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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
For the fiscal year ended December 31, 1997
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 AMERICAN STOCK EXCHANGE
REDEEMABLE COMMON STOCK PURCHASE WARRANTS
(TITLE OF EACH CLASS) (NAME OF EACH EXCHANGE ON WHICH
REGISTERED)
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, 1998, computed by reference to the closing sale price
of such stock on the American Stock Exchange, was approximately $17,000,000.
(All directors and executive officers of Registrant are considered affiliates
for this purpose.)
As of April 10, 1998, Registrant had 24,437,000 shares of Common Stock,
$.005 par value, issued and outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Not Applicable
1
TABLE OF CONTENTS
Item Page
Part I
1. Business 3
2. Properties
3. Legal Proceedings
4. Submission of Matters to a Vote of Security Holders
Part II
5. Market for Registrant's Common Equity and Related Stockholder Matters
6. Selected Financial Data
7. Management's Discussion and Analysis of Financial Condition and Results of
Operations
8. Consolidated Financial Statements and Supplementary Data
9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure
Part III
10. Directors and Executive Officers of the Registrant
11. Executive Compensation
12. Security Ownership of Certain Beneficial Owners and Management
13. Certain Relationships and Related Transactions
Part IV
14. Exhibits, Consolidated Financial Statement Schedule, and Reports on Form 8-K
Index to Consolidated Financial Statements and Schedule F-1
2
This Report contains "forward-looking statements" within the meaning of
Section 27A of the Securities Act and Section 21E of the Exchange Act,
including, without limitation, statements that include the words "believes,"
"expects," "anticipates," "plans" or similar expressions and statements relating
to anticipated costs savings, the Company's strategic plans, capital
expenditures, industry trends and prospects and the Company's financial
position. Such forward-looking statements involve known and unknown risks,
uncertainties and other factors that may cause actual results, performance or
achievements of the Company to differ materially from those expressed or implied
by such forward-looking statements. Although the Company believes that its
plans, intentions and expectation reflected in such forward-looking statements
are reasonable, it can give no assurance that such plans, intentions or
expectation will be achieved. Important factors that could cause actual results
to differ materially from the Company's expectations are set forth in this
Report.
PART I
ITEM 1. BUSINESS
--------
GENERAL
- -------
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 Industries completed a public offering of its Common Stock on
November 26, 1984. On April 15, 1985, Alroy Industries acquired all of the
outstanding stock of National Telecommunicator Network, Inc. In connection with
the acquisition, Alroy Industries 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 substantially all of the assets of New World.
In 1994, the Company formed LearnStar, Inc. ("LearnStar"), which operated
throughout 1997 as a wholly-owned subsidiary of NTN. In January 1998, the Board
of Directors of NTN resolved to either sell or cease the operations of
LearnStar.
In 1994, the Company also formed IWN, Inc. ("IWN"), which serves as the
general partner of 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 the general partner of IWN L.P. In January
1998, the Board of Directors of NTN resolved to either sell or cease the
operations of IWN and IWN L.P.
Unless otherwise indicated, references herein to "NTN" or the "Company"
include NTN and its consolidated subsidiaries, LearnStar, IWN and IWN L.P.
RECENT DEVELOPMENTS
RECENT MANAGEMENT PERSONNEL CHANGES
-----------------------------------
The Company experienced a broad change in its executive management during
1997. Gerald Sokol, Jr. was appointed as Chief Executive Officer of the Company
in October 1997. He joined the Company as Chief Financial Officer in July 1996,
was appointed Chief Operating Officer in November 1996, and in February 1997, in
connection with the management reorganization described below, was appointed
President of the Company. In September 1997, Geoffrey D. Labat assumed from Mr.
Sokol the duties of Chief Operating Officer after having joined the Company in
May 1997 as Chief Technical Officer.
In March 1997, Edward C. Frazier, who has served as a director of the
Company since August 1996, was also appointed Chairman of the Board. In
February 1998, Mr. Frazier resigned his position as Chairman of the Board, but
remains a director of the Company. Under the Bylaws of the Company, Mr. Sokol,
as Chief Executive Officer, became the acting Chairman of the Board of
Directors.
3
In August 1997, three of the Company's incumbent directors resigned, and in
September and November 1997, respectively, Esther L. Rodriguez and Stanley B.
Kinsey were appointed as directors. There can be no assurance that the new
management of the Company, under the supervision of the Board of Directors, will
be able to operate the Company more successfully than prior management or that
additional management changes will not be made in the future.
RESIGNATION AGREEMENTS AND MODIFICATION OF RESIGNATION AGREEMENTS
-----------------------------------------------------------------
In late 1996, Ronald E. Hogan, the Company's former Chief Financial Officer
resigned as an executive officer of the Company and the Company discontinued
certain consulting arrangements with Alan P. Magerman, who was then serving as a
director of the Company. In March 1997, the Company announced a further
reorganization of its executive management personnel in which Patrick J. Downs,
then Chief Executive Officer and Chairman of the Board of the Company, Daniel C.
Downs, then the Company's President, Gerald McLaughlin, then an Executive Vice
President of the Company, and Michael Downs, then President of LearnStar,
resigned or were terminated. The Company entered into separate Resignation and
General Release Agreements (the "Resignation Agreements") with each of the
former officers pursuant to which the officers' prior employment agreements were
terminated and each former officer entered into a Consulting Agreement under
which he agreed to consult with the Company on such matters as it may request
from time to time. The three-year terms of the Consulting Agreements coincided
with the remaining terms of the executives' prior employment agreements.
In consideration of entering into the Consulting Agreements, NTN agreed to
extend the expiration dates of certain options and warrants held by the former
officers and, with respect to Patrick J. Downs and Daniel C. Downs, to waive
provisions of certain stock options which required that the options be exercised
within a specified period of time following termination. In the first quarter of
1997, the Company recorded charges of $1,450,000 related to the modifications of
options and warrants held by the former officers.
Under the Resignation Agreements, the Company agreed to honor certain
provisions of the officers' prior employment agreements to continue to pay the
former executives their prior annual salaries and other benefits for the
remaining terms of such agreements including certain medical and life insurance
benefits and car allowances. Total payments to or on behalf of former
executives were approximately $1,944,000 in 1997.
In March 1998, the Company and three of the former officers agreed to
modify the respective Resignation Agreements of the former officers to defer
payment of a total of approximately $627,000 of the amounts which were to have
been paid in 1998 and 1999. The deferred amounts will be paid monthly during
2000, with an aggregate balloon payment of $102,800 payable on December 31,
2000. Medical and life insurance benefits to the three former executives were
also extended to December 31, 2000 pursuant to the modified Resignation
Agreements. The modifications also provide an option to the Company to settle
all amounts due pursuant to the Resignation Agreements in shares of Common
Stock. The option period commenced March 20, 1998 and extends to June 18, 1998.
