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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
_________
FORM 10-K
_________
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED]
For the fiscal year ended December 31, 1996
COMMISSION FILE NUMBER 1-11460
NTN COMMUNICATIONS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 31-1103425
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
5966 LA PLACE COURT, CARLSBAD, CALIFORNIA 92008
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(760) 438-7400
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
COMMON STOCK, $.005 PAR VALUE
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
filing requirements for the past 90 days.
YES [X] NO [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulations S-K ((S) 229.405 of this Chapter) is not contained herein and
will not be contained, to the best of Registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K [_]
The aggregate market value of the voting stock held by non-affiliates of
Registrant as of April 10, 1997, computed by reference to the closing sale price
of such stock on the American Stock Exchange, was approximately $97,000,000.
(All directors and executive officers of Registrant are considered affiliates.)
At April 10, 1997 Registrant had 23,265,000 shares of Common Stock, $.005
par value, issued and outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of Registrant's Annual Report to Shareholders for the period ended
December 31, 1996 are incorporated by reference into Part I of this Report.
Portions of Registrant's definitive Proxy Statement for its August 1997 meeting
of stockholders are incorporated by reference into Part III of this Report.
1
TABLE OF CONTENTS
Item Page
Part I
1. Business 3
2. Properties 18
3. Legal Proceedings 19
4. Submission of Matters to a Vote of Security Holders 20
Part II
5. Market for Registrant's Common Equity and Related Stockholder 20
Matters
6. Selected Financial Data 21
7. Management's Discussion and Analysis of Financial Condition 22
and Results of Operations
8. Consolidated Financial Statements and Supplementary Data 30
9. Changes in and Disagreements with Accountants on Accounting 30
and Financial Disclosure
Part III
10. Directors and Executive Officers of the Registrant 30
11. Executive Compensation 30
12. Security Ownership of Certain Beneficial Owners and Management 30
13. Certain Relationships and Related Transactions 30
Part IV
14. Exhibits, Consolidated Financial Statement Schedule, and 31
Reports on Form 8-K
Index to Consolidated Financial Statements and Schedule F-1
2
PART I
ITEM 1. BUSINESS
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FORMATION
NTN Communications, Inc. ("NTN" or the "Company") was originally
incorporated in the State of Delaware on April 13, 1984 under the name of Alroy
Industries. Alroy completed a public offering of its common stock on November
26, 1984. On April 15, 1985, Alroy acquired all of the outstanding stock of
National Telecommunicator Network, Inc. In connection with the acquisition,
Alroy changed its name to NTN Communications, Inc.
In 1993, NTN completed a merger with New World Computing, Inc. ("New
World") pursuant to which New World became a wholly-owned subsidiary of NTN. In
1996, the Company sold all the assets of New World. At December 31, 1996, the
New World subsidiary had no remaining assets and was not engaged in any business
activities.
In 1994, the Company formed LearnStar, Inc. ("LearnStar"). In 1995, the
Company reacquired the shares of LearnStar, Inc. held by others to increase its
ownership in LearnStar to 100%. In December, 1995, the Company entered into an
agreement to sell a 45% interest in LearnStar to Associated Ventures Management,
Inc. ("Associated Ventures"). In September 1996, the Company and Associated
Ventures agreed to rescind the agreement. Accordingly, LearnStar once again
became a wholly-owned subsidiary of NTN.
In 1994, the Company also formed IWN, Inc. ("IWN"), which serves as the
general partner in IWN L.P., a limited partnership engaged in the development of
interactive technology for gaming applications. IWN has no business or
operations apart from its service as a general partner of IWN L.P.
Unless otherwise indicated, references herein to "NTN" or the "Company"
include NTN and its consolidated subsidiaries, New World, LearnStar, IWN Inc.
and IWN L.P.
RECENT DEVELOPMENTS
On March 5, 1997, the Company announced a reorganization of its executive
management personnel in which Patrick J. Downs resigned as Chief Executive
Officer and Chairman of the Board, and Daniel C. Downs resigned as President.
Both men continue to serve on NTN's Board of Directors. In connection with the
reorganization, other personnel changes included the resignation of Mr. Ronald
Hogan as Senior Vice President and the terminations of Mr. Gerald McLaughlin,
formerly Executive Vice President, and Mr. Michael Downs, formerly President and
CEO of LearnStar. The Company has entered into separate agreements with each of
the former officers setting out the terms on which their existing contracts with
NTN will be settled. See Item 7 - "Management's Discussion and Analysis of
Financial Condition and Results of Operations" for additional information, which
is incorporated herein by reference.
Concurrent with the reorganization, Mr. Gerald Sokol, Jr., Chief Operating
Officer and Chief Financial Officer was named President of the Company. Mr. Ed
Frazier, a director of NTN, has assumed the role of acting Chairman of the
Board. Further, the Company announced the formation of an Executive Committee
comprised of Mr. Frazier, who is a former President of Liberty Sports, Inc. and
Mr. Peter Sealey, a former Senior Vice President for the Coca-Cola Company. The
Executive Committee is responsible for developing operational, advertising and
market strategies, as well as revising the strategic plan and developing new
business opportunities for the Company.
A discussion of the general development of the Company for the fiscal year
ended December 31, 1996 is set forth in the letter to the Company's shareholders
contained in the Company's Annual Report to Shareholders and is incorporated
herein by reference. A copy of the Annual Report to Shareholders is included as
Exhibit 13 to this Report.
PRINCIPAL SERVICES AND PRODUCTS
3
NTN through its business units and subsidiaries, develops, produces and
distributes individual and multi-player interactive programs to a variety of
media platforms. These interactive sports, trivia games and educational
programs permit multiple viewers to participate with and simultaneously respond
to the programming content. NTN has an exclusive licensing agreement with the
National Football League ("NFL") and understandings or agreements with others to
provide interactive play-along programming, such as its proprietary QB1(R)
football game, in conjunction with live television events. The Company
broadcasts a wide variety of popular games, trivia and informational programming
to group viewing locations such as hotels, sports taverns and restaurants
through its own interactive NTN Network. In addition, NTN brings multi-player
interactive games into consumer households through personal computer on-line
services and interactive television services. NTN currently has two patents
pending with respect to its interactive technology systems. Since NTN
distributes its programs via satellite, cable, telephone and wireless
transmission technologies, its applications are independent of hardware or
technical platforms.
The Company currently provides its products and services to markets which
are in various stages of development. Each is directly related to multi-player
interactive entertainment and education programs, and are as follows:
Network Services ("Network Services", formerly referred to as
"Hospitality") - Live interactive television network ("NTN Network") featuring
sports and trivia games which are broadcast to group environments.
Online/Internet Services (Online/Internet Services", formerly referred to
as "Home") - Live interactive sports and trivia games including those currently
broadcast over the NTN Network to the home consumer market via third-party
providers, such as America On-Line, CompuServe and GTE MainStreet.
LearnStar ("LearnStar") - An interactive, multimedia, curriculum-based
educational system marketed to educational institutions. Marketed through its
wholly-owned subsidiary, LearnStar, Inc.
IWN ("IWN") - IWN is a general partner in a limited partnership that is
currently developing, interactive and transaction processing software and
technology for the gaming industry.
Although the Company has historically derived revenues from licensing it
services to companies in foreign countries ("International Licensing"), there
were no material revenues from this source in 1996. No assurances can be given
that future revenues will be received from this source.
The following is a brief description of each:
NETWORK SERVICES - Network Services represents the majority of the
Company's business, providing a 24-hour-a-day interactive television broadcast
network featuring sports, trivia and informational programming to over 2,600
hospitality sites in the U.S. and 540 sites in Canada. These sites include
restaurant chains (e.g., TGI Friday's, Ruby Tuesdays, Black Angus), national
hotel chains (e.g., Hilton, Holiday Inn, Marriott, Radisson, Sheraton), local
and regional bowling alleys, pizzerias, sports complexes, taverns and military
bases. Through various platforms including satellite, cable and wireless
transmission sources, Network Services can link its subscribers to encourage
local, regional and national competitions for its programming.
ONLINE/INTERNET SERVICES - The Company provides to the home consumer market
many of the same services as Network Services, via on-line, cable delivery and
internet services. Online/Internet Services is not dependent on any particular
technology or method of transmission to deliver its programming. In addition to
the same sports and trivia games which are currently broadcast over the NTN
Network, Online/Internet Services includes other multi-player interactive games
expressly designed for the home environment. For example, through an agreement
with America Online ("AOL"), NTN launched Trivial Pursuit Interactive in May
1996. Currently, revenues are derived from 1) play-along services, in which NTN
services are broadcast along with live events generating subscription fees from
interactive game participation, or "pay-per-play", and 2) information services,
where NTN's database is provided as a value-added information service to
subscribers who want statistical data. Customers include CompuServe, GTE
MainStreet and Bell Canada.
LEARNSTAR - The LearnStar product is provided to educational institutions
in the United States using NTN's proprietary software technology. With a
comprehensive library of over 1,000 interactive academic competitions
4
covering many subject areas, LearnStar offers teachers a new and exciting way to
encourage learning and motivation in kindergarten through 12th grade students.
IWN - IWN, was established in 1994 to develop, distribute and market
interactive and transaction services for the gaming industry. IWN is developing
the software and technology for use in gaming applications. IWN is currently
focusing on pari-mutuel wagering and sports betting. The Company has developed
the IWN Gaming Host System ("Gaming Host System"), an on-line transaction
processing engine that provides security, administration, processing and
switching services. The Gaming Host System is designed to provide the back-end
system and support for all of IWN's products, regardless of market niche
application or technical platform.
INTERNATIONAL LICENSING - The Company has licensed independent companies to
broadcast in Australia/New Zealand and South Africa. Its exclusive licensees,
NTN Australasia, Ltd. and MultiChoice, Ltd., operate broadcast centers in
Australia/New Zealand, and South Africa, respectively. Further, the Company
licenses its programs and software to NTN Interactive Network, a company located
in Canada. Licensees, except in Canada, operate their own broadcast center and
produce interactive programs specifically geared to the local culture and
society. The Canadian licensee uses the broadcast provided by the Company on
the NTN Network.
MARKETING AND DISTRIBUTION OF SERVICES AND PRODUCTS
NETWORK SERVICES. Network Services is provided via the NTN Network. The
NTN Network is currently marketed primarily to public viewing locations such as
restaurant chains (e.g., TGI Friday's, Ruby Tuesdays, Black Angus), national
hotel chains (e.g., Hilton, Holiday Inn, Marriott, Radisson, Sheraton), local
and regional bowling alleys, pizzerias, sports complexes, sports taverns and
military bases ("Locations"). The NTN Network serves over 2,600 locations
throughout all 50 of the United States and over 540 sites in Canada. Locations
in Canada are further serviced and marketed to by the Company's independent
licensee, NTN Interactive Network ("NTN Canada").
