annually to have his or her name added to an issuer's supplemental mailing list in order to receive quarterly reports for the issuer's first, second and third fiscal quarters. Registered shareholders will automatically receive a quarterly report for an issuer's fourth fiscal quarter; and (b) a non-registered shareholder may elect annually to have his or her name added to an issuer's supplemental mailing list in order to receive quarterly reports for the issuer's first, second and third quarters. Non-registered shareholders entitled to receive an issuer's audited annual financial statements, pursuant to the Policy, will receive a quarterly report for an issuer's fourth fiscal quarter. _______________________________ TO: Sanctuary Woods Multimedia Corporation (the "Company") As an owner of shares of the Company, I request that my name and address be placed on your supplemental mailing list to receive interim financial statements. NAME OF SHAREHOLDER: ______________________________________________ Please Print Name ADDRESS: __________________________________________________ _____________________________________________________ _____________________________________________________ SIGNATURE: __________________________________________________ I certify that I am a registered shareholder SIGNATURE: __________________________________________________ I certify that I am a registered shareholder NOTE: PLEASE RETURN THIS DOCUMENT ALONG WITH YOUR PROXY IN THE ATTACHED ENVELOPE. AS THE SUPPLEMENTAL LIST WILL BE UPDATED EACH YEAR, A RETURN CARD WILL BE REQUIRED FROM YOU ANNUALLY IN ORDER FOR YOUR NAME TO REMAIN ON THE LIST. B-3 35 Appendix A 36 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Sanctuary Woods Multimedia Corporation (the "Company") derives revenues from the creation, licensing and distribution of entertainment and educational software, primarily on CD-ROM. As discussed above, the Company formerly provided interactive multimedia services to trade and textbook publishers through its Publisher Services Division, but decided to eliminate this operation in January 1996. The Company expects to concentrate in the future on the development and publishing of consumer titles for the children's home and education markets. RECENT DEVELOPMENTS Throughout 1995, the Company invested substantial capital in the development and production of new products, and the creation and maintenance of an internal sales and distribution organization. While, as discussed below, the Company's revenues grew to $10,981,097 in 1995 from $6,261,226 in 1994, the Company's net loss also grew to $18,698,441 in 1995 from $7,404,436 in 1994. The majority of this net loss occurred in the fourth quarter of 1995, in which the Company reported a net loss of $13,440,511, on negative net revenues of ($1,934,953). This loss is attributable primarily to lower than expected sales, combined with substantial write-offs taken by the Company related to its assessment of the salability of certain products. The Company experienced a substantially increased level of returns in the first quarter of 1996 related to third and fourth quarter 1995 sales, due to lower than expected sales in the fourth quarter of 1995, an extremely competitive marketplace, and high levels of inventory in the retail channel at December 31, 1995. The Company expects that it will also report a loss in at least the first quarter of 1996. As a result of materially lower than expected fourth quarter 1995 net results, the Company restructured its operations, and continues to evaluate further restructuring, strategic partnership and financing options. Included in the restructuring to date were the appointment of a new President and CEO and a new Vice President of Sales. The Company's Publisher Services division is winding down, and the entertainment division, including the Company's Victoria studio, is expected to be sold, refocused, or curtailed. Additionally, the Company reduced its full time work force by over 20% in January 1996, and has eliminated many part time, temporary and contract positions. While the Company is hopeful that such steps will allow the Company to successfully operate in the future, there can be no assurances that the Company will be able to successfully restructure and/or maintain its operations in the future. As discussed further below, the Company currently lacks the cash necessary to continue its operations in the immediate future. Lack of Capital Resources. At April 12, 1996, the Company had cash on hand of $66,000, bank borrowings of $1,875,000, which are due May 15, 1996, and no additional bank borrowing available under its line of credit. The Company believes that it will need to raise significant additional capital prior to May 15, 1996, to sustain its operations, repay its bank line of credit, and fund its 1996 operating plan. To date, the Company has been substantially dependent upon equity financings as its principal source of operating capital and management continues to explore a number of other options to improve its capital resources. No assurance can be given that additional financing will be available or that, if available, such financing will be obtainable on terms favorable to the Company or its stockholders. If the Company is unable to successfully obtain such financing, the Company expects that it may be forced to cease operations. Going Concern Uncertainty. The accompanying consolidated financial statements have been prepared on the going concern basis, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. The matters discussed herein, among others, may indicate that the Company will be unable to continue as a going concern for a reasonable period of time. 37 The consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that may be necessary should the Company be unable to continue as a going concern. The Company's continuation as a going concern is dependent upon its ability to generate sufficient cash flow to meet its obligations on a timely basis, to comply with the terms and covenants of its bank line of credit, to obtain additional financing or refinancing, and ultimately to attain successful operations. Because of the possible material effects of this going concern uncertainty, the independent auditors were unable to express, and did not express, an opinion on the Company's 1995 consolidated financial statements (see Independent Auditors' report on page F-5). LIQUIDITY AND CAPITAL RESOURCES Significant Operating Losses; Continued Use of Cash. The Company has had operating losses in each fiscal year since its inception in 1991 and as of December 31, 1995, had an accumulated deficit of $31,359,942, and total stockholders deficit of $357,380. These losses are primarily due to expenditures incurred by the Company in the development of its CD-ROM publishing business, including significant expenses related to development of internally and externally developed products, development of its own direct sales force, and the write-off of certain significant assets as a result of the Company's lack of capital resources and its reassessment of future salability of certain products. The assets written off include prepaid royalties for externally developed products published by the Company totaling $3,361,212, prepaid and deferred royalties on the Company's Ripley's license totaling $1,144,320, and inventories totaling $1,437,252. Net cash used in operating activities was $11,724,419, $8,909,529, and $4,133,139 in 1995, 1994, and 1993, respectively. In 1995, the increase in net cash used in operations was the result of increased expenditures for prepaid royalty advances, primarily to outside developers of entertainment products to be published by the Company, increased sales and marketing and administrative costs, and increased manufacturing of inventory in anticipation of higher sales. Cash advances made to outside developers in 1995 totaled $2,134,804 and $1,806,493 in 1994. In 1994 and 1993, net cash used in operating activities resulted from large losses caused by heavy research and development and marketing and sales expenditures. Net cash used in investing activities was $958,283, $1,817,911 and $787,357 in 1995, 1994, and 1993, respectively, and consisted mostly of computer equipment and computer software in concert with the Company's focus on and increased research and product development. In 1995, along with R&D expenditures, equipment was purchased to support the building of a sales, marketing and distribution infrastructure. Net cash provided by financing activities was $10,025,390, $12,979,455, and $4,908,617 in 1995, 1994, and 1993, respectively. Such amounts primarily consisted of the proceeds from the issuances of common stock. The 1995 proceeds resulted principally from a July 1995 issuance of 2,000,000 shares at $4.00 per share, and net borrowings on the line of credit of $1,800,000. The 1994 proceeds resulted principally from the January 1994 issuance of 2,650,000 shares at $5.00 per share. The Company believes it must continue spending on the development and acquisition of new products, the maintenance of adequate personnel, and on distribution, sales and marketing efforts in order to continue its business. If the Company's revenues are not sufficient to cover these expenditures, the Company will likely experience ongoing losses. The Company expects to incur operating losses during at least the first quarter of 1996. -2- 38 Bank Line of Credit Agreement; Covenant Violations. On March 10, 1995, the Company obtained a bank revolving line of credit ("Loan Agreement") which was to expire in April 1996. Effective April 2, 1996, the Company amended this agreement with the bank to provide for an expiration date of May 15, 1996 (the "Amendment"). The Loan Agreement contains several restrictive covenants, including restrictions on the ability to incur or guarantee indebtedness, enter into mergers or acquisitions, pay dividends and lease property. In the Loan Agreement, the Company covenants to maintain or achieve by specified dates certain financial criteria relating to the Company's tangible net worth, capital resources, liquidity and results of operations. At December 31, 1995, and thereafter, the Company was and is out of compliance with certain of its Loan Agreement covenants, including without limitation covenants related to tangible net worth and operating losses and currently has borrowed in excess of the amounts allowed under the Loan Agreement, as a result of removal of accounts receivable from the borrowing base over time. The bank has agreed in the Amendment to take no action related to the existing covenant violations at least until May 15, 1996, provided the Company meets its other obligations under the Loan Agreement and Amendment. In addition, specific components of the Amendment include: (1) the borrowing base will be expanded to include certain finished goods inventory, (2) adding to the borrowing base certain accounts receivable balances which under the original terms of the line were ineligible to be included in the borrowing base, and (3) giving the Company access to at least 50% of all accounts receivable collections, which amount may increase to 75% or even 100% in the bank's discretion, depending upon the Company's applicable borrowing base; however, the Amendment also provides that the bank need not make further advances to the Company. There can be no assurance that the bank will waive any future covenant violations, or lend to the Company in the future. Moreover, the bank may require full repayment of the outstanding balance of the line at any time. Amounts outstanding under the Loan Agreement are secured by substantially all of the Company's assets and the line of credit may be immediately terminated in the event of a material default by the Company. Such termination would have a material adverse effect on the Company's business, operating results and financial condition. If the bank should terminate and require such repayment, the Company likely would not be able to repay such amounts without significant additional financing activity. The Company also issued to the bank a warrant to purchase up to 200,000 shares of the Company's common stock at $0.50 per share for five years. The exercise price of the warrant increases 15% per year in years 3, 4 and 5 of the warrant term. The number of shares purchasable under the warrant will be reduced if the Company repays the bank on or before May 15, 1996. March 1996 Financing. In March 1996, the Company completed a private placement of $1.5 million principal amount of bridge notes with an annual interest rate of 10%. Of these notes, one million dollars' principal amount are convertible at the due date into two million shares of the Company's common stock, and the remaining $500,000 of notes will be convertible into one million shares of the Company's common stock if the Company's shareholders approve these conversion rights at the Company's 1996 annual meeting. The notes are due August 31, 1996, subject to the Company's option to extend the due date for three months. The Company may elect to extend this due date for an additional issuance of 250,000 warrants to the investors. In addition, the Company issued to the bridge note holders warrants to purchase 1,875,000 shares of the Company's common stock at an exercise price of $0.50 per share over the next two years. ADDITIONAL RISK FACTORS As discussed throughout this report on form 10-K, there are numerous risks associated with the Company's on-going operations, including without limitation the following: -3- 39 Continued Losses; Fluctuations in Operating Results; Seasonality. The Company has not been profitable on an annual basis in the last three years. The Company has experienced, and expects to continue to experience, significant fluctuations in operating results due to a variety of factors, including the size and rate of growth of the consumer software market, market acceptance of the Company's products and those of its competitors, development and promotional expenses relating to the introduction of new products or new versions of existing products, projected and actual changes in computing platforms, the timing and success of product introductions, product returns, changes in pricing policies by the Company and its competitors, difficulty in securing retail shelf space for the Company's products, the accuracy of retailers' forecasts of consumer demand, the timing of orders from major customers, order cancellations and delays in shipment. In response to competitive pressures, the Company may take certain pricing or marketing actions that could materially adversely affect the Company's business, operating results and financial condition. The Company may be required to pay fees in advance or to guarantee royalties, which may be substantial, or to obtain licenses to intellectual properties from third parties before such properties have been introduced or achieved market acceptance. A significant portion of the Company's operating expenses are relatively fixed, and planned expenditures are based in part on sales forecasts. If net sales do not meet the Company's expectations, the Company's business, operating results and financial condition could be materially adversely affected. See "Quarterly Financial Information on page F-26." Possible Write-Offs from Product Returns, Price Protection; Bad Debts; Collections. As discussed more fully above (see Item 1: Business - Distribution and Marketing), The Company recognizes revenue in accordance with industry practice (net of an allowance for product returns and price protection) from the sale of its products upon shipment to its distributors and retailers. The Company had a reserve balance for price protection and returns as of December 31, 1995, of $4,942,905. Product returns or price protection concessions that exceed the Company's reserves could materially adversely affect the Company's business, operating results and financial condition and could increase the magnitude of quarterly fluctuations in the Company's operating and financial results. In addition, as also discussed above, the Company has experienced in the past, and continues to experience, significant delays in the collection of its accounts receivable. Further, if the Company's assessment of the creditworthiness of its customers receiving products on credit proves incorrect, the Company could be required to significantly increase the reserves previously established. Nasdaq Listing; Lack of Liquidity. The Company is required to satisfy certain financial criteria for its Common Stock to be listed on the Nasdaq market. If the Company continues to incur significant operating losses, is not able to obtain satisfactory sources of financing, or otherwise fails to comply with other Nasdaq listing requirements, Nasdaq may remove the Company's Common Stock from the Nasdaq National Market or, in certain circumstances, from the Nasdaq market completely. The fact that the Company's independent accountants have been unable to give an opinion on the Company's consolidated financial statements, as a result of substantial uncertainty as to the Company's ability to continue its operations in the immediate future, may also result in the removal of the Company's Common Stock from the Nasdaq National Market. In either case, the Company believes the liquidity of the Company's Common Stock could be materially adversely affected. Recent Changes in Management Team. The Company is currently experiencing a period of reorganization that has placed, and could continue to place, a significant strain on the Company's financial, management, personnel and other resources. The Company is operating under the direction of a new President and Chief Executive Officer, and a recently promoted Vice President of Sales. In addition, the Company has promoted the Vice President of its Kids Division to Senior Vice President, with additional responsibilities for all product development. If the Company's executives are unable to effectively manage the Company's business, the Company's operating results and financial condition could be materially adversely affected. -4- 40 Impact of Reorganization of Operations. The Company may take additional steps to reorganize or consolidate its operations. These steps may include, among other things, the sale, reduction of operations in, or refocusing of the Company's Victoria studio, or the sale of other appropriate assets