The number of shares of Common Stock to be issued will be 66% of the number of
shares determined by dividing the present value of the amounts then owing (using
a discount rate of 5%) by the average closing price of the Common Stock for the
ten trading days prior to the third business day before the notice of the
exercise of the option. Should the conversion option be exercised, the Company
has agreed to file a Registration Statement on behalf of the former officers to
register the shares to be issued within 20 days of providing notice of its
intent to exercise its option. If the Company fails to have the Registration
Statement declared effective within 120 days of the notice, the Company will be
obligated to pay a one-time fee of $135,000 to the former officers as additional
compensation. Amounts to be paid pursuant to the modified Resignation Agreements
are expected to be funded from on-going operations.
In 1997, in connection with the management reorganization, NTN agreed to
the vesting of certain options held by Mr. McLaughlin to purchase 100,000 shares
of Common Stock and issued to Mr. McLaughlin a fully vested option to purchase
150,000 shares of Common Stock at an exercise price of $3.88 per share. The
Company also paid Mr. Magerman an aggregate of $225,000 and purchased from him
for a price of $81,250 certain warrants to purchase 325,000 shares of Common
Stock.
4
In the fourth quarter of 1996, the Company laid off approximately 16% of
its workforce as a cost-cutting measure. The Company also laid off a
significant number of employees in 1997 and may continue trimming its workforce
to reduce costs. Severance payments related to the layoff will not affect the
Company's future liquidity, since the majority of the related severance and
other benefit payments were made in 1996 and 1997. See Item 7, "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
RECENT PRIVATE PLACEMENT OF SERIES B PREFERRED STOCK
----------------------------------------------------
On October 31, 1997, the Company completed a private placement in which it
issued and sold to two institutional investors a total of 70,000 shares of the
Company's Series B Convertible Preferred Stock ("Series B Preferred Stock"),
$100 stated value per share, for an aggregate purchase price of $7,000,000. On
February 12, 1998, 25% of the Series B Preferred Stock, or 17,500 shares, were
convertible into approximately 2,940,000 shares of Common Stock at the option of
the holder. In March 1998, the holders of the Series B Preferred Stock
converted 2,000 shares of Series B Preferred Stock plus accrued dividends into
336,658 shares of Common Stock at a conversion price of $0.60 per share. See
Item 5, "Market for Registrant's Common Equity and Related Stockholder Matters."
RECENT EXCHANGES OF CERTAIN OUTSTANDING OPTIONS AND WARRANTS
------------------------------------------------------------
In the first quarter of January 1998, the Company agreed to issue an
aggregate of 759,437 shares of Common Stock in exchange for the surrender and
cancellation of certain previously outstanding options and warrants to purchase
an aggregate of 2,578,250 shares of Common Stock at exercise prices ranging from
$2.00 to $5.75 per share. The terms of the exchanges were determined in
privately negotiated transactions between the Company and the option holders and
warrant holders involved, based on a discount from the valuation of the options
and warrants as determined in accordance with the Black-Scholes method, which
takes into account such factors as the exercise prices and exercise periods of
the options and warrants and the volatility of the market price of the Common
Stock. The Company may enter into similar agreements in the future to exchange
shares of Common Stock for other currently outstanding options or warrants. The
value of the shares issued was approximately $900,000, based on the market price
of the Common Stock at the time of the exchanges which, was less than the
estimated fair value of the warrants and options received in the exchange.
In March 1998, the Company agreed to issue 277,200 shares of Common Stock
and to pay withholding taxes of approximately $107,000 to two former officers in
exchange for the surrender and cancellation of certain previously outstanding
warrants and options to purchase 1,500,000 shares of Common Stock at exercise
prices ranging from $2.00 to $4.75 per share. The value of the shares issued and
cash payments was approximately $300,000, based on the market price of the
Common Stock at the time, which was less than the estimated fair value of the
warrants and options received in the exchange.
RECENT DECISION CONCERNING SUBSIDIARIES
---------------------------------------
In January 1998, the Board of Directors concluded that the interests of the
Company's shareholders are best served by concentrating Company resources and
efforts on its two core businesses, the NTN Network and Online/Internet
services. Accordingly, the Board resolved either to sell or cease the operations
of its two subsidiaries, LearnStar and IWN.
In March 1998, the Company entered into a letter of intent ("LOI") to sell
85% of its interest in LearnStar to NewStar Learning Systems ("NewStar"), a
company in which Sally A. Zoll, President of LearnStar, is a shareholder. Under
the LOI, NewStar would pay $1,200,000 for 85% of the Common Stock of LearnStar
and the Company would retain the LearnStar accounts receivable of approximately
$800,000 as of February 28, 1998. Pending a closing of the transaction, which
might occur as late as September 30, 1998, NewStar would be responsible for
providing operating funds to LearnStar. The Company is currently negotiating a
definitive agreement; however the terms of the sale have not been finalized.
There can no assurance that a definitive agreement will be executed or that
LearnStar will be sold should the proposed transaction not close.
5
On April 1, 1998, the Company reached an agreement in principle with
Omnigon, a California corporation, to sell 85% of the equity of IWN to Omnigon
on or before May 31, 1998. The agreement in principle provides that Omnigon will
pay $2,400,000 at closing for the 85% IWN equity interest. At Omnigon's option,
however, it will have the right to pay $1,200,000 at closing and deliver a
promissory note, secured by the purchased IWN common shares, for $1,600,000
payable with interest in three installments over a five-month term. If Omnigon
elects the latter option, it will acquire only 82.5% of the IWN equity. The
parties are currently negotiating the terms of a definitive agreement for this
transaction and no assurance can be given that the proposed transaction will be
completed. Omnigon paid $100,000 in April 1998 and has agreed to pay $100,000 in
May 1998, for the option to acquire IWN on the foregoing terms. Any such payment
made will be non-refundable and will not be applied to the purchase price of the
IWN shares. The Company has agreed that IWN shall use any such payment from
Omnigon to pay its operating expenses prior to a closing or cancellation of the
proposed transaction.
PRINCIPAL SERVICES AND PRODUCTS
- -------------------------------
Since the Company has decided either to sell or cease the operations of its
two non-core subsidiaries, LearnStar and IWN, the discussions throughout this
report are limited to its remaining core operations. Historical financial
information related to LearnStar and IWN is included as necessary to provide
an understanding of the Company's operations.
NTN develops, produces and distributes individual and multi-player
interactive programs to a variety of media platforms. These interactive sports
and trivia games permit multiple viewers to participate with and simultaneously
respond to the programming content. NTN has an exclusive 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 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 its arrangement with personal
computer on-line services and interactive television services. Since NTN can
distribute its programs via satellite, cable, telephone and wireless
transmission technologies, its applications are not dependent on specific
hardware or technical platforms.
The Company currently provides its products and services to the following
markets which directly related to multi-player interactive entertainment.
Network Services ("Network Services") - Live interactive television network
("NTN Network") featuring sports and trivia games which are broadcast to group
environments.
Online/Internet Services ("Online/Internet Services") - 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 OnLine
("AOL"), CompuServe and GTE MainStreet.
Although the Company has previously derived revenues from licensing it
services to companies in foreign countries ("Foreign Licensing"), there were no
material revenues from this source in 1997, and the Company has no current plans
to pursue foreign licensing as a source of future revenues.