The NTN Network presently features from 14 hours to 17 hours, depending on
the time zone, of interactive sports and entertainment trivia game programming
on weekdays, with extended programming hours on weekends. The balance of
broadcast time is devoted to a non-audible graphics-based service transmitting
information, including sports scores and upcoming program promotions.
Original programming for the NTN Network is developed and produced at the
Company's corporate offices in Carlsbad, California, for distribution to
Locations. The Company's facilities are equipped with video, satellite and
communications equipment, and multimedia computers. The Company can provide
simultaneous transmission of up to 16 live events for interactive play and a
multitude of interactive games and other programs, allowing distribution of
different programs to customers in different geographical locations.
The Company uses two independent services to distribute NTN programming via
satellite to customers, although it is not dependent upon either service because
there are several other providers that offer similar services. The Company
attempts to use the most effective and least expensive multiple data
transmission techniques to distribute data from the Company's facilities to
customers, including direct connect, internet transmission, and direct satellite
broadcast.
Each Location receives NTN proprietary equipment (a "Location System")
including a personal computer, a satellite data receiving unit (usually a small
satellite dish), and a minimum of ten hand-held, portable keypads
("Playmakers(R)") which players use to make their selections. During live
interactive programs, players participate in the play-along programs using two
television screens. One screen features the live broadcast from the television
network (e.g., ABC's Monday Night Football), while the second screen displays
the NTN Network program. Participants play the game by entering their selection
on Playmakers(R), which transmit a radio signal to the on-site computer or
through connection to the NTN broadcast center (the "Broadcast Center") in
Carlsbad, California. At the conclusion of the broadcast, total scores are
calculated and sent via phone lines. Within seconds, rankings are tabulated and
rankings and scores at each participating Location are transmitted back to such
Location via the NTN Network. This allows players to compete not only with
other patrons at their Location, but against all players across the nation who
are participating interactively on the Network. The following diagram depicts
the transmissions for a typical real-time, interactive game via satellite.
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[NTN BROADCAST CENTER GRAPH APPEARS HERE]
In addition to tabulating Playmaker(R) responses at the Location and
communicating with the Company's Broadcast Center, the Location System can
manipulate screens locally by calling up high-resolution computer generated
graphics and inserting the screens into the broadcast schedule. Accordingly, the
Company offers both national and local advertising.
Interactive Sports Game Programs. Network Services offers a variety of
--------------------------------
sports and entertainment trivia games that challenge players' skill and
knowledge and create significant customer loyalty. An example of interactive
sports programming is QB1(R), the Company's first and most renowned game
program. QB1(R) is an interactive football strategy game exclusively licensed
by the NFL, which tests a player's ability to predict an offensive team's plays
during a live televised football game. Points are awarded based on the accuracy
of the player's prediction, rather than whether the team scores or advances the
ball. The Company broadcasts QB1(R) in conjunction with every NFL game and
selected Canadian Football League and college football games.
The NTN Network presently features the following interactive sports games
programs:
6
NTN PLAY-ALONG GAMES - Interactive games played in conjunction with live,
televised events. Games include the following:
GAME DESCRIPTION
---- -----------
QB1(R) NFL licensed interactive strategy game in
conjunction with live telecasts of college and
professional football games
NTN DiamondBall(R) Major League Baseball licensed interactive
strategy game in conjunction with live telecasts
of professional baseball games
Triples(R) Interactive horse racing game in conjunction
with live telecasts of horse races
Uppercut(R) Interactive strategy game in conjunction with
live telecasts of boxing matches
NTN PowerPlay(R) National Hockey League licensed interactive
strategy game in conjunction with live telecasts
of professional hockey games
NTN FANTASY GAMES - Fantasy league games that are played in conjunction
with sporting events or rotisserie leagues. Games include the following:
GAME DESCRIPTION
---- -----------
Brackets(TM) Basketball or hockey tournament prediction game
Dream Team Baseball(TM) Managing a professional all-star baseball team
Football Challenge(TM) Weekly selection of winners of college and
professional football games
Football Fantasy(TM) Managing a professional all-star football team
Hockey Draft(TM) Managing a professional all-star hockey team
Hoops(R) Managing a professional all-star basketball team
Survivor(R) Weekly single elimination prediction game for
professional football
Oddsmaker Challenge(TM) Weekly selection of winners of various sporting
events
INTERACTIVE TRIVIA GAME PROGRAMS. During trivia game programs, each
Location System simultaneously displays selected trivia questions which are
displayed on the NTN television monitor at each Location. Participants use the
Playmaker(R) to select answers, which are collected, transmitted and tabulated
in a similar manner to NTN's interactive sports games. Participants' scores are
displayed on the dedicated television monitors, along with national, regional
and local rankings, as applicable.
While certain of the Company's sports games are available only during the
seasons when the respective sports are played, trivia game programs allow the
Company to offer year-round interactive programming. The NTN Network generally
provides the trivia programming during evening hours, when Locations,
particularly restaurants
7
and taverns, tend to be busiest. Currently, the Company broadcasts between 14
and 17 hours of interactive programs per day. The NTN Network presently
features the following interactive trivia games programs:
NTN PREMIUM TRIVIA GAMES - Promotion-oriented weekly game shows that
generally require 1-2 hours of participation. Prizes are awarded to the top
finishers, except where prohibited by law. Games include the following:
GAME DESCRIPTION
---- -----------
Trivial Pursuit(R) Interactive version of the famous Trivial
Pursuit game - licensed from Hasbro Interactive.
Playback(TM) Music trivia
Showdown(R) Advanced trivia challenge
SportsIQ(TM) Weekly sports trivia game
Sports Trivia Challenge(R) Advanced sports trivia covering multiple topics
Spotlight(TM) Entertainment and media based trivia game
(movies, music)
NTN TRIVIA GAMES - General-themed, standard games typically one-half hour
in length. Games include the following:
GAME DESCRIPTION
---- -----------
Brain Buster(R) Interactive trivia game covering esoteric topics
Countdown(R) Interactive trivia game using word plays
Topix(TM) Theme driven trivia game played under controlled
timing
Wipeout(TM) Interactive trivia game eliminating incorrect
answers
Nightside(R) Adult oriented trivia
Sports Trivia(R) General trivia game covering sports topics
Viewer's Review(R) Audience-supplied content trivia game
Retroactive(TM) Pop-culture trivia with 60's, 70's and 80's
content
Football Weekend Roundup(TM) Football trivia game
CUSTOM GAMES - Interactive games created specifically for media companies
such as Capital Cities/ABC for simultaneous broadcast with their live telecasts.
GAME DESCRIPTION
---- -----------
NTN Awards Show(TM) Interactive game played in conjunction with the
Academy Awards, Grammy Awards and other award
shows
NTN Draft Show(TM) Interactive game played in conjunction with the
annual NFL draft
8
Since 1987, Network Services has broadcast the NTN Awards Show(TM) to all
sites in connection with the live Academy Awards telecast. The NTN Awards
Show(TM) contains movie trivia and biographical information on nominees and
allows players to select winners up to the actual announcement and compete with
other players via the NTN Network, in a manner similar to QB1(R).
Information Programming. During the hours in which the Company is not
-----------------------
broadcasting interactive games, the Company uses its broadcast network to
transmit sports information as well as NTN Network programming information. The
Company obtains the majority of its sports information (for which it pays a
monthly fee) from Sportsticker wire service, electronically formats the
information and then retransmits it for broadcast to Locations.
Advertising. The NTN Network operates in a manner similar to the
-----------
television broadcast medium in that a number of minutes of a broadcast hour are
set aside for advertising, promotional spots (promoting NTN Network's
competitions and special events), "tune-in spots" (promoting NTN Network
programming schedule), and public service announcements.
The Company has currently set aside fourteen minutes each hour for
advertising, promotional spots and "tune-in spots." Each of the spots are
designed to be fifteen seconds in length for a total of 56 spots per hour. The
Company can insert advertising messages into its interactive sports and trivia
programming at any number of Locations. Further, messages can be broadcast over
the NTN Network or custom-tailored for a specific Location or several Locations.
The Company sells advertising in blocks of two-fifteen second ad spots per
hour for a total of fourteen hours per day. Further, programming content has
been innovatively blended with the advertiser's logo and message. For example,
the Miller Lite Countdown(R) and Cuervo 1800 Countdown(R) Shows provide 30
minutes of commercial exposure to Miller and Cuervo products. Sponsorships of
programs are also available and provide advertisers with specific premium
exposure within a sponsored program.
Advertisers are also given the opportunity to communicate directly with the
NTN Network's Players Plus(R) ("Players Plus") members, numbering over
1,000,000. Players Plus is a frequent player club which members join by
entering their name, address, zip code and identification number into a
Playmaker(R), which is then captured at the Broadcast Center. A member earns
points each time they play and also a chance to win prizes in the monthly
Players Plus sweepstakes. Sponsors are capable of receiving feedback through
interaction with customers in the form of customer surveys.
Interactive Programming Under Development. The Company is continuing to
-----------------------------------------
develop and market-test other interactive game programs. These include
interactive programming in conjunction with live broadcasts of other sports
events and award shows, as well as additional trivia and stand-alone interactive
games. The Company is also developing interactive games for broadcast with
television game shows, allowing NTN Network viewers to play a televised game
show simultaneously with studio contestants.
ONLINE/INTERNET SERVICES. The Company provides many of the same services
and programs as seen on the NTN Network to the home consumer market via
Online/Internet Services. Online/Internet Services includes multi-player
interactive games, which have already garnered brand recognition via the NTN
Network, into the consumers' households through personal computer on-line
services and interactive television services. In addition, Online/Internet
Services includes other multi-player interactive games designed expressly for
the home environment. The Company offers the games to end users via third party
networks such as America Online and GTE MainStreet. Revenues received include
development fees and monthly broadcast revenues based upon usage and certain
minimum guarantees from these third-party networks. The end-user does not pay
NTN directly, but pays the online service provider who is responsible for paying
the Company.
The current focus of home distribution is via on-line services, such as
AOL, where a substantial customer base already exists. The Company's
interactive sports and trivia games are available on-line 24 hours a day, seven
days a week. The Company distributes games through PC on-line services in
return for a share of the customer revenue in excess of a minimum monthly fee.
The end-user purchases services from a distributor such as AOL who, in turn,
pays NTN.
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Most of the interactive sports and trivia games currently broadcast over
the NTN Network are also available directly to consumers in their homes through
a variety of media, including computer on-line services and interactive
television (ITV) networks. The Company's Online/Internet Services are unique
since the programs are not dependent upon, and consequently not bound by, any
particular technology or method of transmission. Regardless of which technology
emerges as the primary means of transmission on the "information highway",
management believes its programming content will be available to the household.