of the Company. In an effort to reduce its expense structure, the Company reorganized its operations in the first quarter of 1996, laid off approximately 20% of its work force and revised its product development plans for 1996. These changes or other future steps to reorganize and reduce expenses could result in the delayed introduction of new products which could have a material adverse effect on the Company's financial condition and results of operations. Dependence on Key Personnel; Retention of Employees. The Company's success depends in large part on the continued service of its key creative, technical, marketing, sales and management personnel and its ability to continue to attract, motivate and retain highly qualified employees. Because of the multifaceted nature of interactive media, key personnel often require a unique combination of creative and technical talents. Such personnel are in short supply, and the competition for their services is intense. The process of recruiting key creative, technical and management personnel with the requisite combination of skills and other attributes necessary to execute the Company's strategy is often lengthy. The Company has entered into at-will employment agreements with its management and other personnel, who may generally terminate their employment at any time. The loss of the services of key personnel or the Company's failure to attract additional qualified employees could have a material adverse effect on the Company's results of operations and research and development efforts. In particular, the Company has recently reorganized its operations and has undergone a reduction in force among its employees. Such reduction in force, combined with the Company's disappointing operating performance, the price of the Company's stock, and the availability of substantial alternative employment opportunities for talented employees of the Company, may result in key employees and managers leaving the Company, which could materially adversely impact the Company's ability to develop and sell its products. The Company does not have key person insurance covering any of its personnel. Dependence on New Product Development; Product Delays. The success of the Company depends on the continual and timely introduction of successful new products. In general, consumer preferences for software products are difficult to predict and are often short-lived. The retail life of software programs has become shorter, and may now last only 9-12 months (or even less for unsuccessful products), while the Company typically requires 9 to 12 months or longer for the development of a new CD-ROM title. The short life span of a product combined with a lengthy development cycle makes it especially difficult to predict whether a product will be a success by the time it comes to market. There can be no assurance that new products introduced by the Company will achieve any significant market acceptance or that, if such acceptance occurs, it will be sustained for any significant period. If the Company does not correctly anticipate and respond to demand for its products in a timely manner, the Company's business, operating results and financial condition will be materially adversely affected. A significant delay in the introduction of, or the presence of a defect in, one or more new products could have a material adverse effect on the Company's business, operating results and financial condition, particularly in view of the seasonality of the Company's business. Further, as was the case with the Company's release of Buried in Time at the end of the second quarter of 1995, delays in a product introduction near the end of a fiscal quarter may materially adversely affect operating results for that quarter, as initial shipments of a product may move from one quarter to the next and may represent a substantial percentage of annual shipments of a product. The timing and success of software development is unpredictable due to the technological complexity of software products, inherent uncertainty in anticipating technological developments, the need for coordinated efforts of numerous creative and technical personnel and difficulties in identifying and eliminating errors prior to product release. In the past, the Company has experienced delays in the introduction of certain new products. There can be no assurance that new products will be introduced on schedule or at all or that they will achieve market acceptance or generate significant revenues. -5- 41 Competition. The home entertainment and education software industry is intensely competitive, and market acceptance for any of the Company's products may be adversely affected by the introduction by the Company's competitors of similar products with greater consumer demand. The Company competes against a large number of other companies of varying sizes and resources. Most of the Company's competitors have substantially greater financial, technical and marketing resources, as well as greater name recognition and better access to consumers. Existing competitors may continue to broaden their product lines and potential competitors, including large computer or software manufacturers, entertainment companies, diversified media companies, and book publishers, may enter or increase their focus on the CD-ROM school and home education markets, resulting in increased competition for the Company. Retailers of the Company's products typically have a limited amount of shelf space and promotional resources, and there is intense competition among consumer software producers for high quality and adequate levels of shelf space and promotional support from retailers. To the extent that the number of consumer software products and computer platforms increases, this competition for shelf space may intensify. Due to increased competition for limited shelf space, retailers and distributors are increasingly in a better position to negotiate favorable terms of sale, including price discounts and product return policies. Retailers often require software publishers to pay fees in exchange for preferred shelf space. There can be no assurance that retailers will continue to purchase the Company's products or provide the Company's products with adequate levels of shelf space. Increased competition could result in loss of shelf space for, and reduction in sell-through of, the Company's products at retail stores and significant price competition, any of which could adversely affect the Company's business, operating results and financial condition. In addition, other types of retail outlets and methods of product distribution, such as on-line services, may become important in the future, and it may be important for the Company to gain access to these channels of distribution. There can be no assurance that the Company will gain such access or that the Company's access will be on terms favorable to the Company. Changing Product Platforms and Formats. The Company's software products are intended to be played on machines built by other manufacturers. The operating systems of machines currently being manufactured are characterized by several competing and incompatible formats or "platforms," and new platforms will probably be introduced in the future. The Company must continually anticipate the emergence of, and adapt its products to, popular platforms for consumer software. When the Company chooses a platform for its products, it must commit a substantial development time and investment in advance of shipments of products on that platform. If the Company invests in a platform that does not achieve significant market penetration, the Company's planned revenues from those products will be adversely affected and it may not recover its development investment. If the Company does not choose to develop for a platform that achieves significant market success, the Company's revenues may also be adversely affected. The Company is currently developing products only for DOS and Windows PC, and Macintosh computers. The Company has terminated virtually all current development for other platforms such as the Sony PlayStation and Sega Saturn. There can be no assurance that the Company has chosen to support the platforms that ultimately will be successful. Changes in Technology and Industry Standards. The consumer software industry is undergoing rapid changes, including evolving industry standards, frequent new product introductions and changes in consumer requirements and preferences. The introduction of new technologies, including operating systems and media formats, can render the Company's existing products obsolete or unmarketable. Recent operating setbacks at Apple Computer may adversely affect future sales of Macintosh computers. The development cycle for products utilizing new operating systems, microprocessors or formats may be significantly longer than the Company's current development cycle for products on existing operating systems, microprocessors and formats and may require the Company to invest resources in products that may not become profitable. There can be no assurance that the current demand for the Company's products will continue or that the mix of the Company's future product offerings will keep pace with technological changes or satisfy evolving consumer preferences or that the Company will be successful in developing and marketing products for any future operating system or format. -6- 42 Limited Protection of Intellectual Property and Proprietary Rights; Risk of Litigation. The Company regards its software as proprietary and relies primarily on a combination of trademark, copyright and trade secret laws, and employee and third-party nondisclosure agreements and other methods to protect its proprietary rights. However, the Company does not have signed license agreements with its end-users and does not include in its products any mechanism to prevent or inhibit unauthorized copying. Unauthorized parties may copy the Company's products or reverse engineer or otherwise obtain and use information that the Company regards as proprietary. If a significant amount of unauthorized copying of the Company's products were to occur, the Company's business, operating results and financial condition could be materially adversely affected. Further, the laws of certain countries in which the Company's products are or may be distributed do not protect applicable intellectual property rights to the same extent as the laws of the United States. In addition, the Company holds no patents, and, although the Company has developed and continues to develop certain proprietary software tools, the copyrights to which are owned by the Company, most of the technology used to develop the Company's products is not proprietary. There can be no assurance that the Company's competitors will not independently utilize existing technologies to develop products that are substantially equivalent or superior to the Company's. Also, as the number of software products in the industry increases and the functionality of these products further overlaps, software developers and publishers may increasingly become subject to infringement claims. There can be no assurance that third parties will not assert infringement claims against the Company in the future with respect to current or future products. As is common in the industry, from time to time the Company receives notices from third parties claiming infringement of intellectual property or other rights of such parties. The Company investigates these claims and responds as it deems appropriate. There has been substantial litigation regarding copyright, trademark and other intellectual property rights involving computer software companies in general. The Company may also face suits as a result of employment matters, publicity rights, or due to claims of breach of the Company's obligations under various agreements to publish or develop products, or for goods or services provided to the Company. Currently, the Company, Presto Studios and others are co-defendants in a lawsuit claiming conversion and unfair competition. See Item 3 - Legal Proceedings. Adverse determinations in such claims or litigation could have a material adverse effect on the Company's business, operating results and financial condition. The Company may find it necessary or desirable in the future to obtain licenses relating to one or more of its products or relating to current or future technologies. There can be no assurance that the Company will be able to obtain these licenses or other rights on commercially reasonable terms or at all. Relationship with Vendors. Due to the substantial operating losses in the fourth quarter of 1995, and the Company's current financial condition and lack of capital resources, the Company has in the first quarter of 1996 been unable to pay certain of its vendors. This failure may result in loss of the availability of the services of such vendors, which could hamper the Company's ability to manufacture and ship products, and may ultimately result in the Company being sued for collection of such amounts as may be owed to such vendors. If the Company is unable to produce its products to fill orders, the Company's operating results and financial condition could be materially adversely affected. In the event that suits by vendors are filed against the Company, the Company may find it necessary to seek protection under the applicable bankruptcy statutes of Canada and/or the United States. Market for Common Stock; Stock Price Volatility. The Common Stock has been quoted on the Nasdaq National Market or Small Cap Market since September 8, 1993 and on the Vancouver Stock Exchange since December 1991. Based upon historical trends in the market for other software company stocks, the Company anticipates that the trading price of its Common Stock may be subject to wide fluctuations in response to quarterly variations in operating results, changes in actual earnings or in earnings estimates by analysts, announcements of technological developments by the Company or its competitors, general market conditions or other events largely outside the Company's control. -7- 43 In addition, the stock market has experienced, from time to time, extreme price and volume fluctuations which have particularly affected the market prices of high technology stocks. These fluctuations have often been disproportionate or unrelated to the operating performance of these companies. These broad market fluctuations, general economic conditions or other factors outside the Company's control may adversely affect the market price for the Company's stock. Performance Shares and Related Compensation Expense. In 1991, the Company issued to its founders an aggregate of 4,000,000 Performance Shares for nominal consideration. Pursuant to certain Vancouver Stock Exchange ("VSE") requirements, these Performance Shares are currently held in an escrow account, subject to release upon specified conditions. One Performance Share is scheduled to be released from escrow for each (Canadian dollar) CDN$0.653 of cumulative operating cash flow generated by the Company, as specifically defined by VSE Policy 19. The Company will be required to recognize as compensation expense an aggregate amount equal to the difference between the amount per share originally paid for the Performance Shares (CDN$.01) and the market price of the Common Stock at the time such Performance Shares or pro rata portion thereof are earned. Further, the Company expects that approximately 1,200,000 shares of the Performance Shares may be transferred from one of its founders to certain current key management employees of the Company, which may result in the recognition by the Company of a non-cash compensation expense charge in an amount yet to be determined. Performance Shares are permitted to be released from escrow on an annual basis. Any compensation expense related to the release of the Performance Shares from escrow will be a non-cash charge against income and will have no net impact on total shareholders' equity (deficit). Such pro rata or full expense recognition will occur prior to the pro rata or full release from escrow of the Performance Shares. If and when such expense recognition criteria are achieved, based upon the closing price of the Company's Common Stock at April 12, 1996 of $0.875, (for example purposes only), the aggregate compensation expense that would be recognized as a result would be approximately $3,460,000. The Company may pursue an early release of all or a large portion of the Performance Shares from escrow. Such an early release would reduce a source of continuing uncertainty surrounding the Company's financial statements, but could also result in a similar expense in the quarter in which the release is made. Shares Eligible for Future Sale; Possible Adverse Effect on Future Market Price. Sale of substantial amounts of shares in the public market or the prospect of such sales could adversely affect the market price of the Company's Common Stock. Other than the 4,000,000 Performance Shares issued to the Company's founders (which are currently held in an escrow account and are subject to release upon satisfaction of specified conditions as discussed above) substantially all of the Company's issued and outstanding shares are freely tradable, subject to, in certain circumstances compliance with Rule 144 or Rule 701 or the effectiveness of a resale registration statement. In addition, as of March 31, 1996, the Company had outstanding options to purchase an aggregate of 2,577,838 shares of Common Stock and warrants to purchase 1,915,000 shares of Common Stock. Furthermore, the Company has reserved approximately 800,000 additional shares of Common Stock for future issuance pursuant to the Company's Stock Option Plan, and expects to issue warrants to purchase up to an additional 650,000 shares of Common Stock related to the provision of a loan to the Company and for financial advisory services. No Dividends. The Company has not paid any cash dividends since inception and does not anticipate paying cash dividends in the foreseeable future. The Company's line of credit prohibits the payment of cash dividends without the prior written consent of the lender. -8- 44 RESULTS OF OPERATIONS 1995 COMPARED WITH 1994 NET LOSS The net loss for 1995 was $18,698,441, compared with a net loss of $7,404,436 in 1994. This increase in the net loss of $11,294,005 was primarily the result of operating results reflecting an increasingly competitive marketplace resulting in significantly lower than expected sales, higher than expected returns, and downward pressure on pricing. As a result, during the fourth quarter of 1995, the Company took additional reserves for estimated sales returns and price protection of $5,475,002, wrote off unrecoverable royalty advances of $4,260,532, and reserved for inventory obsolescence of $1,033,389. The Company's total reserves for price protection and estimated returns for 1995 were $8,168,460, compared to $459,814 in 1994. The Company's reserve balance for price protection and estimated returns was $4,942,905 at December 31, 1995, compared to $414,275 at December 31, 1994. NET REVENUES