The following is a brief description of each of the Company's markets:
NETWORK SERVICES - Network Services represents the majority of the
Company's business, providing an interactive television broadcast network
featuring sports, trivia and informational programming to over 2,700 hospitality
sites in the U.S. as of December 31, 1997. These sites include restaurant
chains (e.g., TGI Friday's, Ruby Tuesdays, Black Angus), 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 is available on the NTN Network, via arrangements
with on-line, cable delivery and internet services.
6
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. 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
AOL, CompuServe, GTE MainStreet and Bell Canada.
FOREIGN LICENSING - The Company has licensed independent companies to
broadcast in Australia/New Zealand and South Africa. Further, the Company
licenses its programs and software to Networks North, Inc., a Canadian company
("NTN 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. The South African licensee ceased its NTN-licensed operations
in March 1998. Foreign licensing is not expected to contribute significantly to
revenues in the foreseeable future.
MARKETING AND DISTRIBUTION OF SERVICES AND PRODUCTS
NETWORK SERVICES. Network Services are provided via the NTN Network, which
serves over 2,700 locations ("Locations") throughout all 50 States.
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 is furnished with NTN proprietary equipment (a "Location
System") including a personal computer, a satellite data receiving unit (usually
a small satellite dish), and a minimum of five 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 for 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 NTN Network. The following diagram
depicts the transmissions for a typical real-time, interactive game via
satellite. Customers generally execute a one-year contract to obtain the
Company's services and pay a monthly fee ranging from $400-$800.
7
[GRAPH OF NTN BROADCAST CENTER]
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 can offer both national and local advertising.
Interactive 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 popular game program.
QB1(R) is an interactive football strategy game developed and broadcast under an
exclusive license from 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:
8
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
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 (Canada only)
NTN FANTASY GAMES - Fantasy league games 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.
9
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 and taverns, tend to be busiest. 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 Live(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 Revue(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
10
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
Since 1987, Network Services has broadcast the NTN Awards Show(TM) to all
Locations 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, in a manner similar to the television
-----------
broadcast medium, sets aside a number of minutes of a broadcast hour 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 spot is 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 blended with the advertiser's logo and message. For example, the 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. Members earn
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.
11
ONLINE/INTERNET SERVICES. The Company offers 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 made available to the consumers' households through the
Company's arrangements with 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 AOL.
Revenues received include development fees and monthly 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 maintained on the Company's servers and
are available on-line 24 hours a day, seven days a week.
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 delivery. Regardless of which technology emerges as the primary means
of delivery to home users, 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. This has not been a significant source of revenue in the past and
is not expected to be a significant source of revenue in the future.
Online/Internet Services are distributed to on-line 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.
[GRAPH OF VIA CABLE/TELEPHONE]
FOREIGN LICENSING. NTN has provided its services in certain foreign
markets through licensing agreements with foreign licensees. Generally, the
Company licenses its products in foreign countries by granting the rights to use
NTN's interactive broadcast technology. NTN provides licensees with
technological know-how and assistance to build
12
a broadcast center, and to develop interactive products and programs. 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. The South African licensee ceased
its NTN-licensed operations in March 1998.
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 that utilize direct salespersons as well as independent
representatives. The independent representatives' agreements are typically one-
year agreements, with renewal clauses if the representative meets certain
performance goals. In late 1997, the Company expanded the number of regional
sales managers and direct salespersons in selected markets. The Company also
terminated many of the prior arrangements with independent representatives. In
connection with the cancellation of the independent representative agreements,
the Company paid one representative a total of $288,000 and may pay additional
sums in the future, as other terminations occur. The Company believes its in-
house sales team will be more successful in meeting its sales goals. In March
1998, the Company entered into an agreement with Datatec Systems, Inc. to
provide installation and repair services to its NTN Network customers throughout
the United States.
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 that 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 service provider's customer, the Company relies on the service provider's
marketing efforts to promote its products. However, the Company works in
conjunction with service providers to develop the promotions and advertisements.
For example, service providers such as 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. Subscribers generally pay the service provider a flat fee or
a fee based on the amount of time that the subscriber has participated with the
Company's games and services, and the service provider pays NTN.
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.
13
SOURCES OF REVENUE
The following table sets forth certain information with respect to the
principal sources of the Company's revenues during the years ended December 31,
1997, 1996 and 1995.
(Dollars in thousands) YEARS ENDED DECEMBER 31
----------------------------------
1997 1996 1995
---------- ---------- ---------
Network Services $ 20,245 20,029 15,559
Online/Internet Services 3,326 1,811 620
Advertising 772 1,590 1,128
Equipment Sales, net 55 1,310 1,363
LearnStar Revenues 786 7 440
IWN Revenues 275 0 0
Other Revenue 402 524 972
NETWORK SERVICES. The primary market for Network Services is comprised of
approximately 300,000 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), 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 $400-800 per Location. The Company
currently serves over 2,700 Locations located in all 50 States.
The Company has a license agreement with an independent licensee, NTN
Canada, pursuant to which NTN Canada solicits Locations to the NTN Network in
Canada. The Company provides NTN Network programs to NTN Canada in exchange for
an annual license fee payable in monthly installments based upon the number of
Locations in Canada, which presently number approximately 550.
As a percentage of total revenues, Network Services revenues amounted to
78%, 78% and 77% in 1997, 1996 and 1995, respectively.
ONLINE/INTERNET SERVICES. The Company provides its services to on-line
users pursuant to the agreements with various system providers such as AOL. The
on-line computer industry remains a fast-growing consumer market in terms of
subscribers. Fees from system providers are individually negotiated. In 1997,
the Company received from AOL a one-time fee of $1,000,000 for agreeing to
terminate its existing contract and renegotiate the terms of a continuing
relationship. Revenue from other service providers is based on the actual use
of the NTN interactive programs by their underlying customers.
The Company has granted to 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 any revenues generated from Canadian online
customers. The Company has not received any revenues to date relating to the
Canadian online services and no assurance can be given that the Company will
receive any such royalties in the future. As a percentage of total revenue,
Online/Internet Services revenues amounted to 13%, 7% and 3% in 1997, 1996 and
1995, 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
14
or programs. As a percentage of total revenue, Advertising amounted to 3%, 6%
and 6% in 1997, 1996 and 1995, respectively. Advertising revenue decreased in
1997 due to reorganizations in personnel assigned to sell advertising spots. The
Company has retained an independent advertising agency to obtain additional
advertising revenues from certain industry sectors and intends to execute one or
more other advertising sales agency agreements in the coming year. Although the
Company is confident in its ability to attract substantial advertisers to the
NTN Network, no assurance can be given that the Company will be successful in
the implementation of its advertising strategy.
EQUIPMENT SALES. Typically, Location Systems are provided to customers but
ownership is maintained by the Company or is leased from third parties. The
Company sells interactive equipment, particularly Playmakers(R), to its
licensees in Canada and Australia. 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 0%, 5% and 7% in 1997, 1996 and 1995,
respectively. Equipment sales are not expected to contribute significantly to
revenues in the foreseeable future.