The Company also assists other companies in providing content and programs
via content distributors. For a share of the revenue generated by consumer use,
the Company provides program translation services and maintains the programs on
its servers.
Online/Internet Services are distributed to on-line and ITV networks, also
known as content distributors. These games, in turn, are made available to
their customer base for a fee. The diagram below depicts the transmissions
necessary for a consumer to use the Company's service in his or her home.
[NTN BROADCAST CENTER GRAPH APPEARS HERE]
LEARNSTAR. The LearnStar teaching system (the "LearnStar System") was
developed as a natural extension of the NTN Network and its entertainment
applications. The LearnStar System is targeted at schools and teachers who are
seeking an educational tool to increase student interest in learning via
interactive competitions in the classroom.
The LearnStar System enables a school to evaluate the academic proficiency
of the students, while creating an enjoyable environment in which students seem
more apt to participate. Using similar technology to that used for the NTN
Network, the LearnStar interactive learning system can conduct academic
competitions, collect data for surveys and provides local, regional and national
testing capabilities. All of these services can be utilized within a single
classroom, at one distinct site, or at multiple schools throughout the country,
all with instantaneous feedback.
Students test their comprehension of material by viewing an academic
competition on a television screen, then answer questions interactively via
hand-held keypads that broadcast signals to and from the LearnStar System. The
questions are posed in a multiple choice format, similar to the nationally
administered Scholastic Aptitude Test. Many competitions feature full-motion
video, colorful graphics and sound. Students work individually or in teams to
answer
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the questions, with scores and team rankings displayed on the television screen
after each question. The LearnStar System offers flexibility - it can be
utilized as a stand-alone resource, moving on a portable cart from classroom to
classroom for use by the entire school, or the LearnStar System can be linked
via satellite on the NTN Network for live national competitions with schools
throughout the US. The LearnStar System includes a dedicated computer control
system with a Pentium processor, CD-ROM unit, proprietary software, printer,
satellite dish, receiver, wireless keypad transceiver, classroom keypad pack
with charging trays, and the LearnStar component cart. Teachers can also develop
unique lesson plans by editing the existing competitions or creating their own
customized quizzes to include current events and to highlight important
information.
The multimedia, interactive LearnStar software features over 1,000 academic
competitions in many subject areas written by experienced educators,
instructional designers and software programmers. LearnStar academic
competitions are carefully written according to state guidelines, national
standards, relevant topics and age appropriateness.
IWN. IWN was established in 1994 to develop, distribute and market
interactive and transaction processing services for the gaming and wagering
industry. IWN has developed the software and technology related to gaming
applications. IWN will continue to develop its products and services for
eventual mass marketing.
Initially, IWN is focusing on the North American pari-mutuel market as the
point of entry due to the enabling legislation that already exists in several
states in the United States and Canadian provinces. This legislation currently
allows racing fans to establish and fund an account at the racetrack, and call
in via telephone to either a live operator or an interactive voice response unit
to place their wager. New York, Pennsylvania and Connecticut presently allow
non-residents to establish accounts and place interstate telephone wagers. Ohio
is considering allowing non-resident accounts and interstate telephone wagering.
IWN's first product, HomeStretch(TM), turns a personal computer into a
gateway for pari-mutuel wagering. The Windows 95-based product will allows
racing fans to establish and fund an account at the racetrack, review race
information, and create wagers. Using a modem, the player connects to IWN's
Gaming Host System, located in Carlsbad, California, which provides connectivity
to the racetrack totalisator system, funds transfer system, and information
providers. The Gaming Host System is an on-line transaction processing engine
that provides the security, administration, financial transaction processing
services and switching capabilities necessary to support interactive gaming and
wagering from the home or virtually anywhere. In October 1996, IWN conducted
real-time contest wagering utilizing HomeStretch(TM) in conjunction with the
Ontario Jockey Club, Canada's premier racing organization, and the 1996
Breeders' Cup. Contest wagering and beta testing is ongoing pending final
regulatory approval to operate the IWN system in conjunction with real money
betting. To date, no significant revenues have been realized from this product.
INTERNATIONAL LICENSING. NTN has provided its services internationally to
expand its international services through licensing agreements. For many years,
NTN has provided service to customers in Canada through its unaffiliated
licensee, NTN Canada. In 1993, NTN issued a 20-year license to an unaffiliated
company in Australia ("NTN Australasia"), to create the first interactive
television network in Australia and New Zealand. In 1994, NTN issued a license
to MultiChoice Ltd., an unaffiliated company, to develop and operate an
interactive broadcast network in South Africa. Generally, the company licenses
operations in foreign countries by granting the rights to use NTN's unique
interactive broadcast technology. NTN provides licensees with technological
know-how and assistance to build a broadcast center, and to develop interactive
products and programs.
MARKETING AND EXPANSION STRATEGY
NETWORK SERVICES. Network Services markets services to customers primarily
through advertising in national trade periodicals, national and regional
industry trade shows, telemarketing, direct mail and direct contact through the
field representatives. All sales prospects are organized and tracked through
shared database software. Currently, services are sold through a regional-based
management team and utilize direct salespersons as well as over 50 independent
representatives. The independent representatives' agreements are typically one-
year agreements, with renewal clauses if the representative meets certain
performance goals. Customers generally execute a renewable one-year contract to
obtain the Company's services and pay a monthly fee of approximately $600.
11
The Company's future business strategy related to the NTN Network is to
continue to increase available programming and market to additional group
viewing Locations. In addition, the Company intends to develop additional
revenue sources for the NTN Network such as local and regional advertising. No
assurance can be given as to whether the Company will be successful in the
implementation of its business strategy.
ONLINE/INTERNET SERVICES. Since the end-user of Online/Internet Services
is the distributor's customer, the Company relies on the distributor's marketing
efforts to promote its products. However, the Company works in conjunction with
distributors to develop the promotions and advertisements. For example, AOL may
include the Company's game logo on an initial "start-up" screen which millions
of its subscribers can access at no expense to NTN. Furthermore, the Company
supplies distributors such as GTE MainStreet with existing marketing materials
used for the NTN Network, but GTE MainStreet absorbs the majority of the cost
associated with promoting online games to GTE MainStreet customers. Customers
generally pay the Company a fee based on the amount of time that consumers have
participated with the Company's games and services.
In the future, the Company expects its products to elicit more exposure
from the distributors as a result of increased brand recognition and continued
promotions. NTN will continue to take a proactive position with respect to
marketing products to each distributor to ensure inclusion in as many of their
promotional efforts as possible. The Company expects its direct marketing costs
to continue to be minimal. No assurance can be given as to whether the Company
will be successful in the implementation of its business strategy.
LEARNSTAR. To date, the LearnStar System has been sold by a direct sales
force targeting individual schools. In the future, the Company plans to use
independent representatives familiar with the education market to target inner-
city school districts, the nationwide Catholic archdiocese school system and
others. Further, the Company seeks sponsorship from public and private
foundations as well as funding from federal, state and local government
agencies. The Company currently derives revenues from selling the LearnStar
System and a site license to its customers. Current prices for the LearnStar
System range from $18,000 to $25,000, dependent upon volume and other factors.
The Company plans to test market different flexible pricing and financing
arrangements. Marketing and sales efforts are focused on large population
centers in states with funds designated specifically for technology in
education. No assurance can be given as to whether LearnStar will be successful
in the implementation of its business strategy.
IWN. IWN's marketing strategy is to promote the acceptance of interactive
applications to existing gaming and wagering enthusiasts, on-line services users
and interactive television participants. IWN's marketing strategy for
Homestretch(TM) in the interactive pari-mutuel wagering market, is to target
both the racing organization and the racing end-user. The development of this
business will depend on the adoption of enabling legislation in many states and
countries. Utilizing database marketing, IWN will initially target racing fans
who currently use computers for handicapping. This group has been identified as
"early adopters". IWN intends to expand the market to include on-line services
users and other demographic groups which are comfortable with technology and
have an interest in sports. IWN will seek to utilize resources from both
Network Services and Online/Internet Services to generate potential customer
lists. Targeted direct mail, on-line advertising and telemarketing will all be
utilized to promote the IWN services. IWN will seek to generate revenue through
fees charged to process data including wagers, sports information and switching
and transfer services.
Promotion to the racing industry will be through trade shows and direct
sales. IWN's management team has over 25 years of combined experience marketing
services to the gaming and wagering industry. IWN has a relationship with
Autotote Corporation, a public company which processes approximately 75% of the
pari-mutuel handle in the U.S. and which is the exclusive licensee for operating
off-track betting establishments for the State of Connecticut. IWN has also
contracted with Equibase, the official source of information for the
Thoroughbred Racing Association and the Jockey Club, to provide the raw data for
the racing information products. In 1996, IWN licensed its technology to IWN
Australasia, a joint venture between IWN, NTN Australasia (an unaffiliated
licensee) and Sporting Management Concepts. The licensing agreement provides
for license fees, royalties, development fees and equity ownership for IWN. No
assurance can be given as to whether IWN will be successful in the
implementation of its business strategy.
12
SOURCES OF REVENUE
The following table sets forth information with respect to the principal
sources of the Company's revenues during the years ended December 31, 1996, 1995
and 1994.
YEARS ENDED DECEMBER 31
-----------------------
1996 1995 1994
---- ---- ----
Network Services $ 20,029 15,559 11,271
Online/Internet Services $ 1,811 620 542
Advertising $ 1,590 1,128 431
Equipment Sales, net $ 1,757 1,803 1,634
NETWORK SERVICES. The primary market for Network Services is comprised of
approximately 330,000 taverns and restaurants in North America. Other potential
Locations may also be found among hotels, military bases, college campuses,
hospitals, and other group viewing Locations such as country clubs, fraternal
organizations, and bowling centers.
To date, Network Services' customers have generally been public viewing
locations such as restaurant chains (e.g., TGI Friday's, Ruby Tuesdays, Black
Angus), national hotel chains (e.g., Hilton, Holiday Inn, Marriott, Radisson,
Sheraton), local and regional bowling alleys, pizzerias, sports complexes,
sports taverns and military bases. Many of the Company's customers such as
hotel and restaurant chains have multiple Locations. Locations generally enter
into a one-year broadcast service agreement with the Company pursuant to which
they pay a monthly broadcast fee of approximately $600 per Location. The
Company currently serves over 3,000 Locations located in all 50 States and in
Canada.
The Company has a license agreement with NTN Canada (the "Canadian
License"), pursuant to which NTN Canada solicits Locations to the NTN Network in
Canada. Pursuant to the Canadian License, the Company provides NTN Network
programs to Canadian Locations in exchange for an annual license fee payable in
monthly installments based upon the number of Locations in Canada, which
presently number approximately 540.