INCREASE 1995 1994 (DECREASE) Consumer titles Kids Titles $ 4,256,400 $ 3,033,940 40% Entertainment Titles 6,155,153 2,737,983 125% ----------- ----------- 10,411,553 $ 5,771,923 80% Publisher services 569,544 489,303 (16%)
-9- 45 Net revenue growth from consumer titles in 1995 can be broken down as follows:
1995 1994 INCREASE DECREASE) Retail and Schools - North America $ 6,973,227 $ 4,736,914 47% OEM/Bundling 2,142,083 765,226 180% International 1,296,243 269,783 380% ----------- ----------- 10,411,553 $ 5,771,923 80%
Increased unit sales in 1995 were aided by the addition of ten new products including the release of two new entertainment titles: Buried In Time and Ripley's Believe It Or Not!: The Riddle of Master Lu and the launch of several new education titles including Franklin's Reading World and NFL Math. Approximately 61% of the Company's total 1995 revenues were comprised of these four titles. In 1995, 34 titles were available for sale versus 24 titles in 1994. Revenue per title varies due to factors such as consumer appeal, target audience, competitive products, release date, content, and product type. The increase in unit sales was partially offset by a decline in unit prices due to competitive pressure at the retail level. Revenue from Publishers Services decreased from 1994 due to a slight decrease in work contracted with outside publishers. In January 1996 the Company resolved to focus its efforts on CD-ROM publishing and is therefore discontinuing its Publisher Services division. As discussed above, the Company recognizes income from the sales of its CD-ROM products upon shipment to its distributors net of an allowance for product returns and price protection as, under certain circumstances, products may be returned to the Company rather than "sold through" to consumers. -10- 46 GROSS MARGIN
1995 1994 Cost of sales: Consumer titles Kids Titles $ 2,624,932 $ 1,765,684 Entertainment Titles 9,320,963 974,618 ----------- ------------ 11,945,895 2,740,302 Publisher services 629,936 317,066 Gross margin: Consumer Titles Kids Titles $ 1,631,470 38% $ 1,268,256 42% Entertainment Titles (3,165,812) (51)% 1,763,365 64% ----------- --- ------------ -- (1,534,342) (15)% 3,031,621 53% Publisher Services $ 60,392 (11)% $ 172,237 35%
In March 1995, an Affiliated Label Distribution Agreement (the "Affiliated Label Agreement") with Electronic Arts expired and was not renewed. The Company began the process of developing its own retail distribution -11- 47 network primarily to exert more control over sales and distribution activities. The Company expected its gross margins to increase slightly by selling its products directly into the channel. However, as evidenced by fourth quarter results, the Company now finds itself in an increasingly competitive marketplace as more and more multimedia products are being produced and brought to market. Shelf space in the retail outlets is scarce as many products compete for limited retail space. This, in addition to the emergence of discount wholesalers and retailers in the marketplace, has put downward pressure on prices and resulted in decreasing margins. Sales in the fourth quarter were extremely slow. During the first quarter of 1996, return requests from distributors and retailers significantly exceeded the Company's historical experience. As a result, the Company reserved an additional $5,475,002 for returns and price protection in the fourth quarter of 1995. These reserves related primarily to third quarter 1995 sales. Of this additional reserve, $3,723,001 related to the Company's entertainment titles, and $1,752,000 related to the Company's kids education titles. Considering the increased competition in the marketplace and the downward pressure on prices, the Company determined that it may not recoup certain royalties guaranteed and/or paid to third party developers. Accordingly, cost of sales for 1995 reflects a $4,260,532 charge in the fourth quarter of 1995 to write-off unrecoverable royalty advances. In fiscal 1995 and 1994, $1,127,833 (of which $1,033,389 was included in the fourth quarter 1995 results) and $298,723 of allowances for obsolete, slow-moving and non-salable inventory was charged to cost of goods sold. The Company does not expect significant increases in such allowances in 1996, based upon new policies and procedures for improved inventory control. There is no guarantee, however, that the Company will be successful in optimizing its inventory levels. Cost of sales also includes technology amortization. Technology amortization relating to the Magic Quest acquisition was $532,305 in 1995. The Company capitalized $871,042 as deferred development expenditures at the time of the acquisition in 1994 and the amount was fully amortized by November 1995. OPERATING EXPENSES
INCREASE 1995 1994 (DECREASE) Research and development $ 4,495,963 $ 5,056,661 $ (560,698) Marketing and sales 8,263,739 3,722,789 $ 4,540,950 Administration 3,477,922 1,922,573 $ 1,555,349 Depreciation 852,211 529,636 $ 322,575
-12- 48 Research and Development Research and development expenses decreased 11% to $4,495,963 in 1995 from $5,056,661 in 1994. However, the expense for 1994 includes a one-time charge of $1,034,958 related to the Magic Quest acquisition. If this charge was excluded, expenditures would have increased by 9% from 1994. The increased expense reflects the increased complexity and length of the titles developed in 1995. Marketing and Sales Marketing and sales expenses increased to $8,263,739 in 1995 from $3,722,789 in 1994. This increase is mostly attributable to the Company's development of its internal sales and distribution infrastructure. Additionally, the Company incurred substantial marketing expense in 1995 in launching two new entertainment titles: Buried In Time and Ripley's Believe It Or Not!: The Riddle of Master Lu. The Company charged $118,967 and $203,035 to bad debt expense in 1995 and 1994, respectively. The reserve for bad debt at December 31, 1995, was $200,000, compared to $217,000 at December 31, 1994. Although the Company believes that it is adequately reserved for potential bad debts at December 31, 1995, because of the continued competitive pressures in the marketplace and downward pricing pressures and the Company's uncertain financial condition, there can be no assurances that significant additional allowances for doubtful accounts may not be needed in the future. Administration Administration expenses were higher in 1995 reflecting increased infrastructure necessary to support the Company's overall growth. Administration expenses include a charge of $429,000 related to a warrant to purchase 100,000 shares of the Company's common stock issued to the Company's line of credit bank in connection with the original Loan Agreement. DEPRECIATION Depreciation increased to $852,211 in 1995 from $529,636 in 1994 as a result of continued purchases of the necessary hardware and tools to support the production of new CD-ROM titles. 1994 COMPARED WITH 1993 NET LOSS The net loss for 1994 was $7,404,436, compared with a net loss in 1993 of $4,221,569. The increased net loss of $3,182,867 was primarily the result of lower gross margins and higher research and development as well as sales and marketing expenses offsetting the growth in revenues. NET REVENUES -13- 49
INCREASE 1994 1993 (DECREASE) Consumer titles $5,771,923 $ 749,895 670% Publisher services 489,303 675,076 (28%)
The net revenue increase from consumer titles in 1994 reflected an increase in titles and an increase in units sold for certain titles. In 1994, 24 titles were available versus 8 titles in 1993. Revenue per title varied due to factors such as consumer appeal, target audience, available competitive products, release date, content, and product type. No material price increase contributed to the increase in revenues. Revenues from Publisher Services decreased slightly as a result of the closure of the Ottawa office and the Company's decisions to focus the efforts of the Publisher Services division on the publishing industry and to concentrate these efforts in the Dallas office. The Ottawa office accounted for $220,000 in sales during 1993. Because of the Company's focus on CD-ROM publishing, revenues from the Publisher Services Division accounted for less than 10% of the Company's total revenues. GROSS MARGIN
INCREASE 1994 1993 (DECREASE) Cost of sales: Consumer titles $2,740,302 $ 474,071 478% Publisher services 317,066 520,082 (39)%
1994 1993 Gross margin: Consumer Titles 53% 37% Publisher Services 35 23
-14- 50 The increase in gross margin on consumer titles resulted primarily from a higher proportion of licensing and OEM revenue, partially offset by technology amortization relating to the Magic Quest acquisition and an increase in royalty payments. In 1994, $298,723 of allowances for obsolete, slow-moving and non-salable inventory was charged to cost of goods sold. There was no such provision in 1993 as the Company's inventory levels were minimal. In 1994, the majority of the sales were made directly to retailers while in 1993 the majority of sales were through OEM channels, where goods were not delivered in full retail packaging. Royalty payments increased from $25,000 in 1993 to $328,679 in 1994. During 1994 and 1993, 37% and 49% respectively of net sales were to EA under the Affiliated Label Agreement. On March 30, 1995, the Affiliated Label Agreement with EA expired and was not renewed. Technology amortization relating to the Magic Quest acquisition was $338,737 in 1994. The Company capitalized $871,042 as deferred development expenditures at the time of the acquisition and the net balance was fully amortized by November 1995. OPERATING EXPENSES
1994 1993 INCREASE % INCREASE Research and development $5,056,661 $1,980,884 $3,075,777 155% Marketing and sales 3,722,789 1,098,043 2,624,746 239 Administration 1,922,573 1,551,334 371,239 24 Depreciation 529,636 236,566 293,070 124
Research and Development Research and development expenses increased $3,075,777 or 155% in 1994. The increased expense reflects the costs associated with the development of new CD-ROM titles and the conversion of existing titles from the Macintosh to PC platforms. The Company released 13 new products in 1994 compared to 7 in 1993. In addition, the increase in research and development reflected a charge of $1,034,958 related to the Magic Quest acquisition. Marketing and Sales -15- 51 Marketing and sales expenses increased from $1,098,043 in 1993 to $3,722,789 in 1994. This increase was attributable to increased marketing activities as a result of the increase in new titles, and to direct marketing and sales of Magic Quest titles to retailers. The Company also charged $203,035 and $65,567 to bad debt expense in 1994 and 1993, respectively. The increase in bad debt provision was consistent with the increased sales from 1993 to 1994. Administration Administration expenses were higher in 1994 reflecting increased infrastructure necessary to support the Company's increased product development and marketing activities. As a percentage of sales, these expenses decreased from 109% in 1993 to 31% in 1994. Depreciation Depreciation increased from $236,566 in 1993 to $529,636 in 1994 as a result of leasehold improvements for the San Mateo office and Victoria studio, the addition of the Magic Quest office and continued purchases of the necessary hardware and tools to support the production of new CD-ROM titles. NEW ACCOUNTING STANDARDS See discussion at note 4(m) of the consolidated financial statements. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA See consolidated financial statements of Sanctuary Woods Multimedia Corporation attached to this Report on Form 10-K at pages F-1 through F-25. PART III ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE On May 17, 1994, the Company terminated Chambers, Phillips & Co. as independent auditors for the Company. Chambers, Phillips & Co.'s reports on the consolidated financial statements of the Company for 1992 and 1993 did not contain an adverse opinion or a disclaimer of opinion and the reports were not qualified or modified as to uncertainty, audit scope, or accounting principles. The decision to change accountants was approved by the Company's board of directors. During the fiscal years 1992 and 1993 and subsequent interim period (through May 17, 1994), there were no disagreements with Chambers, Phillips & Co. on any matter of accounting principles or practice, financial statement disclosure, or auditing scope or procedure, which, if not resolved to the satisfaction of Chambers, Phillips & Co., would have caused Chambers, Phillips & Co. to make a reference to the subject matter of the disagreement in connection with its report. During the fiscal years 1992 and 1993 and subsequent interim period (through May 17, 1994), there did not occur any kind of event listed in paragraphs (a)(1)(v)(A) through (D) of Regulation S-K, Item 304. Effective May 17, 1994, the Company engaged Deloitte & Touche (Canada) as independent auditors to audit the Company's financial statements for 1994. On April 11, 1994 the Company engaged Deloitte & Touche (Canada) as independent auditors to audit the financial statements of Magic Quest, Inc. for 1991, 1992 and 1993, pursuant to the Company's acquisition of Magic Quest, Inc. Deloitte & Touche LLP (United States) issued its independent auditors' report, which included a going concern uncertainty paragraph, dated May 6, 1994, on such Magic Quest, Inc. financial statements. Other than described above, during the fiscal years 1992 and 1993 and the subsequent interim period through May 17, 1994, neither the Company nor any person acting on behalf of the Company -16- 52 consulted Deloitte & Touche regarding (i) either: the application of accounting principles to a specified transaction, either completed or proposed; or the type of audit opinion that might be rendered on the Company's financial statements; or (ii) any matter that was either the subject of a disagreement (as defined in paragraph (a)(1)(iv) of Regulation S K, Item 304 and the related instructions) or a reportable event (as described in paragraph (a)(1)(v) of Regulation S-K, Item 304. -17- 53 SANCTUARY WOODS MULTIMEDIA CORPORATION CONSOLIDATED FINANCIAL STATEMENTS INDEX Report of Independent Auditors: Year Ended December 31, 1993 F-2 Report of Independent Auditors: Year Ended December 31, 1994 F-3 Report of Independent Auditors: Year Ended December 31, 1995 F-5 Consolidated Balance Sheets: December 31, 1995, 1994 and 1993 F-6 Consolidated Statements of Operations: F-7 Years ended December 31, 1995, 1994 and 1993 Consolidated Statements of Stockholders' Equity: F-8 Years ended December 31, 1995, 1994 and 1993 Consolidated Statements of Cash Flows: F-9 Years ended December 31, 1995, 1994 and 1993 Notes to Consolidated Financial Statements F-10 Consolidated Financial Statement Schedules Supplemental Schedule II - Valuation and Qualifying Accounts F-27 Years ended December 31, 1995, 1994 and 1993 F-1 54 CHAMBERS, PHILLIPS & CO. CHARTERED ACCOUNTANTS 888 - 1185 West Georgia Street Vancouver, BC Canada V6E 4E6 Telephone (604) 687-4511 Fax (604) 687-5617 AUDITORS' REPORT To the Shareholders of Sanctuary Woods Multimedia Corporation We have audited the consolidated statements of shareholders' equity, operations and changes in financial position of Sanctuary Woods Multimedia Corporation and its subsidiaries for the twelve months ended December 31, 1993 not presented separately herein as reported in Canadian currency and prepared in accordance with Canadian generally accepted accounting principles. Our audit also included the 1993 consolidated financial statement schedules listed in the Item 14(a)(2). These consolidated financial statements and financial schedules are the responsibility of the company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules 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 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, these consolidated financial statements present fairly, in all material respects, the results of its operations and the changes in financial position of the company for the twelve months ended December 31, 1993, in accordance with generally accepted accounting principles accepted in Canada and as reported in Canadian currency. As required by the Company Act of the Province of British Columbia, we report that, in our opinion, these principles have been applied on a consistent basis. Also in our opinion, such 1993 financial statement schedules, when considered in relation to the basic consolidated financial statements as a whole, present fairly in all material respects the information set forth therein. We have also audited the reconciling differences between Canadian and United States generally accepted accounting principles as presented in Canadian currency for 1993, which are the responsibility of the company's management. In our opinion, such reconciling differences present fairly the information shown therein. /s/ Chambers, Phillips & Co. CHAMBERS, PHILLIPS & CO. Vancouver, B.C. Chartered Accountants February 9, 1994 except for comments above on reconciling differences between Canadian and United States generally accepted accounting principles which are as of September 20, 1995. F-2 55 Deloitte & Touche Suite 2000 Telephone: (604) 669-4466 1055 Dunsmuir Street Facsimile: (604) 685-0395 P.O. Box 49279 Four Bentall Centre Vancouver, BC Canada V7X 1P4 INDEPENDENT AUDITORS' REPORT To the Shareholders of Sanctuary Woods Multimedia Corporation We have audited the consolidated balance sheet of Sanctuary Woods Multimedia Corporation and its subsidiaries (the "Company") as of December 31, 1994 and the consolidated statement of operations, stockholders' equity and cash flows for the year then ended. Our audit also included the 1994 consolidated financial statement schedule listed in the Index on page F-1. These consolidated financial statements and the financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and the 1994 consolidated financial statement schedule based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States. 