LEARNSTAR REVENUES. LearnStar revenues are comprised of equipment sales
and software licensed to schools and school districts. Software is licensed and
the Company agrees to provide maintenance of equipment and software upgrades for
three to five years. A portion of the revenue related to licensed software is
deferred and amortized over the contract term. Payment terms are generally
provided over the term of the contract. As a percentage of total revenue,
LearnStar Revenues amounted to 3%, 2% and 2% in 1997, 1996 and 1995,
respectively. LearnStar Revenues are not expected to contribute to revenues in
the foreseeable future, as the Board has determined either to sell or cease the
operations of LearnStar.
IWN REVENUES. IWN Revenues are comprised of a software license agreement
with IWN Australasia Limited, an Australian corporation of which IWN L.P. owns
25% of the outstanding common stock. IWN Revenues are not expected to
contribute to revenues in the foreseeable future, as the Board has determined
either to sell or cease the operations of IWN.
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 the NTN Network, the Location 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 the Location Systems. The
Playmaker(R) is currently manufactured to the Company's specifications by a non-
affiliated manufacturer in Taiwan. In 1997, the Company obtained all design
plans and source codes for the Playmaker(R) from the manufacturer. Over the
past two years, and currently, the Company's Network Services customers have
experienced reliability problems with Playmakers(R). The 1997 results include a
charge of $650,000 for the replacement and repair of defective equipment and a
charge of $1,893,000 for obsolete and destroyed equipment. Equipment function
problems have been a substantial cause of customer contract terminations in the
past. The Company is working to provide a solution to such reliability
problems, although no assurances can be given that a timely solution can be
reached without undue 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. Where the Company has licenses 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 agreement with 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 agreement 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
15
connection with QB1(R) play. The agreement with the NFL expires in March 2000.
This most recent agreement expands the Company's rights to include certain
approved online services 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 agreement in the future. Further, it
is unclear whether non-renewal of the agreement would have a material adverse
effect on the Company.
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 them. The Company's
intellectual property assets are important to the Company's business and,
accordingly, the Company maintains a program directed to the protection of its
intellectual property assets.
SEASONAL BUSINESS
Overall, the Company's business generally is not seasonal. Revenue 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. Likewise, the Company has lost customers due to the
failure of customer businesses; to change in ownership and 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
highest following the completion of the NFL season in February, although churn
occurs in all months. During the Company's operating history, approximately 25-
30% of the existing Network Services customers at the beginning of a year, have
churned by the end of that 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 relatively young and little
historical data is available. No seasonal effect has been noted, however.
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 customer. The Company does not have any individual
customer who accounted for 10% or more of its consolidated revenues in 1997,
1996 or 1995.
16
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 to three
weeks). For other Online Services, there is no backlog because 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 substantially the same
terms and conditions as other corporate customers.
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 AOL, and
cable television, including GTE MainStreet, which is available to households in
certain regions.
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.
17
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 many 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. 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 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.
RESEARCH AND DEVELOPMENT
During the three years ended December 31, 1997, the Company incurred
approximately $1,600,000, $3,396,000 and $1,471,000, respectively related to
Company-sponsored research and development projects, including projects
performed by consultants for the Company.
The Company has previously experienced problems in the performance of its
49 megahertz Playmaker(R) device. The Company is currently developing a new 900
megahertz Playmaker(R) device to augment its existing 49 megahertz Playmaker(R)
device. The new device is expected to be more reliable. Further, the Company
is developing enhancements to its interactive software including a planned
migration to a "Windows" based platform and continued research into new and
enhanced graphics. The Company continuously evaluates various methods of
transmitting its programs and services. There is no assurance that the Company
will successfully complete current or planned development projects or will do so
within the prescribed time parameters and budgets. There can be no assurance,
furthermore, that a market will develop for any product successfully developed.
The Company works closely with independent user groups in an attempt to
develop new and enhanced services and products in response to customer needs.
GOVERNMENT REGULATIONS
The cost of compliance with federal, state and local laws has 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 implemented a corrective action program approved by the
FCC 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
the amount of any such penalty will not 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.
18
EMPLOYEES
The Company and its subsidiaries employ approximately 155 people on a full-
time basis and 30 people on a part-time basis, and also utilize independent
contractors for specific projects. In addition, the Company 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
----------
In 1997, the Company sold its membership in a limited liability company
that owns "The Campus", the three-building complex that houses the Company's
headquarters. The Company continues to lease space in The Campus pursuant to a
six-year lease for approximately 39,000 square feet of office and warehouse
space. The lease expires in June 2001 and the monthly rent is approximately
$36,000. The Company also leases approximately 4,000 square feet of warehouse
space near the corporate headquarters, under a lease that runs through September
1998, at a rent of approximately $3,000 per month. The Company does not expect
to renew this lease and does not anticipate leasing additional space in the next
year.
ITEM 3. LEGAL PROCEEDINGS
-----------------
In February 1998, the Company completed its previously announced settlement
of a class-action lawsuit pending against the Company since 1993. The terms of
the settlement were as follows: A settlement fund was established consisting of
$400,000 in cash plus 565,000 warrants to purchase the Common Stock of the
Company ("Settlement Warrants"). Each Settlement Warrant has a term of three
years from February 18, 1998. The Settlement Warrants were issued on February
18, 1998 and entitle the holder of a Settlement Warrant to purchase a share of
Common Stock of the Company at a price of $0.96. During the period from
February 18, 2000 to February 18, 2001, the holders of Settlement Warrants have
the right, but not the obligation, to put the Settlement Warrants to the Company
for repurchase at a price of $3.25 per Settlement Warrant (the "Put Right"),
provided, however, that this Put Right shall expire, if at any time after
February 18, 1998 the closing price per share of the Company's Common Stock on
the American Stock Exchange is more than $4.22 on any seven trading days,
whether consecutive or not. Upon expiration of the Put Right, the Company shall
have no further obligation to repurchase the Settlement Warrants. In no event
shall the Company have any obligation to repurchase its Common Stock.
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 over the period from September 1996 until February 18, 2000. In 1997, a
total of $225,000 was charged to interest expense.
On April 18, 1995, a class action lawsuit was filed in United States
District Court for the Southern District of California entitled Lenora Isaacs,
--------------
on behalf of herself and all others similarly situated vs. NTN Communications
- -----------------------------------------------------------------------------
and Patrick J. Downs. 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. As previously
announced, the Company has agreed to a settlement having a total value of
$1,450,000. The settlement, which was approved by the Court in January 1998,
consists of $250,000 in cash with the remaining balance of $1,200,000 being
payable with the Company's Common Stock or in cash, at the Company's election.
It is anticipated that the claims process will be completed by the summer of
1998 and that the Common Stock will be issued shortly thereafter. A charge of
$2,800,000 was recorded in 1996 for the estimated settlement. In the fourth
quarter of 1997, the Company reduced
19
the accrual for the settlement and accordingly reduced its legal expense by
$1,350,000 as a result of the change in estimate related to the settlement.