As a percentage of total revenue, Network Services amounted to 78%, 77% and
70% in 1996, 1995, and 1994, respectively.
ONLINE/INTERNET SERVICES. The Company provides its services to on-line
users pursuant to the agreements with various system providers such as AOL,
CompuServe, and GTE. The on-line computer industry is one of the fastest
growing consumer markets in terms of subscribers. Industry analysts project
that by 1999 more than 100 million consumers will be connected to on-line
computer services. Fees from on-line services are based on the actual use of
the NTN interactive programs by their underlying customers. The Canadian
License also grants NTN Canada the exclusive right to market NTN interactive
services to online users in Canada. The Company is entitled to receive a
royalty equal to 25% of revenues generated from Canadian online customers. No
assurance can be given that any such royalties will be received by the Company.
As a percentage of total revenue, Online/Internet Services amounted to 7%, 3%
and 3% in 1996, 1995, and 1994, respectively.
ADVERTISING REVENUE. The Company sells advertising spots for broadcast on
the NTN Network as well as for Online/Internet Services. Advertisers can buy
time for promotional spots as well as sponsorship of specific events or
programs. As a percentage of total revenue, Advertising amounted to 6%, 6% and
3% in 1996, 1995, and 1994, respectively.
EQUIPMENT SALES. Equipment sales of LearnStar Systems is another source of
revenue for the Company. Typically, Location Systems are provided to customers
but ownership is maintained by the Company or are leased
13
from independent companies. The Company also sells interactive equipment,
particularly Playmakers(R), to its licensees in Canada, Australia, and South
Africa. Equipment is generally sold to customers with no return rights except in
the case of defect. As a percentage of total revenue, Equipment sales amounted
to 7%, 9% and 10% in 1996, 1995, and 1994, respectively.
RAW MATERIALS
For media platforms such as on-line services, the Company distributes its
programs to the recipients who maintain their own receiving, translation and re-
broadcasting equipment. Accordingly, the Company has no raw materials or
equipment needs for these customers beyond its own back-end servers.
For media platforms such as the NTN Network and LearnStar applications, the
System is assembled from off-the-shelf components available from a variety of
sources, except for the Playmaker(R) package. The Company installs and
maintains service of the Location Systems and LearnStar Systems. The
Playmaker(R) package is currently manufactured to the Company's specifications
by a non-affiliated manufacturer in Taiwan. In 1996, the manufacturer of the
Playmaker(R) package made certain changes to the design and source code of the
Playmakers(R), some of which were not previously authorized by the Company. As
a result, the Company is uncertain if it has all such design plans and source
codes for the Playmaker(R) package. In recent months and currently, the
Company's Network Services customers who have received manufactured
Playmakers(R), have experienced reliability problems with equipment. The
Company has recently experienced an unusually high rate of customer
discontinuing service which is effecting the Company's ability to generate cash
flow and earnings. The Company and the manufacturer are jointly working to
provide a solution to such reliability problems, although no assurances can be
given that a solution can be reached without undue delay and cost. The Company
believes that there are numerous other manufacturers who could supply
Playmakers(R) although no assurances can be given that, if necessary, such
alternative sources could be secured at commercially reasonable costs and
without undue delay.
LICENSING, TRADEMARKS, COPYRIGHTS AND PATENTS
The Company's sports games make use of simultaneous telecasts of sporting
events. As a consequence of the Company's licensees with various sporting
leagues, the Company is also permitted to utilize the trademarks and logos of
national teams and leagues in connection with the playing of an interactive
game.
The Company is party to an exclusive license from the NFL, which grants the
Company the exclusive right to use the trademarks and service marks of the NFL
in connection with the playing and marketing of QB1(R). The NFL license grants
the Company the exclusive data broadcast rights to conduct interactive games in
conjunction with the broadcast of NFL football games, for which the NFL receives
a royalty based on revenues billed by the Company in connection with QB1(R)
play. The agreement with the NFL was renewed on March 25, 1997 and expires in
2000. This most recent agreement expands the Company's rights to include
certain approved online service to all territories in which such online services
are accessible and significantly includes the Internet. There can be no
guarantee that the Company will be able to renew the license in the future.
Further, it is uncertain as to whether the Company's failure to renew the
license will have a material adverse effect on the Company.
In 1994, the Company entered into a three-year exclusive contract with the
Canadian Football League ("CFL") granting the Company the exclusive rights to
the simulcast of data accounts of the events occurring at CFL games, for which
the Company paid a royalty fee to the CFL. The license also includes the
exclusive right to use the CFL trademarks and logos for an interactive game in
connection with the playing and marketing of QB1(R). The Company has no
immediate plans to renew this license.
The Company currently has non-exclusive agreements with Major League
Baseball and the National Hockey League to use live broadcasts of their
respective games in conjunction with broadcasts of NTN DiamondBall(R) and NTN
PowerPlay(R) in Canada. No assurances can be given that the Company will be
able to renew such licenses in the future. Further, it is uncertain as to
whether the Company's failure to renew such licenses will have a material
adverse effect on the Company.
No action has been brought against the Company by the owners of the
applicable rights with respect to any of the Company's broadcasts of interactive
games in conjunction with live sports events.
14
The Company keeps confidential as trade secrets the software used in the
production of its programs. The hardware used in the Company's operations is
virtually off-the-shelf, except for the Playmaker(R) keypads. The Company owns
copyrights to all of its programs. In addition to the registration of the
trademark for QB1(R), the Company has either received, or is presently applying
for, trademark protection for the names of its other proprietary programming, to
the extent that trademark protection is available for same.
The Company maintains a program directed to the protection of its
intellectual property assets. As part of this program, the Company presently
has two patents pending for an Interactive Learning System and Automated System
for Conducting Auctions with Participants in Remote Locations.
SEASONAL BUSINESS
Overall, the Company's business is not generally seasonal. Revenue from
Network Services and Online/Internet Services is billed monthly as service is
provided to customers. However, sales of new Locations have traditionally been
higher in the Summer and early Fall months compared to the rest of the year.
This trend coincides with the start of the NFL season in August. The
hospitality industry has historically experienced a relatively high business
failure rate. Similarly, the Company has lost customers due to the failure of
customer businesses, to change in ownership or non-renewal of contracts,
collectively referred to as "churn". The Company's historical churn experience
has also been seasonal in that the percentage of churn has been higher following
the completion of the NFL season in February, although churn does occur in all
months. Although the Company's operating history is short, historically,
approximately 25% of the existing Network Services customers at the beginning of
a year, have churned during a year. The Company has implemented marketing
programs and other efforts to reduce the churn rate, however no assurance can be
given that such efforts will be successful.
Online/Internet Services are provided to consumers via online distributors
such as AOL and CompuServe. This industry is still in its infancy and little
historical data is available. The Company has experienced a continual increase
in the number of consumers using these services and no seasonal effect has been
noted.
Sales of LearnStar Systems are generally higher in the early part of the
year and at the traditional beginning of school in September with little or no
activity during the Summer break period.
WORKING CAPITAL
The discussion under "Liquidity and Capital Resources" included in Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations", is incorporated herein by reference.
SIGNIFICANT CUSTOMERS
The Company's customers are diverse and varied in size as well as location.
The services are provided point to multi-point so that the Company is not
dependent on any one, or a few customers. The Company does not have any
individual customers who accounted for 10% or more of its consolidated revenues
in 1996, 1995 or 1994.
BACKLOG
The Company generally does not have a significant backlog at any time
because the Company normally can deliver and install new Location Systems within
the delivery schedule requested by customers (generally within two weeks)
related to the NTN Network, with a similar delivery and installation pattern for
the LearnStar System. However, the Company announced on October 25, 1996 that
it had suspended shipments of its Playmakers(R) keypads to new Network Services
locations pending approval of the Playmaker(R) by the United States Federal
Communications Commission ("FCC"). The Company's application for approval was
subsequently submitted to the FCC and was approved by the FCC on January 15,
1997. Shipments to new locations, including approximately 290 sites which were
previously awaiting installation, resumed immediately following the FCC approval
and installation was completed on these sites in January and February. For
other distribution platforms, there is no backlog because
15
services are generally distributed point to multi-point and the Company does not
have to provide specific equipment to the customer, making it relatively simple
to add new customers without any significant delay.
GOVERNMENT CONTRACTS
The Company provides its distribution services to a small number of
government agencies (usually military base recreation units), however the number
of government customers is small compared to the overall customer base.
Contracts with government agencies are provided under generally the same terms
and conditions as other corporate customers and with only minor revisions which
are required by such government agency.
COMPETITIVE CONDITIONS
The Interactive Entertainment industry is still in its formative stage, but
currently may be divided into three major segments: (1) media distribution
services such as on-line services, telephone companies and cable television
companies and the NTN Network; (2) equipment providers such as computer and
peripheral equipment manufacturers; and (3) content and programming providers,
such as movie studios, NTN and software publishers. The Company does not act as
a direct provider of equipment to consumers. The Company operates as a media
distribution service through its own NTN Network. Also, the Company is a
program provider to an array of other media distribution services to consumers
utilizing a variety of equipment and delivery mechanisms.
NTN has a growing number of competitors in the programming segment of the
Interactive Entertainment industry. The Company's programming content is not
dependent upon, and consequently not bound by, any particular technology or
method of distribution to the consumer. The Company's programming is,
therefore, readily available to consumers on a wide variety of entertainment and
media services including: the NTN Network; on-line services including America
Online, Compuserve, and cable television, including GTE MainStreet, which is
available to households in certain regions.
The Interactive Television industry is still in its infancy. The Company
competes with other companies for total entertainment dollars in the
marketplace. The Company's programming competes generally with broadcast
television, pay-per-view, and other content offered on cable television. On
other mediums, the Company competes with other content and services available to
the consumer through on-line services. The Company's programming is interactive
in nature but is distinguished from other forms of interactive programming by
its simultaneous multi-player format and the two-way interactive features.
Presently, the technological capabilities of transmitting entertainment products
to the consumer exceed the supply of quality programming and services available
on the existing delivery systems. The Company is able to utilize the wide
variety of services available for transmission of entertainment products to the
consumer by forming strategic alliances with service providers to supply the
Company's programs for re-transmission. The Company's programming is available
to the consumer over a multitude of media platforms and delivery systems.
NETWORK SERVICES. Currently, Network Services on the NTN Network have no
competitors that furnish live, multi-player interactive entertainment similar in
scope and nature. Although the Company has no direct competitors in this area,
it does compete for total entertainment dollars in the marketplace. Other forms
of entertainment provided in public eating and drinking establishments include
music-based systems and cable and pay-per-view television. However, evidence
provided by customers indicates that patrons are inclined to stay longer and
consume more food and drink when NTN Network interactive games are offered as
the main source of entertainment. Accordingly, Network Services customers
generally tend to view these services as a profit generator rather than a cost
center.