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. We believe that our audit provides a reasonable basis for our opinion. In our opinion, these consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 1994, and the results of its operations and its cash flows for the year then ended in accordance with accounting principles generally accepted in the United States. Also, in our opinion, the 1994 consolidated financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein. F-3 56 As discussed in Note 4 to the financial statements, effective July 1, 1994, the Company changed its functional currency to United States dollars from Canadian dollars, and effective November 1, 1994, the Company changed its reporting currency to United States dollars from Canadian dollars. In addition, the 1994 financial statements have been prepared in accordance with accounting principles generally accepted in the United States. Prior years' financial statements have been restated to be presented in U.S. dollars and prepared in accordance with accounting principles generally accepted in the United States to conform to the 1994 presentation. We also audited the translation adjustments that were applied to restate the 1993 consolidated financial statements, which were audited by other auditors who expressed an unqualified opinion on those statements in their report dated February 9, 1994 (except for certain comments which are as of September 20, 1995), to give retroactive effect to the change in presentation to United States dollars. In our opinion, such translation adjustments are appropriate and have been properly applied. DELOITTE & TOUCHE LLP CHARTERED ACCOUNTANTS VANCOUVER, CANADA February 23, 1995 (except for Note 11 which is as of March 10, 1995 and Notes 10 and 17 which are as of September 20, 1995 F-4 57 DELOITTE & TOUCHE LLP 50 Fremont Street Telephone: (415) 247-4000 San Francisco, CA 94105-2230 Facsimile: (415) 247-4329 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Stockholders of Sanctuary Woods Multimedia Corporation: We have audited the accompanying consolidated balance sheet of Sanctuary Woods Multimedia Corporation and its subsidiaries (the "Company") as of December 31, 1995, and the related consolidated statements of operations, stockholders' equity (deficit), and cash flows for the year then ended. Our audit also included the 1995 consolidated financial statement schedule listed in the Index on page F-1. These consolidated financial statements and the consolidated financial statement schedule are the responsibility of the Company's management. Our responsibility is to express (or disclaim) an opinion on these consolidated financial statements and the consolidated financial statement schedule based on our audit. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our report. The accompanying 1995 consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the consolidated financial statements, the Company has experienced recurring and increasing losses from operations, has generated negative cash flows from operations and has negative working capital and a stockholders' deficit at December 31, 1995. As discussed in Note 2, the Company was not in compliance with certain covenants of its bank credit line at December 31, 1995 and thereafter; on April 2, 1996, the Company and the bank amended the credit line and extended the maturity date to May 15, 1996; however, due to the Company's severe liquidity problems, the Company does not have any funds available to repay such bank line. These matters raise substantial doubt about the Company's ability to continue as a going concern. Management's plans concerning these matters are also described in Note 2. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. Because of the possible material effects of the uncertainty referred to in the preceding paragraph, we are unable to express, and we do not express, an opinion on the 1995 consolidated financial statements and the 1995 consolidated financial statement schedule. DELOITTE & TOUCHE LLP April 12, 1996 F-5 58 SANCTUARY WOODS MULTIMEDIA CORPORATION CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1995 AND 1994
- - - --------------------------------------------------------------------------------------- 1995 1994 ASSETS CURRENT ASSETS: Cash $ 11,484 $ 2,669,431 Accounts receivable 1,308,603 2,918,258 Inventories 1,977,858 700,225 Prepaid and deferred royalties 80,000 1,784,470 Prepaid expenses 662,179 387,235 ------------ ------------ Total current assets 4,040,124 8,459,619 ------------ ------------ PROPERTY AND EQUIPMENT 2,367,589 2,211,532 PREPAID AND DEFERRED ROYALTIES 181,000 1,321,500 DEFERRED DEVELOPMENT EXPENDITURES 532,305 LICENSES AND OTHER INTANGIBLES 9,921 324,458 ------------ ------------ TOTAL ASSETS $ 6,598,634 $ 12,849,414 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) CURRENT LIABILITIES: Bank line of credit $ 1,800,000 $ Accounts payable 2,486,497 1,478,683 Accrued expenses 1,557,648 416,968 Royalty obligations 480,884 200,000 Current portion of capital lease obligations 29,626 ------------ ------------ Total current liabilities 6,354,655 2,095,651 ------------ ------------ LONG-TERM ROYALTY OBLIGATIONS 581,000 770,000 CAPITAL LEASE OBLIGATIONS 20,359 COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY (DEFICIT): Authorized, 100,000,000 common shares, no par value; issued and outstanding, 22,153,580 and 19,950,263 common shares in 1995 and 1994 31,754,188 23,396,255 Accumulated deficit (31,359,942) (12,661,501) Accumulated translation adjustments (751,626) (750,991) ------------ ------------ Total stockholders' equity (deficit) (357,380) 9,983,763 ------------ ------------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) $ 6,598,634 $ 12,849,414 ============ ============
See notes to consolidated financial statements. F-6 59 SANCTUARY WOODS MULTIMEDIA CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993
- - - ------------------------------------------------------------------------------------- 1995 1994 1993 SALES: Consumer titles $ 10,411,553 $ 5,771,923 $ 749,895 Publisher services 569,544 489,303 675,076 ------------ ------------ ----------- Total sales 10,981,097 6,261,226 1,424,971 ------------ ------------ ----------- COST OF SALES: Consumer titles 11,413,590 2,401,565 439,468 Technology amortization 532,305 338,737 34,603 Publisher services 629,936 317,066 520,082 ------------ ------------ ----------- Total cost of sales 12,575,831 3,057,368 994,153 ------------ ------------ ----------- GROSS MARGIN (DEFICIT) (1,594,734) 3,203,858 430,818 ------------ ------------ ----------- OPERATING EXPENSES: Research and development 4,495,963 5,056,661 1,980,884 Marketing and sales 8,263,739 3,722,789 1,098,043 Administration 3,477,922 1,922,573 1,551,334 Depreciation 852,211 529,636 236,566 ------------ ------------ ----------- Total operating expenses 17,089,835 11,231,659 4,866,827 ------------ ------------ ----------- LOSS BEFORE OTHER INCOME (EXPENSE) (18,684,569) (8,027,801) (4,436,009) ------------ ------------ ----------- OTHER INCOME (EXPENSE) Foreign exchange gain (loss) (4,307) 378,951 Interest and other income (expense) (9,565) 244,414 214,440 ------------ ------------ ----------- Total other income (expense) (13,872) 623,365 214,440 ------------ ------------ ----------- NET LOSS $(18,698,441) $ (7,404,436) $(4,221,569) ============ ============ =========== NET LOSS PER SHARE ($ 1.11) ($ 0.53) ($ 0.46) ============ ============ =========== SHARES USED IN COMPUTATION 16,873,748 13,993,675 9,231,421 ============ ============ ===========
See notes to consolidated financial statements. F-7 60 SANCTUARY WOODS MULTIMEDIA CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) YEARS ENDED DECEMBER 31, 1995, 1994, 1993
- - - ------------------------------------------------------------------------------------------------------------------- Accumulated Common Stock Accumulated Translation Shares Amount Deficit Adjustments Total ------------------------------------------------------------------------------ Balances, January 1, 1993 11,442,599 $ 2,943,971 $ (1,035,496) $(118,256) $ 1,790,219 Exercise of warrants 570,000 812,489 812,489 Exercise of stock options 703,482 906,444 906,444 Shares issued for cash 1,500,000 3,296,764 3,296,764 Stock option compensation 225,004 225,004 Accumulated foreign currency translation adjustments (210,036) (210,036) Net loss (4,221,569) (4,221,569) ------------------------------------------------------------------------------ Balances, December 31, 1993 14,216,081 8,184,672 (5,257,065) (328,292) 2,599,315 Exercise of warrants 164,168 436,671 436,671 Exercise of stock options 453,764 685,007 685,007 Shares issued for cash 2,650,000 11,933,809 11,933,809 Shares issued on acquisition of subsidiary 2,106,250 1,838,791 1,838,791 Stock option compensation 317,305 317,305 Accumulated foreign currency translation adjustments (422,699) (422,699) Net loss (7,404,436) (7,404,436) ------------------------------------------------------------------------------ Balances, December 31, 1994 19,590,263 23,396,255 (12,661,501) (750,991) 9,983,763 Exercise of warrants 8,000 22,905 22,905 Exercise of stock options 555,317 1,033,617 1,033,617 Shares issued for cash 2,000,000 7,168,868 7,168,868 Stock option compensation 132,543 132,543 Accumulated foreign currency -- translation adjustments (635) (635) Net loss (18,698,441) (18,698,441) ------------------------------------------------------------------------------ Total other income (expense) 22,153,580 $ 31,754,188 $(31,359,942) $(751,626) $ (357,380) ==============================================================================
See notes to consolidated financial statements. F-8 61 SANCTUARY WOODS MULTIMEDIA CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993
- - - ----------------------------------------------------------------------------------------------------- 1995 1994 1993 CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $(18,698,441) $ (7,404,436) $(4,221,569) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 1,709,552 975,859 288,294 Research and development purchased -- 1,034,958 Write-off of deferred development expenditures -- -- 368,268 Stock option compensation 132,543 317,305 225,004 Changes in assets and liabilities Accounts receivable 1,609,655 (2,780,750) (73,530) Inventories (1,277,633) (649,537) (44,146) Prepaid royalties and expenses 2,661,911 (1,847,225) (611,537) Licenses and other intangibles (10,500) (74,314) (349,893) Accounts payable 1,007,814 1,233,147 154,466 Accrued expenses 1,140,680 285,464 131,504 ------------ ------------ ----------- Net cash used in operating activities (11,724,419) (8,909,529) (4,133,139) ------------ ------------ ----------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of property and equipment (958,283) (1,817,911) (553,746) Cash paid for acquisitions -- -- (233,611) ------------ ------------ ----------- Net cash used in investing activities (958,283) (1,817,911) (787,357) ------------ ------------ ----------- CASH FLOWS FROM FINANCING ACTIVITIES Issuance of common stock 8,225,390 13,055,487 5,015,697 Net borrowings on bank line of credit 1,800,000 -- -- Repayments on note payable -- (76,032) (33,113) Repayments of loans from related party -- -- (73,967) ------------ ------------ ----------- Net cash provided by financing activities 10,025,390 12,979,455 4,908,617 ------------ ------------ ----------- EFFECT OF EXCHANGE RATE CHANGES ON CASH (635) (363,294) -- ------------ ------------ ----------- NET INCREASE (DECREASE) IN CASH (2,657,947) 1,888,721 (11,879) CASH, BEGINNING OF YEAR 2,669,431 780,710 792,591 ------------ ------------ ----------- CASH, END OF YEAR $ 11,484 $ 2,669,431 $ 780,712 ============ ============ =========== Cash paid during the year for: Interest $ 73,972 $ 2,237 $ 8,531 Income taxes 1,600 NONCASH INVESTING AND FINANCING ACTIVITIES: Issuance of common stock on Magic Quest acquisition $ 1,838,791 Issuance of note payable on Literatek acquisition $ 109,145 Capital lease obligations 49,985
See notes to consolidated financial statements. F-9 62 SANCTUARY WOODS MULTIMEDIA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 - - - -------------------------------------------------------------------------------- 1. NATURE OF OPERATIONS Sanctuary Woods Multimedia Corporation and its subsidiaries (the "Company") is a developer and provider of computer-based interactive multimedia software products and services. The Company develops, markets and distributes interactive multimedia software products ("consumer titles") targeted at the home entertainment and childrens' education markets in North America and overseas (international). Consumer titles are sold primarily to distributors that channel product into retail outlets. The Company also provides interactive multimedia services to trade and textbook publishers through its Publishers Services division. The Company also distributes its products under agreements with Original Equipment Manufactuers (OEM). Under these arrangements, consumer titles are sold with hardware products or bundled with other third party software. 2. GOING CONCERN UNCERTAINTY 1995 Net Loss The Company incurred a net loss of $18,698,441 in 1995 , compared to net losses of $7,404,436 in 1994 and $4,221,569 in 1993. Net cash used by operating activities was $11,724,419 in 1995, compared to net cash used by operating activities of $8,909,529 in 1994 and $4,133,139 in 1993. At December 31, 1995, the Company had cash of $11,484 and bank borrowings of $1,800,000 which were due on April 15 ,1996. A number of factors contributed to the Company's 1995 net loss. Sales of the Company's products in the fourth quarter of 1995 were significantly below expectations and the Company experienced significantly higher than expected returns. As discussed in Note 3, in light of the continued competitive pressures in the marketplace, inventory levels in the retail channel, the introduction of competitive products, downward pricing pressures and the focusing of the Company's operations and cash resources on products targeted at the children's home and education markets, in the fourth quarter of 1995 the Company accelerated write-offs of prepaid and deferred royalties for certain products and made additional provisions for returns and price protection and inventory obsolesence. As a result, since January 1996 the Company has experienced severe liquidity problems. The Company has had difficulty in generating sufficient cash flow to meet its obligations and sustain its operations. Management believes that the Company will need to raise significant additional debt or equity before May 15, 1996 to sustain its operations, repay its bank line of credit, and fund its 1996 operating plan. If the Company is unable to successfully obtain such funding, management believes that the Company may be forced to cease operations. F-10 63 January 1996 Actions In January 1996, the Company's Board of Directors and management formulated plans and instituted specific measures to improve operations, cash flows and cash management and to enable the Company to continue to sustain its operations, as follows: - Appointment of a new President and Chief Executive Officer and a new Vice President of Sales and termination of the employees who previously held those positions. - Plans to shut down or sell the Publishers Services Division. - Plans to review its portfolio of assets in its Entertainment Division, which includes its Victoria Studio, for sale or disposition. - Focus the Company's operations on the children's home and education markets. - An immediate short term cost reduction and cash generation program that identifies the largest, most timely opportunities for cost reductions and cash collections. Some specific components of this program include: - A 20% decrease in the Company's full-time workforce and elimination of many part time, temporary and contract positions. - A 10% reduction in senior management salaries. - The Company deferred or terminated plans to invest in certain software development projects which were not expected to generate significant sales or whose cost estimates to complete exceeded planned expenditures and available resources. - Cash collection efforts have been increased and intensified in order to accelerate cash receipts. March 1996 Financing - In March 1996, the Company completed a private placement of $1,500,000 of bridge notes, with an annual interest rate of 10%. The notes are due August 31, 1996, subject to the Company's option to extend the due date until November 30, 1996. Bridge notes of $1,000,000 are convertible at the due date into 2,000,000 shares of the Company's common stock. Subject to approval by the Company's shareholders, the remaining $500,000 of the bridge notes are convertible at the due date into 1,000,000 shares of the Company's common stock. In addition, the Company issued the bridge note holders warrants to purchase 1,875,000 shares of the Company's common stock at an exercise price of $.50 per share over the next two years. Bank Line of Credit As a result of the significant losses discussed above, the Company was in violation of certain covenants of its bank line of credit (see Note 11) at December 31, 1995 and thereafter. In addition the Company has borrowed in excess of the amounts allowed under the bank line of credit agreement. On April 2, 1996, the Company and the bank agreed to amend the bank line of credit agreement as follows: - The maturity date of the bank line of credit was extended to May 15, 1996. - The bank line of credit was set at a maximum of $2,253,000. - No further advances to the Company were allowed. - The borrowing base definitions and calculations were modified. - The borrowing base is being monitored by the bank with 50% of all accounts receivable collections to be applied to the outstanding bank line of credit balance while the borrowing base is in an overadvanced condition or until further notice by the bank. - The bank agreed to take no action related to the existing covenant violations until at least May 15, 1996. - The bank may require full repayment of the outstanding line of credit at any time. - The Company issued the bank a warrant to purchase 200,000 shares of the Company's common stock at $.50 per share. The warrant expires in five years and the number of shares may be reduced if the Company repays the bank prior to May 15, 1996. F-11 64 Current Status as of April 12, 1996 and Management's Plans At April 12, 1996, the Company had cash of $66,000, bank borrowings of $1,875,000 which are due May 15, 1996 and no additional bank borrowings available. Management believes that the Company will need to raise significant additional debt or equity financing prior to May 15, 1996 to sustain its operations, repay its bank line of credit and fund its 1996 operating plan. The Company currently lacks the cash necessary to continue its operations for the immediate future. The Company is actively pursuing various sources of additional funding including, but not limited to, debt, equity and strategic investors. The Company is also actively exploring various business combinations and strategic relationships that may enhance the Company's ability to develop, publish and/or distribute its products. The Company expects to sell or license the rights to its entertainment product catalog. No assurance can be given that additional financing will be available or that, if available, such financing will be obtainable on terms favorable to the Company. If the Company is unable to successfully obtain such funding, management believes that the Company may be forced to cease operations. Going Concern Uncertainty Conclusion The accompanying consolidated financial statements have been prepared on the going concern basis, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. The matters discussed above, among others, may indicate that the Company will be unable to continue as a going concern for a reasonable period of time. The consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern. The Company's continuation as a going concern is dependent upon its ability to generate sufficient cash flow to meet its obligations on a timely basis, to comply with the terms and covenants of its bank line of credit, to obtain additional financing or refinancing, and F-12 65 ultimately to attain successful operations. Management is continuing its efforts to obtain additional funds so that the Company can meet its obligations and sustain its operations. 