In May 1997, a shareholder derivative complaint was filed in the Superior
Court of California, San Diego, North County Branch. The complaint, which
sought injunctive relief and an unspecified amount of damages, was brought by a
current shareholder against the Company and certain officers and directors.
More specifically, the plaintiff alleged that the Company was injured by a lack
of independence and breach of business judgment by virtue of certain agreements
entered into in connection with the recent management reorganization. The
Company believed that the lawsuit was without merit and conveyed its position to
the plaintiffs' counsel. On June 10, 1997, the plaintiff voluntarily dismissed
the lawsuit without any payment from the Company.
On June 11, 1997, the Company was included as a defendant in litigation
entitled Eliot Miller and Jay Iyer, shareholders on behalf of themselves and all
-----------------------------------------------------------------------
others similarly situated vs. NTN Communications, Inc., Patrick J. Downs, Daniel
- --------------------------------------------------------------------------------
C. Downs, Donald C. Klosterman, Ronald E. Hogan, Gerald P. McLaughlin and KPMG
- ------------------------------------------------------------------------------
Peat Marwick LLP, which complaint was filed by the same lead plaintiff and lead
- ----------------
attorneys as in the previously dismissed derivative action. The new complaint
alleges violations of state and federal securities laws based upon purported
omissions from the Company's filings with the Securities and Exchange
Commission. More particularly, the complaint alleges that the directors and
former officers devised an "exit strategy" to provide themselves with undue
compensation upon their resignation from the Company. Plaintiffs further allege
that defendants made false statements about, and failed to disclose, contingent
liabilities (guaranteed compensation to management and the right of an investor
in IWN to require the Company to repurchase its investment during 1997) and
phantom assets (loans to management) in the Company's financial statements and
KPMG Peat Marwick LLP's audit reports, all of which served allegedly to inflate
the trading price of the Company's Common Stock. In 1997, KPMG Peat Marwick LLP
was dismissed from the suit after filing a motion to dismiss. In November 1997,
the Court dismissed all of the plaintiff's state law causes of action against
the Company but retained the plaintiff's federal law causes of action. In
February 1998, the attorneys representing the plaintiffs in this litigation
filed an action entitled Dorman vs. NTN Communications, Inc. in the Superior
Court of San Diego County, California in which they essentially replead the
state law causes of action dismissed in the federal lawsuit. In the Company's
opinion, the claims in these two lawsuits are covered by directors and officers
liability insurance providing $10,000,000 of coverage. The Company has submitted
these claims to its directors and officers liability insurance underwriters, who
have accepted such claims subject to reservation of rights. The Company's
deductible under the insurance policy is $250,000 per claim.
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 courts 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. These actions affect only the
Canadian operations of the Company and its Canadian licensee and do not extend
to the Company's operations in the United States or elsewhere. Although they
cannot be estimated with certainty, any damages the Company might incur are not
expected to be material.
The Company is a defendant in two other lawsuits. In November, 1997, the
Company's former advertising manager brought a suit alleging breach of an
alleged employment contract and age discrimination. The Company has denied any
liability in this case and does not believe its resolution will have a material
adverse effect on the financial position, results of operations and liquidity
of the Company.
In March, 1998, the Company's former independent representative in the
State of Georgia filed suit against the Company in Atlanta, Georgia alleging
wrongful termination of its distributor agreement and other breaches of such
agreement. The Company denied these claims and intends to defend itself
vigorously in this litigation. It is not anticipated at the present time that
the outcome of this lawsuit will have a material adverse effect on the financial
position, results of operations and liquidity of the Company.
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 all claims made.
During the pendency of such claims, the Company will continue to incur the costs
of defense of same. Other than set forth above, there is no material litigation
pending or threatened against the Company.
20
Recently the Company was informed that it was in default of certain
covenants contained in two leases for equipment installed at various NTN Network
locations. The Company has made all payments pursuant to these leases when and
as due and expects to do so for the remaining terms of the leases, which expire
in June and October, 1999, respectively. The respective covenants provide for a
minimum working capital ratio, for customer payments to be directed to a
specific account maintained by an independent bank, and for a minimum collection
to lease payment ratio. The Company has agreed to direct the payments of
additional customers to the specific bank accounts each month to provide the
lessors with further security. Excess account balances are returned to the
Company each month following the monthly lease payments. The Company has reached
an agreement to cure the alleged lease defaults with one lessor and such lessor
has rescinded its default notice to the Company subject to the execution and
delivery of a lease amendment and an additional collateral assignment agreement
on or before April 30, 1998. The other lessor has agreed to accept the
Company's offer to cure the default if it is paid an administrative fee. The
Company believes that it will reach an agreement to cure the alleged default on
the second lease transaction. The Company's only other sale-leaseback
transaction also contains similar covenant provisions and the Company is in
default for the same reasons. The third lessor has not declared a default. If it
does, the Company believes it may be able to enter into a similar arrangement to
direct payments from additional customers to the individual collateral bank
account. The third lease also expires in 1999.
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
-------------------------------------------------
The Company held its annual meeting of stockholders on November 3, 1997.
The matter voted upon at such meeting was the election of three directors to the
Board of Directors.
The voting for the proposal was as set forth in the table below.
VOTES VOTES
"FOR" "AGAINST" * ABSTENTIONS**
------------------------------------------------------------------
Elections of Directors
Gerald Sokol, Jr. 18,369,343 75,461 --
Edward C. Frazier 18,396,953 103,071 --
Robert Bennett 18,397,453 74,961 --
* As to election of directors, represents shares where authority to vote for
the specified nominee was withheld.
** Abstentions include "broker non-votes", which are abstentions by nominee
holders on behalf of beneficial owners who have given no instruction to the
nominee holder. When no such instructions are received, such nominee holders
have no authority to vote even though present or represented at the meeting.
21
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
("AMEX"), under the symbol "NTN." The prices below are the high and low sales
prices for the Common Stock reported by the AMEX for the two most recent fiscal
years.
1997 LOW HIGH
---- --- ----
First Quarter $3 - 3/8 $4 - 7/16
Second Quarter 2 - 5/16 4 - 3/4
Third Quarter 2 - 3/16 4 - 7/16
Fourth Quarter 1 2 - 1/4
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
On April 10, 1998, the closing price for the Common Stock reported on the
AMEX was $0.81. On that date, there were approximately 4,000 record owners of
the Common Stock.
Trading of the Company's redeemable common stock purchase warrants ("NTNW")
commenced on the AMEX in February 1998. Through April 10, 1998, the low and
high sales prices of the warrants as reported on the AMEX were $5/8 and $1 5/16,
respectively.
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.
On October 31, 1997, the Company sold and issued an aggregate of 70,000
shares of Series B Preferred Stock at a purchase price of $100 per share to two
institutional purchasers Stark International and Shepherd Investments
International, Ltd. (which each purchased 35,000 shares of Series B Preferred
Stock). The sale of the Series B Preferred Stock was effected pursuant to
Regulation D of the Securities and Exchange Commission under the Securities Act
of 1993 as amended. LG Partners, Inc. provided financial advisory services to
the Company in connection with the sale of the Series B Preferred Stock and
received a fee for such services of $210,000. The Series B Preferred Stock bears
a cumulative annual dividend of $4 per share, payable in quarterly installments
of $1 per share on the last day of January, April, July and October of each
year, commencing January 31, 1998.