ONLINE/INTERNET SERVICES. In the Online/Internet Services market, the
consumer has a plethora of entertainment options from which to choose, ranging
from cable television to telephone based services to computer on-line providers
and the Internet. The Company offers live, multi-player games and services
which are available to multiple interactive platforms in the home. Also, the
Company competes for a share of the total home entertainment dollars against
broadcast television, pay-per-view and other content offered on cable
television. The Company also competes with other programming available to
consumers through on-line services such as AOL and CompuServe. Cable
television, in its various forms, provides consumers the opportunity to make
viewing selections from anywhere between 30 to 100 free and pay channels, thus
limiting the amount of time devoted to any particular channel. For the
16
most part, cable television is predominantly a passive medium, and does not
offer the viewer the opportunity to participate in its programming, and even
less frequently, does it offer programming designed for active participation.
On-line providers, such as AOL, can provide literally thousands of options for
content and entertainment, however, such on-line services have traditionally
been confined to that company's subscriber base. Interaction among viewers is
thus limited to the particular program as offered only on the specific on-line
service. The Company offers consumers the opportunity to participate and compete
against other viewers who are seeing the identical program over several
different technological media, including interactive television, personal
computers and/or the NTN Network.
LEARNSTAR. Products and services to education customers utilizing the
LearnStar System were first sold beginning in 1995. The Company competes with
some established businesses which offer educational products, however, the
majority of existing products in the marketplace are passive, rather than
interactive. Such companies include Jostens' Learning, C.C.C. and the Eduquest
Division of IBM. The competitive advantage of the LearnStar System is that it
provides an easy to use, two-way interactive learning method, is very
competitively priced and requires less equipment than traditional systems.
Moreover, the LearnStar System is adaptable to the particular needs of the
individual users and is designed such that it can be used for local, regional,
and national competitions on a mass basis utilizing existing satellite
technology. Although the market for providing learning services to schools is
mature, the Company believes that the market for advanced educational products
which use computers, interactive software and satellite technology is embryonic.
IWN. The U.S. Gaming industry has grown rapidly in recent years. In 1994,
Americans wagered over $400 billion on legal commercial gaming compared to $126
billion in 1982. One survey showed that 61% of American adults wagered in one
or more types of government-approved gambling last year.
One of the reasons for the growth in gaming has been the favorable
regulatory and legislative environment. Many states have accepted gaming as a
means to raise tax revenue and encourage economic development. There are
approximately 200-250 pari-mutuel facilities in the U.S., and seven states have
legalized account-based telephone wagering, including New York and Connecticut,
which allow interstate telephone wagering.
Pari-mutuel wagering is the fourth largest segment in the gaming industry.
While the overall growth of the pari-mutuel handle has been stagnant over the
last five years, particularly when compared to the significant growth in the
overall gaming industry, the shift from on-track wagering to off-track betting
is an important trend. With the total U.S. thoroughbred horse racing handle in
the $10 billion range, off-track betting increased from $2.2 billion in 1987 to
$6.1 billion in 1994. Off-track betting is allowed in 20 of the 40 states where
pari-mutuel wagering is legal and is an increasingly important source of revenue
for racetracks and state governments. IWN's HomeStretch(TM) product is intended
to leverage the trend to off-track wagering by allowing fans to place wagers
from virtually anywhere to their account at the racetrack. Legislative
regulations are pending in many states and countries relating to placing wagers
electronically via computer services or on the Internet. IWN is still in the
development stage and no assurances can be given that it can attain its business
objectives or that regulatory bodies will provide legislation for on-line
wagering.
Assuming enabling legislation, IWN seeks to eventually compete for total
entertainment dollars in the market place. Within the gaming and wagering
industry, competition for the pari-mutuel wagering dollar comes from expanded
alternative gaming opportunities. Outside the industry, pari-mutuel wagering
competes with all forms of entertainment vying for consumer spending dollars.
Potential competitors in the interactive pari-mutuel wagering and gaming market
will include:
COMPANY DESCRIPTION
------- -----------
On Demand Services Originally part of United Video. Developed a
proprietary set-top box to deliver interactive
television racing and wagering.
Simulcast Racing Network Plans to broadcast a pay-per-view racing channel
with interactive wagering.
Gaming and Entertainment Plans to offer the hotel and sports bar markets
Television closed circuit pay-per-view and sports fantasy
leagues with participant wagering.
17
RESEARCH AND DEVELOPMENT
During the three years ended December 31, 1996, the Company incurred
$3,396,000, $1,471,000 and $1,972,000, respectively related to on Company-
sponsored research and development projects, including projects performed by
consultants for the Company.
The Company is currently developing interactive and transaction services
for the gaming industry and continues to develop enhancements to its interactive
software for several media platforms and continues its research into new and
enhanced graphics. There is no assurance that the Company will successfully
complete current or planned development projects or will do so within the time
parameters and budgets established by the Company, and there is no assurance
that a market will develop for any product successfully developed.
The Company works closely with independent user groups in an attempt to
develop enhancements and new services and products in response to customer
needs.
GOVERNMENT REGULATIONS
Compliance with federal, state and local laws have not had a material
effect upon the Company's capital expenditures, earnings or competitive position
to date. On October 25, 1996, the Company reported that it was advised by the
United States Federal Communications Commission (FCC) that its Playmaker(R)
keypad had never received FCC approval. Upon notification, the Company
commenced testing its equipment and submitted its application to the FCC. There
was no interruption of the Company's services to existing NTN Network customers,
nor were any of the Company's Online/Internet Services ever affected. The
Company will also implement a corrective action program to be approved by the
FCC. The Company received approval on January 15, 1997 and immediately began
shipments to new Locations. To date, the FCC has not advised the Company of the
amount of penalty, if any, which may be imposed. In light of the circumstances,
the Company believes that such a monetary penalty may be imposed, however, based
in part on the advice of outside counsel, the Company does not believe that the
amount of such penalty will be substantial so as to have a material, adverse
effect on the financial condition of the Company. The Company does not
anticipate that it will have to incur any material expenses in the future in
order to comply with federal, state or local laws because of the nature of its
current services and products. Gaming laws in certain states currently restrict
the ability of individuals to place wagers off-site from a regulated wagering
facility. The ability of IWN to carry out its business objective will be
dependent upon enabling legislation in states and other countries related to
gaming and electronic wagering.
EMPLOYEES
The Company and its subsidiaries employ approximately 200 people on a full-
time basis and 60 people on a part-time basis, and utilizes independent
contractors on a project basis. In addition, NTN retains a number of non-
affiliated programming and systems consultants. It is expected that as the
Company expands, additional employees and consultants will be required. The
Company believes that its present employees and consultants have the technical
knowledge necessary for the operation of the Company and that it will experience
no particular difficulties in engaging additional personnel with the necessary
technical skills when required. None of the Company's employees are represented
by a union and the Company believes its employee relations are satisfactory.
ITEM 2. PROPERTIES
----------
The Company has a membership in a limited liability company that owns "The
Campus", the three-building complex that houses the Company's headquarters. The
Company has a six-year lease for approximately 39,000 square feet of office and
warehouse space, at a rent of approximately $30,000 per month. The Company also
leases approximately 4,000 square feet of space under a lease that runs through
September, 1998, at a rent of approximately $3,000 per month. The Company does
not anticipate leasing additional space in the next year.
18
ITEM 3. LEGAL PROCEEDINGS
-----------------
Until recently, the Company was involved as a plaintiff or defendant in
various previously reported lawsuits in both the United States and Canada
involving Interactive Network, Inc. ("IN"). With the court's assistance, the
Company and IN have been able to reach a resolution of all pending disputes in
the United States and have agreed to private arbitration regarding any future
licensing, copyright or infringement issues which may arise between the parties.
There remain two lawsuits involving the Company, its unaffiliated Canadian
licensee and IN, which were filed in Canada in 1992. No substantive action has
been taken in furtherance of either action.
In June, 1996, the Company entered into a Settlement Agreement to resolve
litigation filed by various shareholders of the Company. The case, originally
filed in June, 1993, in the United States District Court for the Southern
District of California, is a consolidation of four lawsuits seeking class action
status to recover unspecified damages for a drop in the market price of the
Company's common stock following an announcement that an anticipated agreement
under which the Company would sell certain equipment and services to an arm of
the Mexican government may be put out to bid. Whereas the Company vigorously
defended this litigation and believes, in part, based upon the opinion of
outside counsel, in the merits of its defense, the Company has entered into the
Settlement Agreement to resolve this matter out-of court to avoid costly and
protracted litigation, in the best interests of its shareholders.
The terms of the settlement are as follows: A settlement fund of $400,000
in cash plus 565,000 warrants to purchase the common stock of NTN ("Settlement
Warrants") was established. Each Settlement Warrant will have a term of three
years from the Date of Issuance, as that term is defined in the Agreement, and
an exercise price equal to the average closing price per share of NTN common
stock on the American Stock Exchange during the twenty trading days immediately
preceding the Date of Issuance. During the period from the second anniversary
of the Date of Issuance until the expiration or exercise of a Settlement
Warrant, the holder of such Settlement Warrant shall have the right, but not the
obligation, to put the Settlement Warrant to NTN for repurchase at a price of
$3.25 per Settlement Warrant (the "Put Right"), provided, however, that this Put
Right shall expire, once, if ever, during the period from and after the Date of
Issuance that the closing price per share of the NTN common stock on the
American Stock Exchange is more that $3.25 above the exercise price of the
Settlement Warrants on any seven trading days, whether consecutive or not. Upon
expiration of the Put Right, NTN shall have nor further obligation to repurchase
the Settlement Warrants. In no event shall NTN have any obligation to
repurchase its common stock. The Settlement cannot be finalized nor can the
exercise price of the Settlement Warrants be set, until an S-3 registration,
which registers the Settlement Warrants, becomes effective. Currently, the
registration is being reviewed by the United States Securities and Exchange
Commission ("SEC") and the Company has responded to inquiries posed by the SEC
related to such registration.
On April 18, 1995, a class action lawsuit was filed in the United States
District Court for the Southern District of California. The complaint alleges
violations of federal securities laws based upon the Company's projections for
the fourth quarter of 1994 and for the 1994 fiscal year, and further alleges
that certain of the Company's insiders sold stock on information not generally
known to the public. The Company, which has assumed the defense of this matter
on behalf of all defendants, has denied liability based upon the allegations
contained in the complaint. Plaintiffs have claimed to be entitled to damages
between $8 million to $10 million. The Company believes, based in part on the
advice of outside counsel, that the actual damages, if any, would be
substantially less than such amount. A pretrial conference to set a trial date
has been scheduled for October 14, 1997. See Item 7 - "Management's Discussion
and Analysis of Financial Condition and Results of Operations" for additional
information, which is incorporated herein by reference.