3. FOURTH QUARTER 1995 ADJUSTMENTS The Company's sales for the fourth quarter of 1995 were significantly below the Company's expectations due to an extremely competitive environment, inventory levels in the retail channel and downward pressure on prices. During the first quarter of 1996, return requests from distributors and retailers significantly exceeded the Company's historical experience. In addition, as a result of certain strategic measures implemented in January 1996, including refocusing the Company's operations on products targeted to the children's home and education market and the Company's uncertain financial condition, the Company recorded additional write-offs of royalty advances and other intangibles, and reserves for inventory obsolesence. The Company's 1995 net loss includes certain significant adjustments recorded during the fourth quarter related to these matters as follows: Estimated sales returns and price protection $5,475,002 Write-off of unrecoverable prepaid and deferred royalties 4,260,532 Reserve for inventory obsolesence 1,033,389 Write-off of licenses and intangibles 235,000 ----------- Total $11,003,923 ===========
4. SIGNIFICANT ACCOUNTING POLICIES BASIS OF PRESENTATION - The consolidated financial statements have been prepared in accordance with generally accepted accounting principles of the United States of America (U.S. GAAP) a. Consolidation - The consolidated financial statements include the accounts of Sanctuary Woods Multimedia Corporation (a Canadian corporation) and its wholly-owned subsidiaries, Magic Quest Inc. (California, U.S.A.) and Sanctuary Woods Multimedia Inc. (Nevada, U.S.A.). All material intercompany balances and transactions are eliminated. b. Change in Functional and Reporting Currency - Effective July 1, 1994, the Company changed its functional currency from the Canadian dollar to the United States dollar, due to significant changes in economic facts and circumstances, which included the issuance of common stock in the U.S., the relocation of the Company's principal operations, the acquisition of Magic Quest Inc. (see Note 5(a)) and other factors. Such change in functional currency as of July 1, 1994 was accounted for prospectively. As of November 1, 1994, the Company no longer qualified as a foreign private issuer due to certain management, operating and ownership changes. The Company now files with The Securities and Exchange Commission in accordance with the filing requirements for domestic issuers. The Company's financial statements are now presented in U.S. dollars and prepared in accordance with U.S. GAAP. Such change in reporting currency was accounted for retroactively. F-13 66 Foreign Currency Translation - The consolidated financial statements are stated in U.S. dollars. Assets and liabilities of foreign operations that have a different functional currency are translated into their U.S. dollar equivalents based on the rate of exchange as of the balance sheet dates. Revenue and expense accounts are translated based on average rates of exchange during the period. Gains or losses resulting from foreign currency translation are reported as a separate component of stockholders' equity. Foreign currency transaction gains and losses are included in the statements of operations. c. Use of Estimates. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. d. Inventories consist of finished goods and raw materials and are stated at the lower of cost (first-in, first-out) or market (net realizable value). The Company estimates the net realizable value of inventory based on anticipated future revenues. It is reasonably possible that such estimates of anticipated future revenues will be significantly reduced in the near term due to competitive pricing pressures. In the event that inventory cannot be sold above its estimated net realizable value, the Company could incur significant additional expense in the near term. e. Prepaid and deferred royalties represent prepayments made and current guaranteed minimum payments to be made to independent companies under licensing and development agreements. Prepaid and deferred royalties are expensed as cost of goods sold based on actual net product sales. Prepaid and deferred royalties are classified as current or noncurrent based upon estimated product sales within the next year. Management estimates the future value of prepaid and deferred royalties quarterly and any amounts that management deems unlikely to be recouped through anticipated product sales are charged to cost of goods sold (see Note 3). It is reasonably possible that such estimates of anticipated product sales will be significantly reduced in the near term. As a result, the carrying amount of prepaid and deferred royalties could be reduced significantly in the near term. Royalty obligations represent guaranteed minimum payments to be made pursuant to contractual license agreements. Additional royalties are generally payable as a percentage (generally ranging from 5% to 35%) of sales. Royalty expense was as follows: 1995 - $ 7,233,046 1994 - 330,185 1993 - 53,412 Royalty expense for 1995 includes write-offs of prepaid and deferred royalties to net realizable value totalling $4,505,532 (see Note 3). F-14 67 f. Property and equipment are recorded at cost and depreciation is provided using the declining balance method over the following useful lives: Computer equipment 3 years Computer software 3 years Furniture and equipment 5 years Leasehold improvements are amortized on the straight-line basis over the term of the lease. g. Deferred development expenditures represent the cost of technology acquired through the Magic Quest Inc. acquisition (see Note 5(a)) and relate to products for which technological feasibility had been established. Amortization of the deferred development expenditures commenced in 1994 upon general release of product and is included in cost of sales. Amounts are amortized using the straight-line method and were fully amortized as of December 31, 1995. h. Research and Development Expenses - Software development costs incurred prior to achieving technological feasibility are considered research and development expenses and are expensed as incurred. All software development costs incurred by the Company in 1995, 1994 and 1993 were expensed as incurred. The establishment of technological feasibility and the ongoing assessment of recoverability of capitalized software development costs requires considerable judgment by management with respect to certain factors affecting the Company's products, including, but not limited to, anticipated future gross revenues, estimated economic life and changes in software and hardware technologies. Amounts that could have been capitalized after consideration of the above factors, were immaterial and, therefore, no costs have been capitalized to date. i. Licenses and Other Intangibles - The Company capitalizes costs relating to the acquisition of licenses, copyrights and trademarks. These costs are capitalized until the related products are available for sale, at which time these costs are amortized against income on a straight-line basis over management's estimate of the economic lives of the underlying assets, generally five years. In the fourth quarter of 1995, such estimates of the economic lives were significantly reduced; as a result, $235,000 of licenses and other intangibles were written-off. j. Revenue Recognition - Revenue from consumer titles is recognized when the product is shipped to customers, distributors and retail dealers. The Company recognizes revenue net of an estimated reserve for future returns and price protection. It is reasonablly possible that actual future returns and price protection could exceed such estimates. As a result, the Company's reserves could be significantly increased in the near term. Revenue from sales and licensing agreements with original equipment manufacturers ("OEM") is recognized when the Company fulfills its obligations under the related agreement, which include the Company's delivery of software and related documentation to the OEM in reproducible form, in accordance with Statement of Position 91-1, "Software Revenue Recognition." Other vendor obligations are immaterial. Revenue from publisher services is recognized when earned. F-15 68 k. Income taxes are recorded using the asset and liability approach as defined by the Statement of Financial Accounting Standards No. 109 "Accounting for Income Taxes". l. Net loss per share has been calculated using the weighted average number of shares outstanding during the period. The weighted average number of shares outstanding excludes common stock equivalents such as stock options, stock warrants, and the 4,000,000 performance shares (issued and outstanding but not yet earned - see Note 17) because their effect would be anti-dilutive. m. New accounting standards- The Company is required to adopt Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation" in 1996. SFAS No. 123 establishes accounting and disclosure requirements using a fair value based method of accounting for stock based employee compensation plans. Under SFAS No. 123, the Company may either adopt the new fair value based accounting method or continue the intrinsic value based method and provide pro forma disclosures of net income and earnings per share as if the accounting provisions of SFAS No. 123 had been adopted. The Company plans to adopt only the disclosure requirements of SFAS No. 123, therefore, such adoption will have no effect on the Company's net earnings or cash flows. The Company is required to adopt SFAS No. 121, "Accounting for the Impairment of Long Lived Assets and Long Lived Assets to be Disposed Of" in 1996. SFAS No. 121 establishes recognition and measurement criteria for impairment losses whenever events or changes in circumstances indicate that the carrying value of assets may not be recoverable. The Company does not expect the adoption of SFAS No. 121 to have a material effect on its financial statements (see Note 8). 5. ACQUISITIONS a. Magic Quest Inc. - Pursuant to an Agreement and Plan of Merger dated as of May 27, 1994 the Company acquired Magic Quest Inc., a California corporation, effective June 30, 1994. The Company issued 2,373,709 shares of its common stock to the former shareholders of Magic Quest (which became a wholly-owned subsidiary accounted for by the purchase method). The Company has recorded the value of the common stock issued in the merger at an aggregate amount of $1,838,791. The Company incurred a total of $437,984 of expenses in connection with the merger, resulting in a total recorded purchase price of $2,276,775. Based on appraised values, utilizing a discounted cash flow analysis applied to each of Magic Quest Inc.'s product lines and reference to the Company's software capitalization policies, $871,042 of the purchase price was allocated to purchased developed software technology which was capitalized as deferred development expenditures, (of which $532,305 and $338,737 was amortized during 1995 and 1994 respectively). The remaining $1,034,958 was allocated to in-process research and development and charged to operations during 1994 because technological feasibility had not been established and no alternative future uses existed at the acquisition date. F-16 69
Net assets acquired: Capital assets $ 370,775 Developed software technology 871,042 In-process research and development 1,034,958 ------------- Total $ 2,276,775 =============
The operating results of this acquisition are included in the Company's consolidated results of operations from the date of acquisition. The following unaudited pro forma summary presents the consolidated results of operations as if the acquisition had occurred at the beginning of 1993. These pro forma results have been prepared for comparative purposes only and do not purport to be indicative of what would have occurred had the acquisition been made as of those dates or of results which may occur in the future.
1994 1993 Net sales $ 6,663,633 $ 2,110,507 =========== =========== Net loss $(8,367,323) $(5,755,385) =========== =========== Net loss per common share $ (0.60) $ (0.62) =========== ===========
b. Mind F/X Inc. - On July 31, 1993, the Company purchased 100% of the common shares of Mind F/X Inc., an Ontario based company which produced CD-ROM titles for the home education market. This business combination has been accounted for by the purchase method and the only assets acquired were the capital assets and a 50% ownership in the Literatek Joint Venture. Subsequently, Mind F/X was dissolved and its assets distributed to the Company. Net assets acquired: Capital assets $ 18,335 Intangible assets 106,131 ---------- Total $ 124,466 ========== Consideration given - cash $ 124,466 ==========
c. Literatek Joint Venture - On September 29, 1993, the Company acquired the remaining 50% interest (see Note 5b) in the Literatek Joint Venture for consideration of $218,290. This business combination has been accounted for by the purchase method. Net assets acquired - intangible assets $ 218,290 ========== Consideration given: Cash $ 109,145 Note payable 109,145 ---------- Total $ 218,290 ==========
This acquisition, in conjunction with that disclosed in Note 5(b), allowed the Company to obtain 100% of the joint venture and all rights to products owned by the joint venture F-17 70 These costs were classified as other intangibles and were fully written-off as of December 31, 1995. 6. ACCOUNTS RECEIVABLE Under certain circumstances the Company allows customers to exchange and/or return damaged or unsold products, or provides "price protection" on products previously sold by the Company. In addition, the Company's products are sold with a ninety-day warranty against defects. The Company has recorded reserves for such sales returns and allowances and price protection based on historical experience and management's current estimate of potential returns and allowances and price protection. Accounts receivable at December 31 consist of:
1995 1994 Accounts receivable - trade $ 6,936,840 $3,549,533 Less: Allowance for doubtful accounts (200,000) (217,000) Sales returns and allowances (5,428,237) (414,275) ----------- ---------- Total $ 1,308,603 $2,918,258 =========== ==========
As a result of slow fourth quarter 1995 sales and first quarter 1996 requests for returns, the Company reserved $5,475,002 for returns and price protection in the fourth quarter of 1995. These reserves relate primarily to third quarter sales (see Note 3). Sales returns and allowances as of December 31, 1994 primarily represent an allowance for estimated returns resulting from the termination of a distribution agreement. 7. INVENTORIES Inventories consisted of as of December 31:
1995 1994 Finished goods $ 2,532,033 $ 660,638 Raw materials 963,825 338,310 ----------- ---------- 3,495,858 998,948 Less allowance for obsolete, slow-moving and non-salable inventory (see Note 3) (1,518,000) (298,723) ----------- ---------- Inventories, net $ 1,977,858 $ 700,225 =========== ==========
8. PROPERTY AND EQUIPMENT Property and equipment at December 31 consist of: 1995 1994 F-18 71 Computer equipment $ 2,451,876 $1,832,626 Computer software 516,427 404,048 Furniture and equipment 840,913 626,407 Leasehold improvements 270,028 207,895 ---------- ----------- Total 4,079,244 3,070,976 Less accumulated depreciation (1,711,655) (859,444) ----------- ---------- Property and equipment, net $ 2,367,589 $2,211,532 =========== ==========
As discussed in Note 2, in 1996 the Company plans to review its portfolio of assets in its Entertainment Division, which include its Victoria, British Columbia studio, for sale or disposition. At December 31, 1995, property and equipment, net includes approximately $1,000,000 related to such operations. Management believes this amount is recoverable from a future sale of such operations. However, it is reasonably possible that the carrying value of such net property and equipment will be reduced in the near term. 9. LICENSES AND OTHER INTANGIBLES Licenses and other intangibles at December 31 consist of:
1995 1994 Trademarks and copyrights $ 53,960 49,390 Product licenses 405,608 399,679 --------- ---------- 459,568 449,069 Less accumulated amortization (449,647) (124,611) --------- ---------- Licenses and other intangibles, net $ 9,921 $ 324,458 ========= ==========
The amount of amortization of licenses and intangibles (see Note 3) included in cost of sales is as follows: 1995 - $ 325,036 1994 - 107,486 1993 - 17,125
10. COMMON SHARES STOCK OPTIONS - From time to time, the Company provides stock options for employees, officers, independent contractors, and directors. The options are granted by the Board of Directors F-19 72 subject to approval by the Vancouver Stock Exchange. The options generally vest over a three-year period and expire five years from the date of grant. Prior to August 1995, options were granted at a discount of 10-15% to fair market value. Over the option vesting period, the Company records as compensation expense an amount equal to the difference between the fair market value of the stock and the exercise price of the option at the date of grant or repricing. Compensation expense was $ 132,543, $317,305, and $225,004 in 1995, 1994 and 1993 respectively. Beginning August 1995, the exercise price of all options granted is the fair market value of the Company's common shares. Option activity is summarized as follows:
OUTSTANDING OPTIONS -------------------------- NUMBER PRICE PER OF SHARES SHARE Balances, January 1, 1993 851,002 $ .79-1.34 Granted 1,043,500 $1.89-6.34 Exercised (673,482) $ .75-3.90 --------- Balances, December 31, 1993 1,221,020 $ .76-6.34 Granted 1,096,000 $1.85-4.50 Exercised (453,764) $ .71-1.85 Canceled (120,813) $1.85-5.98 --------- Balances, December 31, 1994 1,742,443 $ .71-6.34 Granted 1,640,500 $2.34-6.31 Exercised (555,317) $ .73-3.66 Canceled (308,038) $1.89-6.13 --------- Balances, December 31, 1995 2,542,838 $ .72-6.34 ========= Options exercisable, December 31, 1995 819,813 $1.85-5.75 =========
On September 22, 1994, the Company amended the exercise price of 755,500 options (granted from $3.90 to $5.98) to $1.85 per share. On July 14, 1995, the Company issued 2,000,000 shares of common stock at $4.00 per share for gross proceeds of $8,000,000. In March and April 1996, warrants to purchase 1,875,000 shares of the Company's common stock were issued to bridge note holders and warrants to purchase 200,000 shares of the Company's common stock was issued to the bank (see Note 2). 11. BANK LINE OF CREDIT The Company has a revolving bank line of credit which was to expire April 15, 1996 to provide working capital borrowings of up to $5,000,000 to be made at the Company's option based on the bank's prime rate (10.25% at December 31, 1995). The agreement contains several F-20 73 restrictive covenants, including restrictions on the Company's ability to incur or guarantee indebtedness, enter into mergers or acquisitions, pay dividends or lease property. The agreement also requires the Company to maintain a minimum level of tangible net worth, limit capital expenditures and maintain certain defined ratios of cash flow, liquidity and leverage. Amounts outstanding under the revolving credit agreement are secured by substantially all of the Company's assets. At December 31, 1995, outstanding borrowings totalled $1,800,000. As part of the consideration for the original revolving credit facility, a warrant to purchase 100,000 shares of common stock at $2.80 per share, (the fair market value of the Company's common stock at March 10, 1995) was granted. The "Bank Warrant" was subject to certain trading restrictions and other conversion rights. Due to such conversion rights, administrative expenses in the second quarter of 1995 included a $395,000 expense related to the bank's notice to exercise its right to convert the Bank Warrant to cash, based upon the $6.75 per share fair market value of the Company's common stock at the notice date. On October 25, 1995 the Company paid the bank $428,750 in settlement of the Bank Warrant. The Company recorded an additional $33,750 of expense in the third quarter of 1995 related to this payment. As of December 31, 1995, the Company was in violation of several of the covenants under the agreement and in January 1996 the bank has ceased lending of additional funds to the Company. Effective April 2, 1996, the Company and the bank agreed to amend the present credit agreement; the credit facilities were extended to May 15, 1996. See further discussion at Note 2. 12. INCOME TAXES Deferred income taxes which result from temporary differences in the recognition of revenue and expense for tax and financial reporting purposes, consists of:
1995 1994 Reserves and accruals $ 3,397,000 298,000 Deferred development expenditures 321,000 321,000 Depreciation and amortization (105,000) (366,000) Operating loss carryforwards 9,246,000 5,244,000 Tax Credits 239,000 -- Valuation allowance (13,098,000) (5,497,000) ------------ ---------- Net deferred taxes $ -- $ -- ============ ==========
The Company has not recorded an income tax benefit due to the recording of a 100% valuation allowance against the deferred tax assets reflecting the uncertainty of the future realization of the deferred tax assets. In 1995, the valuation allowance was increased to continue to reflect a 100% valuation allowance. At December 31, 1995 the Company had approximately $14,000,000, $8,000,000, and $4,000,000 of net operating loss carryforwards to reduce future taxable income for foreign, federal and state purposes, respectively. If not utilized, these carryforwards expire beginning in the year 2000. F-21 74 13. MAJOR CUSTOMERS During 1995, the Company had sales to two customers that represented 16% and 11% of total net sales. In 1994 and 1993, persuant to a distribution agreement, the Company had sales to one customer, which represented 37% and 49% of total net sales, respectively. Such distribution agreement was terminated effective March 30, 1995. 14. RELATED PARTY TRANSACTIONS a. At December 31, 1995 and 1994 the Company has an unsecured loan receivable from an officer of the Company in the amount of $24,500, without interest. The amount is expected to be completely repaid by July 1996. The amount is included in accounts receivable. b. In 1993, professional fees of $305,830 were paid to a law firm. A partner of this law firm was also a director of the Company until January 1995. The director resigned from the law firm in June 1993. c. In 1993, the Company had a licensing agreement with a private company having a former director in common. The terms of the agreement require royalty payments based on units sold and sales volume and for office expenses. The Company paid $48,120 in royalties and $4,274 for office expenses during 1993. The director did not stand for reelection during 1993. 15. COMMITMENTS AND CONTINGENCIES a. Litigation -The Company, Presto Studios and others are defendants in a lawsuit filed by Quadra Interactive Inc., in San Diego Superior Court. Quadra Interactive previously contracted with Presto Studios to publish the original version of "The Journeyman Project," a title developed by Presto Studios and upgraded and released by the Company as part of its entertainment line of products. Quadra Interactive claims to have a continuing right to publish the title in certain platforms. The Company was named in the original Quadra complaint as a defendant only on causes of action contained in the complaint alleging conversion and unfair competition. That complaint seeks damages against the Company in excess of $1.5 million, and also seeks punitive damages against the Company in the amount of $5 million. Extensive discovery has now been conducted by both plaintiffs and defendants. Defendants, including the Company, filed motions for summary judgment on all causes of action in the original Quadra complaint. These motions were denied by the Court. Concurrently, the Court granted motions by Quadra to amend its complaint to state additional causes of action, and by Presto Studios to file an amended cross-complaint against Quadra. In connection with these motions, the Court granted Quadra's request to extend the time for the taking of discovery in the case to May 24, 1996, and set a new trial date of July 12, 1996. The Company has requested a defense and indemnification against all claims from Presto Studios pursuant to the publishing and distribution agreement between the Company and Presto Studios. Presto Studios has assumed the defense of the Company. The Company believes that it is entitled to indemnification from Presto Studios against the claims made in the lawsuit. The Company believes that the lawsuit, and all claims in the original and amended complaint are without merit and intends to vigorously defend the case. The Company tendered the case to its former insurance company for defense and coverage, F-22 75 which tender was refused. The Company has re-tendered the case and continues to believe that the Company is entitled to coverage under that policy. The Company may also be entitled to coverage under its current policy of insurance. If the case is adversely determined against the Company, and the Company is not indemnified by Presto, its former insurance company or its current insurance company, then the Company may be materially adversely affected. The Company is a party to various other claims, litigation and threatened litigation in the normal course of operations. Management believes, based upon the advice of counsel, that the ultimate resolution of all the litigation matters described above will not have a material adverse effect on the Company's financial statements taken as a whole. b. Lease Obligations - The Company leases its facilities and certain equipment under noncancellable operating lease agreements. In addition to rental payments, the Company is required to pay property taxes, insurance and normal maintenance costs for certain of its facilities. The lease terms include future rent increases based on inflation. The future minimum annual lease payments are as follows: 1996 $ 658,985 1997 782,260 1998 704,412 ---------- Total $2,145,657 ==========
Rent expense under operating leases totalled $494,711, $360,500, and $127,088 in 1995, 1994 and 1993, respectively. The Company also leased certain equipment under a capital lease in 1995. Future minimum annual lease principal payments are as follows: 1996 $ 29,626 1997 20,359 --------- Total 49,985 =========
F-23 76 16. SEGMENT INFORMATION
Consumer Publishers' Services Titles Consolidated Canada U.S. Totals Canada U.S. Total ------------ ------ ---- ------ ------ ---- ----- 1995 Sales $10,981,097 - $10,411,553 $10,411,553 $569,544 $569,544 Loss By Segment (14,943,723) $(3,661,154) (10,769,542) (14,430,696) (513,027) (513,027) Corporate 3,754,718 Net Loss (18,698,441) Identifiable Assets 5,688,788 1,142,870 4,360,597 5,503,467 185,321 185,321 Corporate 909,846 Total 6,598,634 Capital Expenditures 725,248 267,456 341,735 609,191 116,057 116,057 Corporate 233,035 Total 958,283 Depreciation Expense 744,234 531,953 146,747 678,700 65,534 65,534 Corporate 107,977 Total 852,211 1994 Sales $6,261,226 $5,771,923 $5,771,923 $73,668 $415,635 $489,303 Loss By Segment (5,387,719) $(2,892,493) (2,190,502) (5,082,995) (105,915) (198,809) (304,724) Corporate 2,016,717 Net Loss (7,404,436) Identifiable Assets 12,259,272 3,226,692 8,884,501 12,111,193 39,998 108,081 148,079 Corporate 590,142 Total 12,849,414 Capital Expenditures 1,510,348 936,509 510,809 1,447,318 - 63,030 63,030 Corporate 307,563 Total 1,817,911 Depreciation Expense 432,062 321,139 57,029 378,168 21,905 31,989 53,894 Corporate 97,574 Total 529,636 1993 Sales $1,424,971 $170,312 $579,583 $749,895 $367,484 $307,592 $ 675,076 Loss By Segment (2,703,926) (661,453) (1,980,891) (2,642,344) (107,487) 45,905 (61,582) Corporate 1,509,110 Interest Expense 8,533 Net Loss (4,221,569) Identifiable Assets 2,827,935 1,857,697 537,025 2,394,722 268,802 164,411 433,213 Corporate 241,055 Total 3,068,990 Capital Expenditures 669,505 504,212 53,055 557,267 78,633 33,605 112,238 Corporate 117,852 Total 787,357 Depreciation Expense 193,443 133,878 3,803 137,681 36,761 19,001 55,762 Corporate 43,123 Total 236,566
F-24 77 17. PERFORMANCE SHARES In October 1991, in connection with a private placement of 1,800,000 common shares to the Company's founders and principal stockholders, the Company issued an additional 4,000,000 common shares at CDN $0.01 per share as performance shares (the "Performance Shares") to certain of these individuals. These Performance Shares were issued pursuant to Local Policy #3-07 of the British Columbia Securities Commission ("BCSC") and policy 19 of the Vancouver Stock Exchange, which provide the guidelines for the issuance of performance shares. The Performance Shares are held in escrow to be released as the Company achieves positive operating cash flow on an annual basis as defined by the BCSC ("BCSC Operating Cash Flow"). The holder of Performance Shares will be entitled to a pro rata release from escrow on the basis of one share for every CDN $0.653 of positive BCSC Operating Cash Flow, subject to approval by the BCSC and the Vancouver Stock Exchange. Performance Shares are permitted to be released from escrow on an annual basis, and all of the Performance Shares will be released once CDN $2,612,000 of positive BCSC Operating Cash Flow has been generated by the Company. Through December 31, 1995, no Performance Shares have been earned or released. The Company will be required to recognize as compensation expense an amount equal to the difference between the CDN $0.01 per share originally paid for the Performance Shares and the market price of its common stock at the time such Performance Shares or pro rata portion thereof are earned. Such pro rata or full expense recognition will occur prior to the pro rata or full release from escrow of the Performance Shares. If and when such expense recognition criteria are achieved, based on the closing price of the Company's common stock at April 12, 1996, of $0.875 per share (for example purposes only), the aggregate compensation expense that would be recognized as a result would be approximately $3,460,000. Any compensation expense recognized related to the Performance Shares will be a noncash charge against income and will have no net impact on total stockholders' equity (deficit). If and when the Performance Shares are earned, the number of shares used to calculate net income (loss) per share will increase by the number of Performance Shares earned. F-25 78 SANCTUARY WOODS MULTIMEDIA CORPORATION QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31(1) YEAR ENDED FISCAL 1995 Net revenues $ 1,505,115 $ 2,058,870 $ 9,352,065 ($ 1,934,953) $ 10,981,097 Cost of sales 727,177 1,270,286 4,047,937 6,530,431 12,575,831 Gross (loss) margin 777,938 788,584 5,304,128 (8,465,384) (1,594,734) Operating expenses 3.676,581 4,031,338 4,405,099 4,976,817 17,089,835 Operating (loss) income (2,898,643) (3,242,754) 899,029 (13,442,201) (18,684,569) Net (loss) income (2,896,992) (3,262,300) 901,362 (13,440,511) (18,698,441) Net (loss) income per share $ (.18) $ (.21) $ .05 $ (.74) $ (1.11) Weighted average shares 15,739,957 15,837,356 19,171,452 18,123,179 16,873,748 FISCAL 1994 Net revenues $ 464,759 1,139,317 2,025,384 2,631,766 6,261,226 Cost of sales 260,433 473,714 1,044,765 1,278,456 3,057,368 Gross margin 204,326 665,603 980,619 1,353,310 3,203,858 Operating expenses 1,590,440 3,407,867 3,764,658 2,468,694 11,231,659 Operating loss (1,386,114) (2,742,264) (2,784,039) (1,115,384) (8,027,801) Net loss (782,515) (2,852,580) (2,876,533) (892,808) (7,404,436) Net loss per share $ (.06) $ (.22) $ (.19) $ (.06) $ (.53) Weighted average shares 12,074,968 13,108,638 14,951,076 15,183,735 13,993,675
(1) See Note 3 to the Consolidated Financial Statements for a discussion of significant fourth quarter 1995 charges F-26 79 SANCTUARY WOODS MULTIMEDIA CORPORATION SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS - - - --------------------------------------------------------------------------------
BALANCE AT CHARGED BALANCE AT BEGINNING TO WRITE-OFFS/ END OF PERIOD EXPENSE RETURNS OTHER OF PERIOD YEAR ENDED DECEMBER 31, 1995: Allowance for doubtful accounts $217,000 $ 118,967 $ (135,967) $ 200,000 Sales returns and allowances 414,275 8,168,460 (3,396,414) $ 241,915 5,428,236 Inventory obsolescence 298,723 1,083,389 (132,255) 268,143 1,518,000 YEAR ENDED DECEMBER 31, 1994: Allowance for doubtful accounts 65,000 203,035 (88,517) 37,482 217,000 Sales returns and allowances 242,018 459,814 (330,270) 42,713 414,275 Inventory obsolescence -- 298,723 -- -- 298,723 YEAR ENDED DECEMBER 31, 1993: Allowance for doubtful accounts 12,739 65,567 (13,306) -- 65,000 Sales returns and allowances -- 242,018 -- -- 242,018