Any holder of Series B Preferred Stock is entitled to convert 25% of the
Series B Preferred Stock owned by the holder into shares of Common Stock at any
time on or after February 12, 1998 (the "Initial Conversion Date"). An
additional 25% of the Series B Preferred Stock owned by a holder will become
convertible on each of the dates 60, 90 and 120 days, respectively, following
the Initial Conversion Date. Notwithstanding the foregoing, no holder will be
entitled to convert Series B Preferred Stock to the extent that the shares of
Common Stock issuable upon such conversion would cause the aggregate shares of
Common Stock beneficially owned by the holder and its affiliates to exceed 4.9%
of the shares of Common Stock outstanding following such conversion. Any
outstanding shares of the Series B Preferred Stock not converted by October 31,
2000 will automatically be converted as of such date.
The number of shares of Common Stock issuable upon conversion of each share
of Series B Preferred Stock is determined by dividing the sum of $100 plus any
accrued and unpaid dividends on the Series B Preferred Stock by the conversion
price then in effect. The conversion price on any conversion date will be equal
to the lesser of (a) 140% of the average of the closing bid prices of the Common
Stock on the AMEX on the five trading days immediately preceding the Initial
Conversion Date, but in no event more than $3.50 per share, (the "conversion
ceiling") and (b) 85% of the lowest average of the closing bid prices of the
Common Stock on any three trading days during the 20 trading days immediately
preceding the conversion date. The conversion price and conversion ceiling are
subject to adjustment in certain events, including stock dividends or
subdivisions or reclassifications of the Common Stock. The actual number of
shares of Common Stock into which the Series B Preferred Stock shall be
converted will depend on the conversion price and conversion rate in effect on
the relevant conversion date.
The number of shares issuable on conversion of the Series B Preferred Stock
is subject to adjustment in the event of a stock split, stock dividend or
similar transaction involving the Common Stock. The Company will not be
22
required to issue shares of Common Stock on any conversion to the extent that it
is prohibited from doing so by applicable law or the rules or regulations of the
AMEX or other exchange on which the Common Stock is then traded. In such event,
the holders may elect to have the Company either (i) redeem the Series B
Preferred Stock for cash at a redemption price per share equal to the product of
the number of shares of Common Stock then issuable upon the closing bid prices
of the Common Stock on the five trading days immediately preceding the
redemption election, (ii) rescind the conversion and retain the Series B
Preferred Stock, subject to the future right to convert on the terms described
herein or (iii) issue shares of Common Stock at a conversion price equal to the
average of the closing bid prices of the Common Stock for the five trading days
immediately preceding the date on which the Company receives the holders
election.
A registration statement on Form S-3 covering 8,820,000 shares of Common
Stock, some or all of which may be issuable upon conversion of the Series B
Preferred Stock, was declared effective by the Securities and Exchange
Commission on February 12, 1998.
As of April 10, 1998, the holders of the Series B Preferred Stock had
converted 2,000 shares of Series B Preferred Stock and accrued dividend thereon
into 336,658 shares of Common Stock at a conversion price of $.60 per share of
Common Stock.
23
ITEM 6. SELECTED FINANCIAL DATA
-----------------------
The following tables furnish information with respect to selected
consolidated financial data of the Company over the past five years. The Board
of Directors has recently determined either to sell or cease operations of its
two subsidiaries, LearnStar and IWN, effective March 31, 1998. The following
table has not been modified to reflect the possible sale or disposal of the
operations of LearnStar or IWN.
Statement of Operations Data
(in thousands, except per share data)
YEARS ENDED DECEMBER 31,
------------------------------------------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
Total revenue $ 25,861 25,711 20,082 16,146 11,123
Total operating expenses 38,668 51,566 25,508 16,102 13,210
------------------------------------------------------------------------------------
Operating income (loss) (12,807) (25,855) (5,426) 44 (2,087)
Other income, net 350 1 1,409 412 457
------------------------------------------------------------------------------------
Earnings (loss) from continuing
operations (12,457) (25,854) (4,017) 456 (1,630)
Earnings (loss) from
discontinued operations -- (1,317) 69 251 329
Gain on sale of discontinued
operations -- 4,219 -- -- --
Income taxes -- -- -- -- --
------------------------------------------------------------------------------------
Net earnings (loss) $ (12,457) (22,952) (3,948) 707 (1,301)
====================================================================================
Basic and diluted net earnings
(loss) per share:
Continuing operations $ (0.55) (1.15) (0.19) 0.02 (0.10)
Discontinued operations -- 0.13 -- 0.01 0.02
------------------------------------------------------------------------------------
Net earnings (loss) $ (0.55) (1.02) (0.19) 0.03 (0.08)
==================================================================================
Weighted average equivalent
shares outstanding 22,696 22,568 20,301 21,124 17,135
==================================================================================
Balance Sheet Data
(in thousands)
DECEMBER 31,
--------------------------------------------------------------------
1997 1996 1995 1994 1993
-----------------------------------------------------------------------------
Total current assets $ 8,390 10,655 26,009 18,844 23,102
Total assets $ 20,271 28,504 41,221 31,239 27,240
Total current liabilities $ 8,373 12,775 6,541 4,958 2,933
Total liabilities $ 11,545 18,282 7,770 5,782 3,587
Shareholders' equity $ 8,726 10,222 33,451 25,457 23,653
24
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
the 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.
The Company has traditionally funded its operations through cash flow from
operations and sales of equity and various debt financings. Although the
Company should benefit from additional operational cash flow from the growth of
new Locations, there can be no assurances that this cash flow will be sufficient
to sustain the Company's operations. The Company has generated cash in the past
from the sale of licenses, however, this source is sporadic and dependent upon
many influences, including the Company's willingness to continue foreign
licensing activities. Another source of cash in recent years has been
advertising revenue. Although this revenue source has grown in prior years,
advertising revenues decreased in 1997 and the NTN Network remains a relatively
new media for advertisers. There can be no assurances that advertising revenue
will grow or that the interactive broadcasting medium will become an accepted
advertising venue.
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 as more fully described below.
RESULTS OF OPERATIONS
Following is a comparative discussion by fiscal year of the results of
operations for the three years ended December 31, 1997. The Company believes
that inflation has not had a material effect on its operations to date.
YEAR ENDED DECEMBER 31, 1997 AS COMPARED TO THE YEAR ENDED DECEMBER 31, 1996
In March 1997, the Company announced a reorganization of its executive
management personnel as described under "Recent Developments" in Item 1 of the
Report, which information is incorporated herein by reference. Charges for
severance and other costs associated with the management reorganization recorded
in 1996 were $5,092,000. A charge for severance and other costs associated with
the management reorganization and other personnel changes was $4,998,000 in
1997, including accreted interest expense. The Company has recorded the
charges in 1996 and 1997 in accordance with Emerging Issues Task Force Issues
No. 94 - 3.