On July 3, 1995, a single shareholder filed a separate lawsuit in the
United States District Court for the Northern District of Texas containing
allegations essentially identical to those raised in the shareholder lawsuit in
April, 1995. Upon the Company's motion, the case was transferred from Texas to
California. The Company denied the allegations in the complaint and filed its
own counterclaim against third parties for indemnification. On January 21,
1997, the Plaintiff voluntarily dismissed the separate lawsuit against the
Company without prejudice and the Company similarly dismissed its third party
counterclaims.
19
There can be no assurance that any or all of the foregoing claims will be
decided in favor of the Company, which is not insured against the claims made.
During the pendency of such claims, the Company will continue to incur the costs
of defense of same. If the shareholder litigation is decided in a manner
adverse to the Company, it may have a material adverse effect on the Company's
financial condition and result of operations.
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
-------------------------------------------------
No matters were submitted to a vote of security holders through the
solicitations of proxies or otherwise during the fourth quarter of the fiscal
year ended December 31, 1996.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
-------------------------------------------------------------
MATTERS
- -------
The Company's Common Stock is listed on the American Stock Exchange, under
the symbol "NTN." The prices below are the high and low sales prices for the
Common Stock reported by the American Stock Exchange for the two most recent
fiscal years.
1996 LOW HIGH
---- --- ----
First Quarter $3 - 1/8 $4 - 7/8
Second Quarter 3 - 7/8 5 - 1/8
Third Quarter 4 - 9/16 6 - 1/8
Fourth Quarter 3 - 7/16 5 - 3/16
1995 LOW HIGH
---- --- ----
First Quarter $5 - 5/8 $8 - 1/4
Second Quarter 4 - 7/16 5 - 13/16
Third Quarter 4 - 3/8 6 - 1/8
Fourth Quarter 4 - 1/8 5 - 3/16
On April 10, 1997, the closing price for the Common Stock reported on the
American Stock Exchange was $4.625. On that date, there were approximately
4,000 record owners of the Common Stock.
To date, the Company has not declared or paid any cash dividends with
respect to its Common Stock, and the current policy of the Board of Directors is
to retain earnings, if any, after payment of dividends on the Preferred Stock to
provide for the growth of the Company. Consequently, no cash dividends are
expected to be paid on the Company's Common Stock in the foreseeable future.
Further, there can be no assurance that the proposed operations of the Company
will generate the revenues and cash flow needed to declare a cash dividend or
that the Company will have legally available funds to pay dividends.
20
ITEM 6. SELECTED FINANCIAL DATA
-----------------------
The following tables furnishes information with respect to selected
consolidated financial data of the Company over the past five years.
Statement of Operations Data
(in thousands, except per share data)
YEARS ENDED DECEMBER 31,
-------------------------------------------------
1996 1995 1994 1993 1992
------- ------ ------ ------ ------
Total revenue $ 25,711 20,082 16,146 11,123 6,047
Total operating expenses 51,566 25,508 16,102 13,210 8,466
------- ------ ------ ------ ------
Operating income (loss) (25,855) (5,426) 44 (2,087) (2,419)
Other income, net 1 1,409 412 457 24
------- ------ ------ ------ ------
Earnings (loss) from continuing operations (25,854) (4,017) 456 (1,630) (2,395)
Earnings (loss) from
discontinued operations (1,317) 69 251 329 155
Gain from discontinued operations 4,219 - - - -
Income taxes - - - - -
------- ------ ------ ------ ------
Net earnings (loss) $ (22,952) (3,948) 707 (1,301) (2,240)
======= ====== ====== ====== ======
Earnings per share:
Continuing operations $ (1.15) (0.19) 0.02 (0.10) (0.21)
Discontinued operations 0.13 0.00 0.01 0.02 0.01
------- ------ ------ ------ ------
Net earnings (loss) $ (1.02) (0.19) 0.03 (0.08) (0.20)
======= ====== ====== ====== ======
Weighted average equivalent
shares outstanding 22,568 20,301 21,124 17,135 11,344
======= ====== ====== ====== ======
Balance Sheet Data
(in thousands)
DECEMBER 31,
------------------------------------------------
1996 1995 1994 1993 1992
------- ------ ------ ------ ------
Total current assets $ 10,655 26,009 18,844 23,102 9,004
Total assets $ 28,504 41,221 31,239 27,240 10,171
Total current liabilities $ 12,775 6,541 4,958 2,933 2,554
Total liabilities $ 18,282 7,770 5,782 3,587 2,739
Shareholders' equity $ 10,222 33,451 25,457 23,653 7,432
21
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
---------------------------------------------------------------
RESULTS OF OPERATIONS
---------------------
GENERAL
Management's discussion and analysis of financial condition and results of
operations should be read in conjunction with the selected financial data and
consolidated financial statements and notes thereto included elsewhere herein.
The Company uses existing technology to develop, produce and distribute
two-way multi-player interactive live events and also produces and distributes
its own original interactive programs. The Company's principal sources of
revenue from distribution activities are derived from (a) service distribution
fees in the United States; (b) advertising fees, (c) sales of equipment to
foreign licensees; (d) service distribution fees and royalties from foreign
licensees; and (e) licensing fees from foreign and domestic licensees.
On October 25, 1996, the Company reported that it was advised on September
9, 1996 by the United States Federal Communications Commission that its
Playmaker(R) keypad had not received FCC approval. The Company immediately
suspended shipment of the Playmakers(R) to new NTN Network Locations pending
approval by the FCC. Upon notification, the Company commenced testing its
equipment and submitted its application to the FCC. There was no interruption
of the Company's services to existing NTN Network customers, nor were any of the
Company's Online/Internet Services ever affected. The Company received approval
on January 15, 1997 and immediately began shipments to new Locations, including
approximately 290 new customers which were previously awaiting installation.
The installation of the Locations was completed in January and February 1997.
The Company will also implement a corrective action program to be approved by
the FCC.
On March 5, 1997, the Company announced a reorganization of its executive
management personnel in which Patrick J. Downs resigned as Chief Executive
Officer and Chairman of the Board, and Daniel C. Downs resigned as President.
In addition, three other officers resigned or were terminated in connection with
the reorganization. The Company recorded substantial charges related to the
management reorganization and other items more fully described below.
Accordingly, the following analysis has been expanded to provide a more detailed
description of the significant charges that occurred in 1996.
RESULTS OF OPERATIONS
Following is a comparative discussion by fiscal year of the results of
operations for the three years ended December 31, 1996. The Company believes
that inflation has not had a material effect on its operations to date.
YEAR ENDED DECEMBER 31, 1996 AS COMPARED TO THE YEAR ENDED DECEMBER 31, 1995
The Company incurred a net loss of $22,952,000 for the year ended December
31, 1996 compared to a net loss of $3,948,000 for the year ended December 31,
1995. In 1996, the Company treated New World as a discontinued operation. The
results include a gain on the sale of the Company's New World subsidiary of
$4,219,000, net of taxes of $16,000, and operating losses of $1,317,000. In the
second quarter, the Company reported an estimated tax expense of $1,000,000. The
change in the estimated tax liability resulting from the sale resulted from a
revision in the estimated income tax provision based on a recently concluded
analysis of the relevant tax laws and a valuation study performed to establish
the Company's minimum tax liability. The 1995 results have been adjusted to
reflect the sale of New World in 1996 as a discontinued operation. The 1996
results also include other significant charges for the resignation and
termination of officers and layoffs of other personnel, cancellation of notes
receivable, loss on buyout of lease commitments, a write-down of assets
associated with business activities that the Company has determined will no
longer be pursued, a write-down for obsolete inventory and equipment, and
accrual for costs and expenses for the resolution of litigation. In addition,
the current year's results of operations include charges related to the issuance
of equity instruments pursuant to the guidelines of SFAS 123. An analysis of
revenue and operating costs follows a discussion of the significant other
charges.
On March 5, 1997, the Company announced a reorganization of its executive
management personnel in which Patrick J. Downs resigned as Chief Executive
Officer and Chairman of the Board, and Daniel C. Downs resigned as President.
Other personnel changes include the resignation of Mr. Ronald Hogan, as Senior
Vice President, and the terminations of Mr. Gerald McLaughlin, formerly
Executive Vice President, and Mr. Michael Downs, formerly
22
President and CEO of LearnStar, in connection with the reorganization
("Reorganization"). The Company has entered into separate agreements
("Agreements") with each of the former officers setting out the terms on which
their existing employment contracts with NTN will be settled. In compliance with
the Agreements, NTN will continue to pay the former executives their current
annual salaries and other benefits for the remaining terms of their employment
agreements with NTN, which expire on or before December 31, 1999. Charges for
severance recorded related to terminations in 1996 amounted to $840,000. Charges
for severance to be recorded as an expense and liability in the first quarter of
1997 will be $4,578,000. Contractual payments for employment contracts related
to the Agreements are $1,711,000 in 1997, $1,350,000 in 1998 and $1,269,000 in
1999. The Company expects that such amounts will be funded from its on-going
operations. The Company has recorded the charges in 1996 and to be recorded in
1997 in accordance with Emerging Issues Task Force Issues No. 94 - 3.
Most of the former officers, along with Mr. Donald Klosterman, a director
of NTN, were indebted to NTN for certain loans that were made in previous years.
By their terms these loans were cancelable under certain circumstances in
connection with the termination of the officer's employment. Accordingly, in
conjunction with the management reorganization, all outstanding notes receivable
were canceled, and accordingly a charge for $4,252,000 for principal and accrued
interest was recorded in 1996. Included in the loans canceled were personal
loans made to Alan Magerman, a director, and Patrick J. Downs of approximately
$185,000 ($145,000 of principal and $40,000 of accrued interest) and $251,000
($227,000 of principal and $24,000 of accrued interest), respectively.
In addition to the reorganization of executive personnel noted earlier, the
Company had earlier announced the planned lay-offs of non-executive personnel.
The planned lay-offs were not due to a contraction in the Company's core
businesses, but rather were to cost-cutting measures implemented to improve
operations. Severance payments for non-executive lay-offs will not effect
liquidity as the majority of severance and other benefit payments were made in
1996.
From 1993 through June 30, 1996, the Company had entered into various sale
and leaseback arrangements with independent third parties. In the fourth
quarter of 1996, the Company completed a plan to repurchase equipment related to
the aforementioned lease arrangements. The Company recorded a charge of
approximately $2,007,000 related to the termination of these lease transactions.
To the extent possible, management does not intend to use the same sale and
leaseback arrangements as a method of financing in future periods. In addition,
management does not intend to purchase equipment to be held as inventory for
sale and leaseback arrangements. Accordingly, in the fourth quarter of 1996,
the Company reclassified all remaining inventory to Broadcast Equipment and
began recording depreciation charges on all assets placed in service. Although
the program required the immediate use of cash, it is expected to result in
improved future cash flow due to the elimination of many lease payments.