F-27 80 Appendix B 81 SANCTUARY WOODS MULTIMEDIA CORPORATION STOCK OPTION PLAN I. PURPOSE The purpose of the Plan is to promote the interests of Sanctuary Woods Multimedia Corporation, a corporation duly incorporated under the laws of the Province of British Columbia ("Company"), its stockholders and its subsidiaries, by encouraging certain present and future key employees, directors and independent contractors of the Company and its subsidiaries, to purchase shares of common stock (no par value) of the Company ("Common Stock"), and to increase their personal and proprietary interest in the success of the Company, and to act as an incentive to continue their employment or association with the Company or its subsidiaries. It is further intended that options issued pursuant to this Plan shall constitute incentive stock options within the meaning of Section 422 of the Internal Revenue Code of 1986, as amended (the "Code"), or shall constitute non-qualified stock options as described in Treasury Regulation Section 1.83-7 to which Section 421 does not apply. II. ADMINISTRATION 2.1 The Plan should be administered by a committee, comprised of not less than two directors, to be appointed by the Board of Directors. The Board of Directors may, from time to time, at its sole discretion, remove members from, or add members to, the Committee. Vacancies on the Committee, however caused, shall be filled by the Board of Directors. The Committee shall select one of its members as Chairman, and shall hold meetings at such time and place as it determines advisable. A majority of the Committee shall constitute the quorum; and the acts of a majority of the members present at any meeting, or acts reduced to and approved in writing by a majority of the Committee, shall be valid acts of the Committee. With the exception of option grants to non-employee members of the Board of Directors which shall be made pursuant to the express terms and conditions of the Plan, the Committee shall have the sole power to grant options pursuant to the Plan, including the determination of the persons to whom options shall be granted, the times when they shall receive them, the option price of each option, and the number of shares to be subject to each option. 2.2 Incentive stock options granted pursuant to the Plan are intended to be "incentive stock options" within the meaning of Section 422 of the Code, and the interpretation by the Committee of any provision of the Plan or of any incentive stock option agreement entered into hereunder shall be in accordance with Section 422 of the Code and Regulations issued thereunder as such Section or Regulations may be amended from time to time, in order that the rights granted hereunder and under said option agreement shall constitute "incentive stock options" within the meaning of such Section. Non-qualified options granted pursuant to the Plan are intended to be nonqualified stock options described in Treasury Regulation Section 1.83-7 to which Section 421 of the Code does not apply, and the interpretation by the Committee of any provision of the Plan or of 82 any non-qualified stock option agreement entered into hereunder shall be in accordance with Treasury Regulation Section 1.83-7 as such Regulation may be amended from time to time, in order that the rights granted hereunder and under said option agreement shall constitute "non-qualified stock options" within the meaning of such Regulation. The Committee shall have the sole authority and power, subject to the express provisions and limitations of the Plan, to construe the Plan and option agreements granted thereunder, and to adopt, prescribe, amend, and rescind rules and regulations relating to the Plan, and to make all determinations necessary or advisable for administering the Plan. The interpretation and construction by the Committee of any provisions of the Plan or of any option granted thereunder shall be final and conclusive, unless otherwise determined by the Board of Directors. No member of the Board of Directors or the Committee shall be liable for any action or determination made in good faith with respect to the Plan or any option granted thereunder. 2.3 Notwithstanding any provision of this Article II to the contrary, the previously granted non-qualified stock options, which have been canceled by the Company subject to regrant under this Plan, shall be granted hereunder subject generally, in the case of each such option, to the same terms and conditions provided in the prior option agreement' to the extent such terms and conditions are not inconsistent with the express provisions and limitations of this Plan. 2.4 All options granted under the Plan shall be evidenced by written option agreements signed by an officer of the Company and the person receiving the option. Subject to the requirement that incentive stock options only be granted to employees of the Company, an optionee may be granted incentive stock options or non-qualified stock options or both under the Plan; provided, however, that the grant of incentive stock options and non-qualified stock options to an optionee shall be the grant of separate options and each incentive stock option and each non-qualified stock option shall be specifically designated as such in accordance with the applicable provisions of the Treasury Regulations. 2.5 The Committee shall report to the Board of Directors with respect to all acts taken by the Committee. III. ELIGIBLE PARTICIPANT 3.1 All directors, officers and other executive, managerial, and other employees of the Company or its subsidiary corporations, as such term is defined in Section 424(f) of the Code ("subsidiary corporations or subsidiaries"), shall be eligible to participate under the Plan with respect to both incentive stock options and non-qualified stock options, and all independent contractors rendering services to the Company or its subsidiaries shall be eligible to participate under the Plan with respect to non-qualified stock options only; provided, however, that no director of the Company or its subsidiaries shall be eligible to receive an incentive stock option unless, in addition to being a director, he is an employee of the Company or its subsidiaries in a class eligible to receive incentive stock options. 3.2 An individual may hold more than one option, and may be granted additional options from time to time, as the Committee may determine, but only on the terms and subject to the -2- 83 restrictions herein set forth. No person shall be eligible to receive an incentive stock option under the Plan if he directly or indirectly owns (within the meaning of Section 422(b)(6) of the Code) stock possessing more than 10% of the total combined voting power or value of all classes of stock of the Company or of its parent or any of its subsidiaries. This limitation shall not apply if at the time such incentive stock option is granted the option price is at least 110% of the fair market value of the stock subject to the option and such option by its terms is not exercisable alter the expiration of five years from the date such option is granted. 3.3 Notwithstanding any provision of the Plan to the contrary, each non-employee member of the Board of Directors shall be granted annually, as of the date he/she commences service as a director and as of each anniversary date thereafter, an option to purchase 25,000 shares of Common Stock. Further, each non-employee director shall be granted annually an additional option to purchase 10,000 shares of Common Stock for each Board committee on which he/she serves. The exercise price for each such option granted to a non-employee director shall be, in the case of an incentive stock option, equal to 100% of the fair market value of the shares covered by the option on the date of the grant, and in the case of a non-qualified stock option, equal to the applicable discount percentage (i.e., 85% or 90% of the fair market value of the covered shares on the date of the grant) as determined in accordance with the rules and regulations of the Vancouver Stock Exchange. Non-employee directors are not eligible for discretionary option grants under the Plan. IV. SHARES SUBJECT TO THE PLAN 4.1 Shares subject to the options will be shares of the Company's authorized but unissued Common Stock, or treasury shares reacquired by the Company or any combination thereof. 4.2 The aggregate number of shares of Common Stock of the Company which may be issued or delivered upon the exercise of all incentive stock options and non-qualified stock options granted under the Plan shall not exceed 1,970,000 shares, subject to adjustment as provided in Article VI hereof. The foregoing limit on the aggregate number of shares of Common Stock which may be issued under options pursuant to this Plan shall be inclusive of the total number of treasury shares reserved by the Company in accordance with the terms of the previously outstanding and unexercised non-qualified stock options which have been canceled by the Company, subject to regrant under this Plan. In the event any option granted under the Plan shall expire, terminate or be surrendered without having been exercised in full, the common shares of the Company for which such option or unexercised portion thereof were granted shall be available again for future grant of options pursuant to the Plan. 4.3 The aggregate number of shares of Common Stock which may be reserved for issuance to any one individual upon exercise of incentive stock options and/or non-qualified stock options granted under the Plan shall not exceed 5% of the Company's total issued shares of Common Stock at the date of grant. -3- 84 V. TERMS AND CONDITIONS OF OPTION 5.1 Each option shall state the number of shares of Common Stock to which it pertains, and shall state the option price, which price, in the case of an incentive stock option, shall not be less than 100% of the fair market value of such shares on the date on which the option was granted, and in the case of a non-qualified stock option, shall not be less than the applicable discount percentage (i.e. 85% or 90% of the fair market value of such shares on the date of the option grant) as determined in accordance with the rules and regulations of the Vancouver Stock Exchange. Subject to Section 3.3 and Section 5.2, the Committee shall exercise its best judgment in good faith in fixing the option price, shall have full authority and discretion to do so, and shall be fully protected in so doing. The option price shall be payable in United States dollars upon exercise of the option, and may be in cash, check or in such other manner as determined by the Committee in order to facilitate the exercise of the option. 5.2 The fair market value per share of Common Stock shall be determined by the Committee in accordance with the following provisions: A. If the Common Stock is traded on the NASDAQ Small Cap Market or the NASDAQ National Market System, the fair market value shall be the closing selling price per share on the date in question, as such price is reported by the National Association of Securities Dealers through the NASDAQ Small Cap Market or the NASDAQ National Market System, whichever is applicable. If there is no reported closing selling price for the Common Stock on the date in question, then the closing selling price on the last preceding date for which such quotation exists shall be determinative of fair market value. B. If the Common Stock is not at the time listed or admitted to trading on the NASDAQ Small Cap Market or the NASDAQ National Market System but is traded on the Vancouver Stock Exchange, the fair market value shall be the closing selling price per share on the date in question on such exchange. If there is no reported closing selling price for the Common Stock on the date in question, then the closing selling price on the last preceding date for which such quotation exists shall be determinative of fair market value. C. If the Common Stock is not at the time traded on the NASDAQ Small Cap Market, the NASDAQ National Market System or the Vancouver Stock Exchange, but is listed or admitted to trading on another national stock exchange, then the fair market value shall be the closing selling price per share on the date in question on the exchange determined by the Committee to be the primary market for the Common Stock, as such price is officially quoted in the composite tape of transactions on such exchange. If there is no reported sale of Common Stock on such exchange on the date in question, then the fair market value shall be the closing selling price on the exchange on the last preceding date for which such quotation exists. D. If the Common Stock is not at the time listed or admitted to trading on any national stock exchange and is not traded on the NASDAQ Small Cap Market or the NASDAQ -4- 85 National Market System, the fair market value on the date in question shall be determined in good faith by the Committee. 5.3 Notwithstanding Section 5.1, the aggregate fair market value (determined as of the time each respective incentive stock option is granted) of the stock with respect to which incentive stock options are exercisable for the first time by any optionee during any calendar year (under all plans of the Company and its parent and subsidiary corporations) shall not exceed the sum of $100,000. 5.4 The period of time within which an option may be exercised shall be determined in each case by the Committee, but shall in no event exceed ten years from the date of grant, at which time any unexercised option shall expire. Each option shall be exercisable in such installments, which need not be equal, upon such contingencies as the Committee shall determine; provided, however, that if an optionee shall not in any given installment period purchase all the shares which such optionee is entitled to purchase in such installment period, such optionee's right to purchase any shares not purchased in such installment period shall continue until expiration of such option. The Committee may at its discretion, subsequent to the grant of any option, accelerate the date on which any or all of the installments may become exercisable. No option may be exercised for a fraction of a share, but a cash payment in lieu of a fractional share may be made if appropriate in the event that options for fractional shares are created pursuant to any adjustment made under Article VI below. Options granted to directors and to executive officers who fall within the definition of "officer" under Rule 16a-1(f) promulgated under the Securities Exchange Act of 1934, as amended, must be held for a minimum period of six months from the date of their grant. 5.5 Except as provided in Section 5.6 below, an optionee may not exercise his/her incentive stock option unless he/she has been in the employ of the Company or one of its subsidiaries continuously during the period beginning on the date of the granting of the incentive stock option and ending on the day thirty days before the date of such exercise. Continuous employment shall not be deemed to be interrupted by transfers between subsidiaries or between parent and subsidiary, whether or not effected by termination from one entity or rehire by another: All employment with the Company and all subsidiaries shall be totaled and considered as one employment for purposes of this Plan, provided there is no such interval between employments, as, in the opinion of the Committee, shall be deemed to break continuity of service. The Committee shall in its discretion determine the effect of approved leaves of absence and all other matters affecting "continuous employment". 5.6 Subject to earlier expiration as provided in Section 5.4, above, if an optionee ceases to be employed by the Company or a subsidiary corporation (or, in the case of a non-qualified option, ceases to serve as a non-employee director or independent contractor of the Company or a subsidiary corporation) for any reason other than death or for cause, such optionee's option or options shall expire thirty days thereafter, and during such period alter such optionee ceases to be an employee (or director or independent contractor, if applicable), such option or options shall be exercisable only to the extent exercisable on the date on which the optionee ceased to be employed by the Company or such subsidiary corporation (or ceased to serve as a director or independent contractor, if applicable). -5- 86 5.7 If the optionee shall die while employed by the Company or any of its subsidiaries (or, in the case of a holder of a non-qualified option, while serving as a non-employee director or independent contractor of the Company or any of its subsidiaries), the option may (subject to earlier expiration under Section 5.4 above) be exercised within a period of not more than one year alter his/her death, and only by his/her personal representatives or persons to whom his/her rights under the option shall pass by will or the laws of descent and distribution. The option may be exercised only as to those shares of Common Stock with respect to which installments had accrued as of the date of death. No transfer of an option by the employee by will or by the laws of descent and distribution shall be effective, nor shall any designation of a person who may exercise the option alter the optionee's death be effective, to bind the Company unless the Company shall have been furnished with written notice thereof and a copy of the will and/or such other evidence as the Committee may deem necessary to establish the validity of the transfer and the acceptance by the transferee or transferees or designee of the terms and conditions of the option. 5.8 Subject to earlier expiration as provided in Section 5.4, above, in the event that an optionee's employment (or relationship, in the case of a non-employee director or independent contractor) with the Company or a subsidiary corporation is terminated by the Company for cause or by order of the Superintendent of Brokers for B.C., B.C. Securities Commission, Vancouver Stock Exchange or any securities regulatory body having jurisdiction to so order, such optionee's option or options shall immediately expire on the date of notice by the Company of such termination for cause. Cause for termination shall include the optionee's: (i) breach of fiduciary obligation to the Company, any of its subsidiaries or affiliates, or any customer, client or supplier of any of them; (ii) commission of any act or omission to perform any act which results or may, in the reasonable view of the Board of Directors, tend to result in serious adverse consequences to the Company, any of its subsidiaries or affiliates, or any client or supplier of any of them; (iii) gross neglect of duty; (iv) insubordination' (v) failure to follow the instructions of any of his/her supervisors or superiors; (vi) performance of illegal act related in any manner to his/her employment by and/or duties to the Company; (vii) conviction for any crime or act involving moral turpitude; (viii) unauthorized use or disclosure of confidential information or trade secrets of the Company or any of its subsidiaries or affiliates or (ix) breach of any of the Company's rules, policies and procedures. 5.9 No option granted under this Plan shall be transferable otherwise than by will (and in accordance with Section 5.7 hereof or the laws of descent and distribution and an option may be exercised, during the lifetime of the optionee, only by him/her. 5.10 An optionee or transferee of an option shall have no rights as a stockholder with respect to any shares of Common Stock covered by his/her option until the date of the issuance of a stock certificate to him/her for such shares. No adjustment shall be made for dividends (ordinary or extraordinary, whether in cash, securities or other property) or distributions or other rights for which the record date is prior to the date such stock certificate is issued, except as provided in Article VI below. 