The Company incurred a net loss of $12,457,000 for the year ended December
31, 1997 compared to a net loss of $22,952,000 for the year ended December 31,
1996. The 1996 results include a net gain from the impact of discontinuing the
operations of the Company's former subsidiary, New World Computing, Inc., of
$2,902,000. The 1997 results include charges totaling $4,998,000 related to the
Reorganization and a $2,543,000 charge related to defective and obsolete
equipment.
For the year ended December 31, 1997, total revenues increased slightly
from $25,711,000 to $25,861,000, primarily as a result of modest growth in the
Company's primary services which offset a significant decrease in equipment
sales and reduced advertising revenue. Since the Company no longer enters into
sale and leaseback financing arrangements, equipment sales have become a minor
revenue source under current operations. Total revenue for the year ended
December 31, 1997, excluding Equipment Sales, net increased 6% over the prior
year.
25
Network Services increased 1% from $20,029,000 to $20,245,000. The
increase is primarily due to a modest growth in the number of subscriber
locations contracting for services partially offset by a revised pricing
structure. Online/Internet Services increased 84% from $1,811,000 to $3,326,000
largely due to non-recurring revenue of $1,000,000 from AOL related to AOL's
termination of its prior contract with the Company, recognition of revenue for
production services related to a large development contract of $380,000 and a
modest increase in the basic services to online customers. Although the hours
of service has remained relatively constant, the pricing structure has continued
to evolve over the past year in a downward pattern. Advertising revenues
decreased 51% during the current year from $1,590,000 to $772,000 due to a
lesser number of commercial spots sold.
Equipment Sales, net of cost of sales, during the current year decreased
73% from $1,757,000 to $475,000. Equipment Sales in the past have included
large sale and leaseback transactions. In late 1996, the Company decided to no
longer enter into sale and leaseback financing arrangements. Currently,
equipment sales are predominantly due to sales to educational customers through
the LearnStar subsidiary. The Company has determined to sell or discontinue its
LearnStar operations. In either case, equipment sales to educational customers
are expected to decline in the future. Equipment sales in the past have also
included sales to foreign licensees which are subject to outside influences and
can occur unevenly throughout the year. 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.
Operating Expenses consist of direct incremental service costs directly
related to revenue sources. Operating Expenses increased 7% from $6,124,000 in
the prior year to $6,565,000 in the current year. The increase in costs is
primarily due to a modest expansion in the number of subscribers and online
services contracting for services, increased field service costs, net of a
reduction in the sales commissions.
Selling, General and Administrative Expenses increased 12% from $17,169,000
to $19,209,000. Included in Selling, General and Administrative Expenses for
1997 are charges for the management reorganization totaling $4,813,000 and costs
associated with the abandoned merger with GTECH Corporation of $376,000. The
1996 results include a charge of $840,000 related to a charge of severance and
a change in estimate for deferred advertising costs of $222,000. Stock-based
compensation charges made in compliance with SFAS No. 123 were $3,205,000 in
1997 compared to $1,910,000 in 1996. Exclusive of these charges, Selling,
General and Administrative Expenses decreased $3,142,000 or 22%. This decrease
is primarily due to trimming the workforce and cost controls implemented in
1997. Stock-based compensation charges result from the issuance, extensions or
modifications of warrants or options to non-employees and can vary from period
to period. Charges in 1997 include $1,450,000 that resulted from extension of
the exercise period and reductions in the exercise price of warrants owned by
certain former officers pursuant to the management reorganization.
Litigation, Legal and Professional expenses decreased from $6,484,000 in
1996 to $808,000 in 1997. The 1996 amount includes charges for the settlement
of litigation of approximately $4,400,000. Charges for litigation in 1997 were
approximately $1,000,000. Included in the charges for 1996 was $2,800,000 for
the settlement of certain litigation, for which a settlement agreement was
executed in 1997 for $1,450,000. The reduction in the settlement estimate of
$1,350,000 was recorded as a reduction of Litigation, Legal and Professional
Services in 1997. In the fourth quarter of 1997, the Company reduced the accrual
for the settlement and accordingly reduced its legal expense by $1,350,000 as a
result of the change in estimate related to the settlement.
Depreciation and Amortization Expense increased 134% from $2,265,000 to
$5,305,000 due to depreciation charges resulting from the buyout of equipment
lease commitments late in 1996. The Company now owns most of its Broadcast
equipment. Equipment Lease Expense decreased 86% from $6,837,000 to $936,000
also due to the buyout of equipment leases in late 1996.
Bad Debt expense relates to trade receivables for Network Services,
Online/Internet services and educational customers. Bad Debt expense decreased
21% from $1,840,000 in 1996 to $1,462,000 in 1997. Beginning in 1996, the
Company began to experience reliability problems with its equipment in NTN
Network Locations. These problems led to an increase in bad debt expense as
customers withheld payments. In 1997, the equipment problems continued but
improved, resulting in a lower bad debt expense in 1997.
Equipment Charges increased 3% from $2,478,000 in 1996 to $2,543,000 in
1997. Equipment Charges consist of charges for obsolescence and shrinkage of the
Company's stock of broadcast equipment. The Company performs periodic reviews of
its broadcast equipment. In connection with these reviews, the Company
determined that certain equipment primarily related to terminated sites had
become obsolete, defective, or could not be located.
26
Other Income (Expense) increased from $1,000 in 1996 to $350,000 in 1997.
Interest Expense increased 103% from $390,000 to $793,000 largely due to
interest charges related to the repurchase of an the shares of IWN from
Symphony, interest paid to GTECH, and accretion of interest for the settlement
warrant liability and the liability for the management reorganization. In 1997,
the Company sold its interest in a building and recorded a gain of $905,000.
There was no tax expense in 1997 and 1996 primarily due to taxable losses and
offsetting temporary differences in both years.
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. The 1996 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 1996, the Company treated New World as a discontinued operation.
In the second quarter, the Company reported an estimated tax expense of
$1,000,000. The change in the estimated tax provision resulted from an
analysis of the relevant tax laws and a valuation study performed to establish
the Company's minimum tax liability which analysis was completed in the fourth
quarter. The 1996 and 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 No. 123. An analysis of revenue and operating costs follows a detailed
discussion of the significant other charges.
Charges for severance recorded related to terminations or resignations of
managers and other employees in 1996 amounted to $840,000. Most of the former
officers involved in the management reorganization in 1997, 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. Therefore, in conjunction with the management reorganization, all
outstanding notes receivable were canceled, and accordingly a charge for
$4,252,000 for principal and the related accrued interest was recorded in 1996.
Also 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, 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 cost-cutting measures implemented to improve operations. Severance
payments for non-executive lay-offs will not affect future 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.
Unamortized 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 was determined that
advancements in technology had rendered obsolete certain equipment and inventory
used by the Company. Accordingly, a charge of $2,478,000 was recorded in the
third quarter of 1996. This charge was not due to a contraction in the
Company's core businesses and will not effect future liquidity or results of
operations.