Deferred revenues associated with prior sale-leaseback transactions were netted
against the cost of repurchasing the assets.
The Company performs periodic reviews of its inventory and broadcast
equipment. In connection with such a review, it recently determined that recent
advancements in technology had rendered obsolete certain equipment and inventory
used by the Company which could not be used in the future. Accordingly, a charge
of $2,478,000 was recorded in the third quarter. This charge was not due to a
contraction in the Company's core businesses and will not effect future
liquidity or results of operations.
In June, 1996, the Company entered into a Settlement Agreement to resolve
litigation filed by various shareholders of the Company. The case, originally
filed in 1993, is a consolidation of four lawsuits seeking class action status
to recover unspecified damages for a drop in the market price of the Company's
common stock following an announcement that an anticipated agreement under which
the Company would sell certain equipment and services to an arm of the Mexican
government may be put out to bid. The Company believes there is no basis for
the claimants' allegations and does not believe that liability exists for the
allegations. Nonetheless, to avoid the expense and disruption of protracted
litigation, the Company has entered into the Settlement Agreement to resolve
this matter out-of court.
To settle the case, a settlement fund was established consisting of
$400,000 in cash plus 565,000 warrants to purchase the common stock of NTN
("Settlement Warrants"). Each Settlement Warrant has a term of three years from
the Date of Issuance, as that term is defined in the Agreement, and an exercise
price equal to the average closing price per share of NTN common stock on the
American Stock Exchange during the twenty trading days immediately preceding the
Date of Issuance. During the period from the second anniversary of the Date of
Issuance until the
23
expiration or exercise of a Settlement Warrant, the holder of such Settlement
Warrant shall have the right, but not the obligation, to put the Settlement
Warrant to NTN for repurchase at a price of $3.25 per Settlement Warrant (the
"Put Right"), provided, however, that this Put Right shall expire, once, if
ever, during the period from and after the Date of Issuance that the closing
price per share of the NTN common stock on the American Stock Exchange is more
that $3.25 above the exercise price of the Settlement Warrants on any seven
trading days, whether consecutive or not. Due to regulatory constraints, the
warrants have not yet been issued and the exercise price has not been
established. Nevertheless, a legal obligation exists for the Company to issue
the warrants, which will be completed as soon as the S-3 registration statement,
which includes the Settlement Warrants, becomes effective, which in turn, will
trigger the issuance of the Settlement Warrants. Although, the Put Right may
expire based on the closing price of the Common Stock over the next three years,
the Company has recognized the potential liability related to the Put Right.
Accordingly, a charge of $1,291,000 for the present value (discounted at 15%)
and related interest expense for the Put Right was recognized in 1996. The
difference between the amount expensed and the total potential liability,
$545,000, will be accreted as interest expense and charged to operations from
September 1996 until the second anniversary of the Date of Issuance. Upon
expiration of the Put Right, NTN shall have no further obligation to repurchase
the Settlement Warrants. In no event shall NTN have any obligation to repurchase
its Common Stock.
On April 18, 1995, a class action lawsuit was filed in United States
District Court. The complaint alleges violations of federal securities laws
based upon the Company's projections for the fourth quarter of 1994 and for the
1994 fiscal year, and further alleges that certain of the Company's insiders
sold stock on information not generally known to the public. The Company, which
has assumed the defense of this matter on behalf of all defendants, has denied
liability based upon the allegations contained in the complaint. Plaintiffs
have claimed to be entitled to damages between $8 million to $10 million. The
Company believes, based in part on the advice of outside counsel, that the
actual damages, if any, would be substantially less than such amount. This
lawsuit has been scheduled for trial to commence in October, 1997. The Company
believes there is no basis for the claimants' allegations. Nonetheless, the
Company may, to avoid the expense and disruption of protracted litigation,
attempt to settle the case. Due to potential settlement costs including the
legal costs and expenses associated with litigation of this nature, including
attorney fees, expert fees and costs, analyses which must be conducted and other
costs necessary to prepare to defend this case at trial and perhaps through the
appeals process, and the inherent expenditures of management time, effort and
resources that will also be required, the Company has recorded a charge against
its current earnings for such costs and expenses.
In December 1995, the Company entered into an agreement to sell a 45%
interest in LearnStar to another company for a $2,500,000 note receivable. No
gain was recognized in 1995 as the Company had not received any payments on the
note. In 1996, the parties agreed to rescind the agreement. No gain was
recorded in 1996.
In October 1995, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 123, "Accounting for Stock-based
Compensation" ("SFAS 123"), effective for fiscal years beginning after December
31, 1995. SFAS 123 establishes the fair value method of accounting for stock-
based compensation arrangements, under which compensation cost is determined
using the fair value of the stock option at the grant date and the number of
options vested, and is recognized over the period in which the related services
are rendered. The Company has chosen to retain its current intrinsic value
based method for issuances to employees, as allowed by SFAS 123. As further
provided in SFAS 123, the Company has disclosed the pro forma effect of adopting
the fair value based method.
Under SFAS 123, transactions involving non-employees for which goods or
services is the consideration received for the issuance of equity instruments
are to be recorded using the fair value method. The fair value method states
that the amount recorded is to be based an the fair value of the consideration
received or the fair value of the equity instrument issued, whichever is more
reliably measurable. In 1996, the Company issued a total of 616,000 warrants to
non-employees for the purchase of the Company's common stock and recorded a
charge of $1,910,000 related to the issuance of those equity instruments.
In December 1995, the Company entered into a sale, purchase agreement and
investment agreement ("Agreement") with Symphony LLC ("Symphony"), an
unaffiliated company whereby Symphony agreed to purchase a 10% interest in IWN,
Inc. for $350,000 and would make capital contributions totaling $2,650,000 to
IWN L.P., a limited partnership of which IWN Inc. is the general partner.
24
The Agreement includes a provision whereby Symphony has the option to put
("Put Option") its partnership interest and its shares of IWN Inc. to NTN during
the period from April 1, 1997 through December 1, 1997 for certain
consideration. Accordingly, the Company has included the accounts and results
of operations of. IWN L.P. in the Company's consolidated financial statements.
On April 8, 1997, Symphony exercised the Put Option. At December 31, 1996,
the aggregate obligation assuming the Put Option would be exercised was
$3,045,000. This amount has been recorded as a short-term borrowing in the
consolidated financial statements as of December 31, 1996. The Put Option is
payable in cash or common stock, or a combination thereof, at Symphony's
election (subject to the Company's determination of sufficient funds available),
or conversely Symphony can elect to accept a promissory note for up to two years
bearing interest at 27.5% per annum. Operating losses for IWN L.P. aggregated
$2,961,000 in 1996.
For the current period, total revenues increased 28% from $20,082,000 to
$25,711,000. This increase is the result of growth in most of the Company's
principal revenue activities, Network Services and Online/Internet Services.
Network Services increased 29% from $15,559,000 to $20,029,000. The
increase is primarily due to an expansion in the number of subscriber locations
contracting for services. Online/Internet Services increased 192% from $620,000
to $1,811,000 due to an increase in services to online customers and a notable
growth in consumer revenue hours. In addition, the Company has increased the
number of programs available through this distribution platform. Advertising
revenues related to both Network Services and Online/Internet Services increased
41% from $1,128,000 to $1,590,000 primarily due to an increased number of
commercial spots sold.
Equipment Sales, net decreased 3% from $1,803,000 to $1,757,000. Equipment
sales are predominantly with foreign licensees which are subject to outside
influences and can occur at random times throughout the year. Equipment sales
have been highly volatile in the past and are expected to remain so, as they are
dependent upon the timing of expansion plans of the Company's foreign licensees
and its educational customers.
Operating Expenses related to Network Services and Online/Internet Services
rose from $4,799,000 to $8,602,000, an increase of 79%. The increase is largely
attributable to a charge of $2,478,000 for a write-down of obsolete equipment
and to the expansion in the number of subscribers and on-line services
contracting for services. Exclusive of the charge for obsolete equipment,
operating costs increased 28% compared to a combined increase in Network
Services and Online/Internet Services revenues of 35%.
Selling, General and Administrative expenses increased 55% from $13,080,000
to $20,232,000. Included in selling, general and administrative expenses are
several significant charges incurred in 1996. The significant charges include an
accrual of $1,910,000 pursuant to SFAS No. 123 related to the issuance of
warrants; an accrual of severance benefits to certain officers and other
employees of $840,000; an increase in the allowance for doubtful accounts of
$1,840,000 due to risks associated with Network Service customers, educational
and international customers; additional marketing expenses incurred during the
period that shipments of Playmakers(R) were suspended pending approval from the
FCC of $350,000; and a charge of $222,000 related to a change in estimate for
deferred advertising costs.
Litigation, Legal and Professional expenses increased 277% from $1,720,000
to $6,484,000 due to charges and legal fees associated with settling various
litigation and on-going operations. Included in Legal and Professional services
in 1996 is a charge of $400,000 for settlement and an additional $1,234,000 for
the potential liability associated with the issuance of warrants as part of a
settlement. Equipment lease expense increased 73% from $3,957,000 to $6,837,000
due to the increase in equipment under lease agreements for the majority of the
year and the buyout in late 1996 of certain lease obligations resulting in a
charge of $2,007,000. Depreciation expense increased 117% from $481,000 to
$1,042,000 due to the higher base of depreciable assets that resulted from the
buyout. Research and Development expense increased 131%, from $1,471,000 to
$3,396,000 as the Company expanded its development of gaming applications and
continued its exploration of new technical platforms and interactive services.
In connection with the Reorganization, the Company canceled certain notes
receivable due from executive officers resulting in an expense of $4,252,000.
Other Charges of $721,000 include a write-down of assets associated with
business activities that the Company has determined will no longer be pursued.
25
Other Income (Expense) decreased from $1,409,000 to $1,000 in 1996. The
1996 results include accreted interest expense associated with the Settlement
Warrants of $57,000. The 1995 results include reimbursement of previously
incurred legal expenses from the Company's insurance carrier of approximately
$1,000,000. There was no tax expense in 1996 and 1995 primarily due to taxable
losses and offsetting temporary differences in both years. The Company
currently has available approximately $33,000,000 of net operating loss
carryovers for federal tax purposes.
YEAR ENDED DECEMBER 31, 1995 AS COMPARED TO THE YEAR ENDED DECEMBER 31, 1994
The Company reported a net loss of $3,948,000 for the year ended December
31, 1995 compared to net earnings of $707,000 for the year ended December 31,
1994. The 1995 and 1994 results have been adjusted to reflect the sale of New
World in 1996 as a discontinued operation.