5.11 Subject to the terms and conditions and within the limitations of the Plan, the Committee may modify, extend or renew outstanding options granted under the Plan, or accept the -6- 87 surrender of outstanding options (to the extent not theretofore exercised) and authorize the granting of new options in substitution therefor (to the extent not theretofore exercised). The Committee shall not, however, modify any outstanding incentive stock options so as to specify a lower price or accept the surrender of outstanding options and authorize the granting of new options in substitution therefor specifying a lower price. 5.12 The option agreements authorized under the Plan shall contain such other provisions, including, without limitation, restrictions upon the exercise of the option, as the Committee shall deem advisable. Any incentive stock option agreement shall contain such limitations and restrictions upon the exercise of the option as shall be necessary in order that such option will be an "incentive stock option" as defined in Section 422 of the Code, or to conform to any change in the law. At the time of exercise of any option, the Committee may require the holder of such option to execute any documents or take any actions that may be then necessary to comply with the Securities Act of 1933 and the rules and regulations adopted thereunder, and any other applicable federal or state laws for the purpose of regulating the sale and issuance of securities, and the Committee may, if it deems necessary, include provisions in the stock option agreements to ensure such compliance. The Company may, from time to time, change its requirements with respect to enforcing compliance with federal and state securities laws including the request for and enforcement of letters of investment intent, such requirements all to be determined by the Company in its judgment as necessary to ensure compliance with said laws. Such changes may be made, with respect to any particular option or shares of Common Stock issued under exercise thereof, prior to or alter the exercise of such option. No shares shall be issued and delivered upon the exercise of an option unless such issuance, in the judgment of the Committee, is in full compliance with all applicable laws, governmental rules and regulations and undertakings of the Company made under the Securities Act of 1933 and stock exchange agreements of the Company. 5.13 As a condition to the exercise, in whole or in part, of any option, the Committee may in its sole discretion require the optionee to pay, m addition to the purchase price of the shares of Common Stock covered by the option, an amount equal to any federal, state and local taxes that may be required to be withheld in connection with the exercise of such option or the transfer of Common Stock pursuant to such exercise. VI. ADJUSTMENTS UPON CHANGES IN CAPITALIZATION 6.1 The aggregate number and class of shares as to which options may be granted under the Plan, the number and class of shares subject to each outstanding option, the price per share thereof (but not the total price), and the minimum number of shares as to which an option may be exercised at any one time, shall all be proportionately adjusted in the event of any change or increase or decrease in the number of the issued shares of Common Stock, without receipt of consideration by the Company, which results from a split-up or consolidation of shares, payment of a stock dividend, a recapitalization, a combination of shares or other like capital adjustment, so that upon exercise of the option the optionee shall receive the number and class of shares he/she would have received had he/she been the holder of the number of Common Shares for which the option is being exercised -7- 88 immediately before the effective date of such change or increase or decrease in the number of issued shares of Common Stock. 6.2 Subject to any required action by its stockholders, if the Company shall be the surviving corporation in any reorganization, merger or consolidation, the aggregate number and class of shares on which options may be granted under the Plan, together with each outstanding option, shall be proportionately adjusted so as to apply to the securities to which the holder of the number of shares of stock of the Company subject to the Plan or to any outstanding option would have been entitled. 6.3 Subject to the restrictions of Section 422(d) of the Code with respect to incentive stock options, in connection with (i) any tender offer for a majority of the outstanding shares of Stock by any person or entity other than an affiliate (as defined in Rule 405 promulgated under the Securities Act of 1933, as amended) of the Company; (ii) any proposed sale or conveyance of all or substantially all of the property and assets of the Company; or (iii) any proposed consolidation or merger of the Company with or into any other corporation, unless the Company is the surviving corporation, the Company shall give written notice to the holder of any option that such option may be exercised within a reasonable period alter the date of such notice (even though the option or portion thereof would not otherwise have been exercisable had the foregoing event not occurred). Upon consummation of the tender offer or proposed sale, conveyance, consolidation or merger to which such notice shall relate, all rights under said option which shall not have been so exercised shall terminate unless the agreement governing the transaction shall provide otherwise. 6.4 In the event of a change in the stock of the Company as presently constituted, which is limited to a change of all of its authorized shares with par value into the same number of shares with a different par value or without par value, or to a change of all of its authorized shares without which par value into the same number of shares with a par value, the shares resulting from any such change and shall be deemed to be the stock of the Company within the meaning of the Plan. 6.5 To the extent that the foregoing adjustments relate to stock or securities of the Company, such adjustment shall be made by the Committee, whose determination in that respect shall such be final, binding and conclusive, provided that each incentive stock option granted pursuant to this Plan shall not be adjusted in a manner that causes the incentive stock option to fail to continue to qualify as an incentive stock option within the meaning of Section 422 of the Code. No fractional shares of stock shall be issued under the Plan on account of any such adjustment. 6.6 The grant of an option pursuant to the Plan shall not affect in any way the right or does power of the Company to make adjustments, reclassifications, reorganizations or changes in its capital or business structure or to merge or to consolidate or to dissolve, liquidate or sell, or transfer all or native any part of its business or assets. -8- 89 VII. INDEMNIFICATION OF COMMITTEE In addition to such other rights of indemnification as they may have as directors or as members of the Committee, the members of the Committee shall be indemnified by the Company against the reasonable expenses, including attorneys' fees, actually and necessarily incurred in connection with the defense of any action, suitor proceeding, or in connection with any appeal therein, to which they or any of them may be a party by reason of any action taken or failure to act under or in connection with the Plan or any option granted thereunder, and against all amounts paid the or by them in settlement thereof (provided such settlement is approved by independent legal counsel selected by the Company) or paid by them in satisfaction of a judgement in any such action, suit or proceeding except in relation to matters as of which it shall be adjudged in such action, suit or proceeding that such Committee member is liable for negligence or misconduct in the performance of his duties; provided that within sixty days after institution of any such action, suit or proceeding a Committee member shall in writing offer the Company the opportunity, at its own expense, to handle of and defend the same. VIII. TERMS APPLICABLE TO INCENTIVE STOCK OPTIONS AND NON-QUALIFIED STOCK OPTIONS 8.1 The following terms and conditions shall also apply to the grant of incentive stock options under this Plan: A. The option shall cease to qualify for favorable tax treatment as an incentive stock option under the Federal tax laws if (and to the extent) the option is exercised for one or more shares of Common Stock: (i) more than three months after the date the optionee ceases to be an the employee for any reason other than death. B. If the option is to become exercisable in a series of installments as indicated in the option agreement, no such installment shall qualify for favorable tax treatment as an incentive stock option under the Federal tax laws if (and to the extent) the aggregate fair market value (determined at the grant date) of the Company's Common Stock for which such installment first becomes exercisable hereunder will, when added to the aggregate fair market value (determined as of the respective date or dates of grant) of the Common Stock or other securities for which such option or one or more other incentive stock options granted to the optionee prior to the grant date (whether under the plan or any other option plan of the Company or any parent or subsidiary), first become exercisable during the same calendar year, exceed One Hundred Thousand Dollars in the aggregate. Should the number of shares of Common Stock for which such option first becomes exercisable in any calendar year exceed the applicable One Hundred Thousand Dollar limitation, such option may nevertheless be exercised for those excess shares in such calendar year as a non-qualified option. C. Should the exercisability of the option be accelerated upon a corporate transaction in accordance with Section 6.3, then such option shall qualify for favorable tax treatment as an incentive stock option under the Federal tax laws only to the extent the aggregate fair market value (determined at the grant date) of the Company's Common Stock for which such option first becomes exercisable in the calendar year in which the corporate transaction occurs does not, when -9- 90 added to the aggregate fair market value (determined as of the respective date or dates of grant) of the Common Stock or other securities for which such option or one or more other incentive stock options granted to the optionee prior to the grant date (whether under the Plan or any other option plan of the Company or any parent or subsidiary) first become exercisable during the same calendar year, exceed One Hundred thousand Dollars in the aggregate. Should the number of shares of Common Stock for which such option first becomes exercisable in the calendar year of such corporate transaction exceed the applicable One Hundred thousand Dollar limitation, the option may nevertheless be exercised for the excess shares in such calendar year as a non-qualified stock option. D. Should the optionee hold, in addition to the foregoing option, one or more other options to purchase Common Stock which become exercisable for the first time in the same calendar year as such option, then the foregoing limitations on the exercisability of such options as incentive stock options under the Federal tax laws shall be applied on the basis of the order in which such options are granted. E. Notwithstanding the designation of an option as an incentive stock option in the option agreement, an option shall not qualify as an incentive under the Federal tax laws if the Optionee directly or indirectly owns (within the meaning of Section 422(b)(6) of the Code) stock possessing more than 10% of the total combined voting power or value of all classes of stock of the Company or its parent corporation or any of its subsidiary corporations, unless the option price is at least 110% of the fair market value per share of Common Stock subject to such option on the grant date and the expiration date is no later than five years after the grant date. F. To the extent an option should fail to qualify as an incentive stock option under the Federal tax laws, the Optionee will recognize compensation income in connection with the acquisition of one or more shares of Common Stock subject thereto, and the optionee must make appropriate arrangements for the satisfaction of all Federal, state or local income and employment tax withholding requirements applicable to such compensation income. 8.2 In the event an option is designated a non-qualified stock option in the option agreement, the optionee shall make appropriate arrangements with the Company (or any parent or subsidiary employing the optionee) for the satisfaction of all Federal, state or local income tax and employment tax withholding requirements applicable to the exercise of such option. IX. TERMINATION AND AMENDMENT OF THE PLAN 9.1 The term during which options may be granted under this Plan shall expire on May 24, 2005. 9.2 The Board of Directors of the corporation may, insofar as permitted by law, from time to time, with respect to any shares at the time not subject to options, suspend or discontinue the Plan or revise or amend it in any respect whatsoever except that, without approval of the stockholders, no such revision or amendment shall (a) change the designation of the class of employees eligible to receive incentive stock options and/or options under the Plan in general, (b) materially increase the -10- 91 total number of shares for which incentive stock options may be granted under the Plan, (c) extend the term of the Plan or the maximum option period thereunder, (d) decrease the minimum option price or permit or make reduction of the price at which shares may be purchased under any option granted under the Plan, except as provided in Article VI above, or (e) otherwise materially increase the benefits and/or rights accruing to individuals participating under the Plan. Further, the specific provisions of the Plan which address the grant of options to non-employee members of the Board of Directors shall not be amended more than once each six months, except to the extent necessary to comply with changes in the Code and/or the regulations thereunder. No termination or amendment to this Plan may, without the consent of an optionee, terminate his option or materially or adversely affect his rights under any outstanding options. 9.3 Amendments to the Plan are subject to the approval of the Vancouver Stock Exchange and, if an individual participating in Plan is an "insider" (as that term is defined in the securities Act, S.B.C. 1985, c.83 as amended) of the Company, by the members of the Company. X. APPLICATION OF FUNDS The proceeds received by the Company from the sale of Common Stock pursuant to options will be used for general corporate purposes. XI. APPROVAL OF STOCKHOLDERS This Plan is effective as of the date of adoption by the Board of Directors (or the date the Plan received stockholder approval, if earlier) but is subject to the approval of the Vancouver Stock Exchange and, if an individual participating in Plan is an insider of the Company, by the members of the Company and the approval of the holders of a majority of the outstanding shares of the stock of the Company, which approval must occur no later than one year after the date of the adoption of this Plan by the Company's Board of Directors. Date Plan Adopted by Board of Directors: May 25, 1995 Date Plan Approved by Stockholders: May 25, 1995 -11- 92 THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS OF SANCTUARY WOODS MULTIMEDIA CORPORATION 1996 ANNUAL MEETING OF SHAREHOLDERS [September 13, 1996] The undersigned shareholder of Sanctuary Woods Multimedia Corporation, a British Columbia corporation, hereby acknowledges receipt of the Notice of Annual Meeting of Shareholders and Proxy Statement and Information Circular, each dated _______________, 1996, and hereby appoints [ ] and [ ], or either of them, proxies and attorneys-in-fact, with full power to each of substitution, on behalf and in the name of the undersigned, to represent the undersigned at the 1996 Annual Meeting of Shareholders of Sanctuary Woods Multimedia Corporation to be held on September 13, 1996 at 10:00 a.m., Pacific time, at __________________________________________, and at any adjournment(s) thereof and to vote all shares of Common Stock which the undersigned would be entitled to vote if then and there personally present, on the matters set forth below: 1. PROPOSAL TO FIX THE NUMBER OF DIRECTORS FOR THE ENSUING YEAR. __ FOR __ AGAINST __ ABSTAIN 2. ELECTION OF DIRECTORS: __ FOR all nominees listed below (except as indicated). __ WITHHOLD authority to vote for all nominees listed below IF YOU WISH TO WITHHOLD AUTHORITY TO VOTE FOR ANY INDIVIDUAL NOMINEE(S), STRIKE A LINE THROUGH THAT NOMINEE'S NAME IN THE LIST BELOW: N. John Campbell Charlotte J. Walker Grant N. Russell 3. PROPOSAL TO RATIFY THE APPOINTMENT OF DELOITTE & TOUCHE AS THE INDEPENDENT AUDITORS: __ FOR __ AGAINST __ ABSTAIN 4. PROPOSAL TO APPROVE THE AMENDMENTS TO THE COMPANY'S 1995 STOCK OPTION PLAN: __ FOR __ AGAINST __ ABSTAIN 93 5. PROPOSAL TO EFFECT A ONE-FOR-THREE SHARE CONSOLIDATION OF THE COMPANY'S COMMON STOCK. __ FOR __ AGAINST __ ABSTAIN 6. PROPOSAL TO ALTER THE COMPANY'S SHARE CAPITAL TO CREATE A CLASS OF PREFERRED SHARES. __ FOR __ AGAINST __ ABSTAIN and, in their discretion, upon such other matter or matters which may properly come before the meeting and any adjournment(s) thereof. THIS PROXY WILL BE VOTED AS DIRECTED OR, IF NO CONTRARY DIRECTION IS INDICATED, WILL BE VOTED FOR THE ELECTION OF DIRECTORS, AND FOR APPROVAL OF EACH OF THE PROPOSALS SET FORTH ABOVE, AND AS SAID PROXIES DEEM ADVISABLE ON SUCH OTHER MATTERS AS MAY COME BEFORE THE MEETING AND ANY ADJOURNMENT(S) THEREOF. Dated:_______________, 1996 _______________________ Signature __________________________________ Signature (This Proxy should be marked, dated, signed by the shareholder(s) exactly as his or her name appears hereon, and returned promptly in the enclosed envelope. Persons signing in a fiduciary capacity should so indicate. If shares are held by joint tenants or as community property, both should sign.) -----END PRIVACY-ENHANCED MESSAGE-----