27
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, sought 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.
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 the
Company ("Settlement Warrants"). Each Settlement Warrant has a term of three
years from February 18, 1998. The Settlement Warrants were issued on February
18, 1998 and entitle the holder of a Settlement Warrant to purchase a share of
Common Stock of the Company at a price of $0.96. During the period from
February 18, 2000 to February 18, 2001, the holders of Settlement Warrants have
the right, but not the obligation, to put the Settlement Warrants to the Company
for repurchase at a price of $3.25 per Settlement Warrant (the "Put Right"),
provided, however, that this Put Right shall expire, if at any time after
February 18, 1998 the closing price per share of the Company's Common Stock on
the American Stock Exchange is more than $4.22 on any seven trading days,
whether consecutive or not. Upon expiration of the Put Right, the Company shall
have no further obligation to repurchase the Settlement Warrants. In no event
shall the Company have any obligation to repurchase its Common Stock.
On April 18, 1995, a second class action lawsuit was filed in United States
District Court. The complaint alleges violations of federal securities laws
based on 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
believes there is no basis for the claimants' allegations. Nonetheless, the
Company, to avoid the expense and disruption of protracted litigation, has been
attempting to settle the case. The Company estimated and recorded a charge of
$2,800,000 in 1996 related to this suit. The case was settled in 1997.
In October 1995, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 123, "Accounting for Stock-based
Compensation" ("SFAS No. 123"), effective for fiscal years beginning after
December 31, 1995. SFAS No. 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 chose to continue using the intrinsic value
based method for issuances to employees, as allowed by SFAS No. 123.
Under SFAS No. 123, transactions involving non-employees for which issuance
of equity instruments for goods or services are to be recorded using the fair
value method. The fair value method states that the amount recorded is to be
based on 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 an agreement ("Agreement") with
Symphony LLC ("Symphony"), an unaffiliated company, whereby Symphony agreed to
purchase a 10% interest in IWN for $350,000 and would make capital contributions
totaling $2,650,000 to IWN L.P., a limited partnership of which IWN is the
general partner.
The Agreement included a provision whereby Symphony had the option to put
("IWN Put Option") its partnership interest and its shares of IWN to NTN
commencing April 1, 1997 through December 1, 1997 for certain consideration.
Accordingly, the Company included the accounts and results of operations of IWN
L.P. in the Company's consolidated financial statements for the year ended
December 31, 1996. On April 8, 1997, Symphony exercised the IWN Put Option. At
December 31, 1996, the aggregate obligation, assuming the Put Option would be
exercised, was $3,045,000. This amount was recorded as a short-term borrowing in
the consolidated financial statements as of December 31, 1996. Operating losses
for IWN L.P. aggregated $2,961,000 in 1996.
For the year ended December 31, 1996, total revenues increased 28% from
$20,082,000 to $25,711,000. This increase is the result of growth in the
Company's principal revenue activities, Network Services and Online/Internet
Services.
28
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 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 decreased 3% from $1,803,000 to $1,757,000. Equipment
sales are predominantly related to foreign licensees which are subject to
outside influences and can occur at random times throughout the year and sale
and leaseback arrangements. 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. In late 1996, the Company
decided to no longer enter into sale and leaseback transactions.
Operating Expenses consist of incremental service costs directly related to
revenues. Operating Expenses rose from $3,799,000 to $6,124,000, an increase of
61%. The increase is largely attributable to the expansion in the number of
subscribers and on-line services contracting for services and increased service
and freight costs associated with increasing equipment reliability issues.
Selling, General and Administrative expenses increased 45% from $11,838,000
to $17,169,000. 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; additional marketing expenses incurred during the period
that shipments of Playmakers(R) were suspended pending approval from the FCC of
$350,000; a charge of $222,000 related to a change in estimate for deferred
advertising costs; and approximately $2,900,000 of costs associated with the
development of a product at the IWN L.P. subsidiary. Prior to 1996, IWN L.P.
was an unconsolidated affiliate.
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 Litigation, Legal and
Professional services in 1996 are charges of approximately $4,400,000 for
settlement of existing lawsuits. 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 and Amortization
expense increased 110% from $1,078,000 to $2,265,000 due to the higher base of
depreciable assets that resulted from the buyout.
Bad Debt expense relates to trade receivables for Network Services,
Online/Internet services and educational customers. Bad Debt expense increased
185% from $645,000 in 1995 to $1,840,000 in 1996. Beginning in 1996, the
Company began to experience reliability problems with its equipment in NTN
Network Locations. These problems led to an increase in bad debt expense as
customers withheld payments.
Equipment Charges increased 148% from $1,000,000 in 1995 to $2,478,000 in
1996. Equipment Charges consist of charges for obsolescence and shrinkage of
its stock of broadcast equipment. The Company performs periodic reviews of its
broadcast equipment. In connection with such a review, it was determined that
certain equipment used by the Company had become obsolete or defective.
Accordingly, a charge of $2,478,000 was recorded in 1996. The increase is
associated with the growth of the number of customers and the amount of
equipment to be replaced.
In connection with the management reorganization, the Company canceled, as
of December 31, 1996, certain notes receivable due from executive officers
resulting in a charge 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.
Other Income (Expense) decreased from $1,409,000 in 1995 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.
29
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. To reduce operating costs, the Company has determined
either to sell or cease operations of its two subsidiaries, LearnStar and IWN as
of March 31, 1998. The Company plans to fund any future operating deficiencies
from its existing cash and, if necessary, from other sources, as discussed
below.
In 1997, the Company reported a loss of $12,457,000. The 1997 results
include charges totaling $4,998,000 related to the management reorganization and
a $2,543,000 charge related to obsolete and defective equipment.
In 1996, the Company reported a loss of $22,952,000. The 1996 results
include substantial charges for the Reorganization and layoffs of other
personnel, cancellation of notes receivable, 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 year included charges related to the issuance of equity
instruments as recorded under the guidelines of SFAS No. 123. Many of these are
non-cash related charges which had little 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 a period of time in
excess of one year, and can, in some cases be settled with the issuance of stock
instead of using cash. The management reorganization and lay-offs of other
employees were not due to a contraction in the Company's core businesses, but
rather were cost-cutting measures being implemented to improve operations. These
liabilities, depending on the extent and timing, could affect future liquidity,
but are expected to be funded from on-going operations.
Total assets decreased 29% from $28,504,000 to $20,271,000 at December 31,
1996 to December 31, 1997. The decrease in assets is primarily due to operating
losses, and repayment of debt, which was offset by net proceeds of Series B
Preferred Stock issuances. Cash decreased from $6,579,000 to $4,764,000 at
December 31, 1997 due primarily to $1,944,000 used for payments to former
officers pursuant to the management reorganization, net of cash proceeds from
the issuance of Series B Preferred Stock of $6,707,000. From the proceeds of the
Series B Preferred Stock, the Company repaid its loan to GTECH Corporation of
$3,700,000. The Company also expended $4,720,000 to