In 1994, the Company formed LearnStar to pursue interactive educational
applications in the United States. Most of 1994 was devoted to beta testing the
product and conducting preliminary market tests. In 1995, LearnStar began
marketing and selling its product on a full-time basis. Due to start-up costs
and relatively higher marketing costs during the first year of operations, the
LearnStar operations incurred a net loss of $2,149,000 for the year ended
December 31, 1995.
In 1995, the Company set up an allowance of $1,000,000 for inventory in
connection with the upgrading of its broadcast distribution system and expensed
$754,000 of costs incurred in connection with the development of the market in
Mexico. Further, in 1995, the Company experienced a substantial increase in
legal expenses due to increased activities in litigation and other legal matters
along with increased costs of developing and providing products and services,
and increased marketing expenditures.
Total revenues increased 24% from $16,146,000 to $20,082,000. This
increase is the result of growth in many of the Company's principal revenue
activities.
Network Services increased 38% from $11,271,000 to $15,559,000. This
increase is primarily due to an expansion in the number of subscriber locations
and contracting for services from the Company. Online/Internet Services
increased 14% from $542,000 to $620,000. This increase is due to the steady
growth of the number of consumers using these services. Advertising revenue
increased 162% from $431,000 to $1,128,000, predominantly due to an increase of
spots and sponsorships sold.
Equipment Sales, net increased 10% from $1,634,000 to $1,803,000.
Equipment sales include both sale and leaseback transactions and direct sales to
the Company's customers. Equipment sales have been highly volatile in the past
and are expected to remain so, as they are dependent on the timing of expansion
plans of the Company's foreign licensees and, its educational subscribers. The
sales price and cost of sales for equipment sold to customers and others has
been constant for the past two years. Accordingly, the increase in sales for
equipment sold to customers from 1994 to 1995 is wholly attributable to changes
in volume.
License and Royalty Fees and Other Revenue decreased from $2,268,000 to
$972,000 in the current year's period and is predominantly comprised of license
fees and royalties. License Fees in 1995 predominantly relates to Network
Services and international licensing opportunities whereas in 1994 license fees
primarily consisted of inventory transferred to the Company by its United
Kingdom licensee in exchange for release from a license agreement. Licensing
arrangements are not dependent upon seasonal forces and will vary in type and
amount from period to period.
Operating Expenses for Network Services and Online/Internet Services
increased 64% from $2,923,000 to $4,799,000. The increase is largely
attributable to a charge of $1,000,000 in connection with broadcast equipment
and the expansion in the number of subscribers contracting for services.
Selling, General and Administrative expenses rose from $7,728,000 in 1994 to
$13,080,000 in 1995, an increase of 69% due to an increase in the number of
employees hired to develop and produce new products and services and large
increases in marketing activities related to the development of the LearnStar
products and services. Legal and Professional Fees increased 192% from $590,000
to $1,720,000 due to substantial legal expenses incurred relating to litigation
and other legal and corporate matters. Equipment lease expense increased 74%
from $2,275,000 to $3,957,000 due to the increase in equipment
26
under lease agreements related to the expansion of the NTN Network. Research and
Development expense decreased from $1,972,000 to $1,471,000, or 25% as the
Company increased its efforts in projects in current production.
Other Income (Expense) increased from $412,000 to $1,409,000 or 228%.
Included in Other Income reimbursement of previously incurred legal expenses
from the Company's insurance carrier of approximately $1,000,000. There was no
tax expense in 1995 and 1994 primarily due to taxable losses and offsetting
temporary differences in both years.
LIQUIDITY AND CAPITAL RESOURCES
Following is a discussion of the Company's recent and future sources of and
demands on liquidity, as well as an analysis of liquidity levels. Expenditures
have exceeded revenues from operations through most of the Company's history and
may do so in the future. The Company plans to fund any such deficiency from its
existing cash and, if necessary, from other sources, as discussed below.
In 1996, the Company reported a loss of $22,952,000. The 1996 results
include substantial other charges for the management reorganization and layoffs
of other personnel, cancellation of debt, loss on buyout of lease obligations, a
write-down of assets associated with business activities that the Company has
determined will no longer be pursued, write-down for obsolete inventory and
equipment, and accrual for legal and litigation settlements. In addition, the
current year includes charges related to the issuance of equity instruments as
recorded under the guidelines of SFAS 123. Many of these are non-cash related
charges which will have no impact on future cash flow. None of the non-cash
charges are due to contractions in the core businesses of the Company, and
therefore are not expected to effect future liquidity or results of operations.
Charges for the management reorganization and potential liabilities related to
settlement of litigation will generally be paid over an extended period of time
in excess of one year. The management reorganization and lay-offs of other
employees were not due to a contraction in the Company's core businesses, but
rather are cost-cutting measures being implemented to improve operations. These
liabilities, depending on the extent and timing, could effect future liquidity,
but are expected to be funded from on-going operations.
Total assets decreased 31% from $41,221,000 to $28,504,000 from December
31, 1995 to December 31, 1996. The decrease in assets is primarily due to the
significant charges recorded in the third and fourth quarters noted above. Cash
increased slightly from $6,485,000 at December 31, 1995 to $6,579,000 at
December 31, 1996. Interest-bearing security deposits decreased from $3,775,000
to zero due to the buyout of certain sale and leaseback agreements.
The 24% decrease in Accounts Receivable - Trade from $2,668,000 to
$2,031,000 at December 31, 1996, reflects the overall growth of the Company's
primary operations, the effect of churn from Network Services customers and an
increase in the allowance for doubtful accounts due to risks associated with
Network Service customers, educational and international customers. Accounts
Receivable - Other decreased from $1,750,000 to zero, the result of payments
received and the buyout of certain lease obligations. Notes Receivable - Related
Parties decreased from $4,468,000 to zero, primarily due to the cancellation of
notes receivable related to the management reorganization.
As previously noted, in the fourth quarter of 1996 the Company completed a
program to repurchase inventory and equipment previously sold to and leased back
from third parties. Accordingly, Broadcast Equipment, formerly shown as
Inventory, has been reclassified to non-current assets. The Company does not
intend to sell this equipment in the future, accordingly, depreciation of these
assets commenced in the fourth quarter of 1996. The new policy is expected to
result in improved cash flow due to the elimination of many lease payments.
Further, the Company evaluated its current inventory in light of current and
anticipated operations and determined that certain equipment had become obsolete
and would not be used in the future. Accordingly, a charge of $2,478,000 was
recorded in the 1996 to write-off these assets.
Total liabilities increased 135% from $7,770,000 to $18,282,000 from
December 31, 1995 to December 31, 1996. The increase in Accounts Payable and
Accrued Liabilities from $2,877,000 to $6,182,000 reflects the overall growth of
the Company, the timing of payments, an accrual for liabilities due to severance
of officers and employees and accounting and legal expenses. Short-term
borrowings of $5,060,000 consists of $2,015,000, secured by the cash surrender
value of life insurance policies, and $3,045,000 related to the IWN Put Option.
On April 8, 1997, the holder of the IWN Put Option (Symphony) informed the
Company that the Put Option was being exercised immediately. The Put Option is
payable in cash or common stock, or a combination thereof, at Symphony's
election
27
(subject to the Company's determination of sufficient funds available), or
conversely Symphony can elect to accept a promissory note for up to two years
bearing interest at 27.5% per annum.
The decrease in total Deferred Revenue (long-term and current) from
$2,253,000 to $1,254,000 reflects the buy-out of lease obligations, amortization
of deferred gains offset by a $500,000 deferral related to an agreement with
Bell Canada. Revenue related to the Bell Canada agreement will be recognized as
product is scheduled to be delivered, beginning in 1997. Other long-term
liabilities is comprised of amounts related to settlement agreements.
Overall, the Company's working capital decreased $21,528,000 from December
31, 1995 to December 31, 1996, primarily the result of the use of cash to buyout
of lease obligations, the significant accruals for settlement agreement and
other liabilities in late 1996 and the reclassification of Broadcast equipment
to non-current assets. At December 31, 1996, the Company had a net working
capital deficiency of $2,120,000. Revenues from the principal business
activities, Network Services, Online/Internet Services, and Advertising grew 35%
in the year ended December 31, 1996 compared to the prior year. The Software
Development and Distribution segment (New World) was sold in June 1996 and no
longer represents a business segment. The Company is expected to continue to
require additional working capital for operating expenses, new services
development, marketing of services and purchase of the hardware components used
in the reception of its services. There can be no assurance that the Company's
currently available resources will be sufficient to allow the Company to support
its operations until such time, if any, as its internally generated cash flow is
able to sustain the Company.
The accompanying consolidated financial statements have been prepared
assuming the Company will continue as a going concern. As shown in the
accompanying consolidated financial statements, the Company has suffered
recurring losses from operations and has a net working capital deficiency of
$2,120,000 as of December 31, 1996. Additionally, the Company has utilized
significant cash flows from operating activities of $8,655,000. These conditions
raise substantial doubt about the Company's ability to continue as a going
concern. These consolidated financial statements do not include any adjustments
that might result from the outcome of this uncertainty.
Management has implemented an organizational and strategic restructuring
aimed at reducing overhead expenses by 20% and focusing on the Company's
business units. This involved a workforce reduction including five senior
officers, the buyout of many high-rate lease obligations, and restructuring its
management personnel and responsibilities. Management believes that these
factors will contribute toward achieving profitability and improving cash flow.
In the past, the Company has been able to fund its operations and improve
its working capital position by sales of Common Stock, upon exercise of warrants
and options, by leasing transactions for equipment in use at subscriber
locations, and by licensing its technology to foreign licensees. The Company is
exploring alternative capital financing possibilities which may include (i)
licensing and related royalties of the Company's technology and products; (ii)
borrowing arrangements under fixed and revolving credit agreements; or (iii)
sale of additional equity securities. The Company may negotiate for additional
lease and debt financing and additional foreign licensing, however, the extent
to which any of the foregoing may be accomplished, if at all, cannot be
predicted at this time.
The Company has certain lawsuits pending as previously described in "Legal
Proceedings. The Company believes, based in part on the advice of outside,
independent counsel, that there is no basis to claimants allegations, but to
avoid the expense and disruption of protracted litigation has settled certain
cases and may continue to attempt to settle others. The Company provided a
charge against its current earnings for such possible actions, There can be no
assurances that the Company will be successful in settling or defending such
actions or that any or all actions would be decided in favor of the Company or
that the continued cost of defending and prosecuting these actions will not have
a material adverse effect on the Company's financial position or results of
operations.
MARKETING AND EXPANSION PLAN
The Company's plan to reach profitability includes the following elements:
(i) reorganizing and expanding the sales staff; (ii) increasing advertising
sales; (iii) expanding products and services to a wider variety of technological
platforms (iv) expanding Company services to education customers; and (v)
pursuit of additional foreign licensing opportunities.
Throughout the Company's history, t