Item 1. Business
Corporate History and Development
Interactive Entertainment Limited (the "Company" or "IEL") was incorporated pursuant to the laws of the Province of British Columbia on January 28, 1981 under the name Tu-Tahl Petro Inc. On May 10, 1990, the Company changed its name to Creator Capital Inc. The Company was reincorporated through the continuance of its corporate existence from the Province of British Columbia to the Yukon Territory on July 15, 1992. On January 23, 1995, the Company changed its name to Sky Games International Ltd. ("SGI"). Effective February 22, 1995, the Company continued its corporate existence from the Yukon Territory to Bermuda as an exempted company under the Companies Act 1981 (Bermuda) (the "Bermuda Act"). In June, 1997, the Company changed its name to Interactive Entertainment Limited following consummation of the amalgamation of the Company's wholly-owned subsidiary, SGI Holding Corporation Limited ("SGIH"), and SGIH's formerly 80% owned subsidiary, then known as Interactive Entertainment Limited ("Old IEL"), which was followed immediately by an amalgamation of SGI with the survivor of the first amalgamation, (the "Amalgamations"). Unless the context otherwise requires, the term "Company" refers to Interactive Entertainment Limited, its wholly-owned subsidiaries, IEL (Singapore) Pte. Ltd., Sky Games International Corporation ("SGIC"), and Creator Island Equities Inc., and for periods prior to June 17, 1997, also SGIH and Old IEL, which was the Company's principal operating subsidiary from December 30, 1994, through such Amalgamations. Also included is Inflight Interactive Limited, a wholly-owned subsidiary of the Company, from January 13, 1998.
The initial purpose of the Company was natural resource exploration and development; however, beginning in January 1991 the Company concentrated its efforts on acquiring, developing and commercializing a gaming technology marketed as Sky Games(TM) for inflight use by international airline passengers and patrons in other non-traditional gaming venues. In pursuit of this purpose, the Company in 1991 acquired the principal assets of Nevada-based Sky Games International, Inc. ("SGII"). In late 1994, the Company formed Old IEL as a joint venture with subsidiaries of Harrah's Entertainment, Inc., ("Harrah's"), which resulted in the transfer to Old IEL of the Company's inflight gaming business and the execution of a management agreement with Harrah's with respect to Old IEL and other related relationships. Pursuant to such management agreement, Old IEL's operations were managed by a Harrah's subsidiary. The description herein of the Company's operations from December 30, 1994 through June 17, 1997 with respect to inflight gaming activities refers to the operations of Old IEL under the management of this subsidiary of Harrah's. Until the Amalgamations, because the management of the business of Old IEL had been substantially delegated to a third party manager the management and affairs of the Company were subject to numerous contractual requirements and limitations.
Business Overview
The Sky Games system was developed to introduce gaming to international airline passengers. The system is designed to enable users to play a number of casino-type games from their seats by way of a built-in, color, interactive, in-seat monitor. The product design in its current form has been possible since the introduction of audio-video interactive inflight entertainment hardware ("IFE") systems. The Sky Games system has been integrated with the IFE systems offered by Matsushita Avionics Systems Corporation ("MASC") and is also intended to be interfaced with systems manufactured by other leading manufacturers including, among others, Sextant Avionique In-Flight Systems, Rockwell Collins, Sony Trans Com Inc. and The Network Connection, Inc.
The Company believes that an opportunity exists to introduce casino games on international air flights, based on the following factors: (i) many commercial international air routes involve long flights which create the opportunity for the entertainment of passengers; (ii) many airlines have indicated that they view IFE systems as a source of additional revenue; (iii) in certain parts of the world and in certain markets, gaming is increasing in popularity and public acceptance; and (iv) as with all casino style gaming, the odds are in favor of the "house"
when played over a period of time. The Company has conducted limited field surveys in conjunction with affiliates of Harrah's to measure passenger reaction to inflight gaming in general and to gather statistical information related to game preferences, projected passenger participation, betting limits and acceptance of the Company's software design. While, these surveys support the Company's belief regarding inflight gaming, operations on Singapore Airlines ("SIA") did not validate the surveys.
In April of 1996, the Company announced the signing of contracts for the provision of gaming services to SIA. The term would commence with SIA's acceptance, for use on its aircraft, of the Company's gaming software. However, the agreements are subject to a trial period and to termination by either party upon the occurrence of specified events. SIA launched the first flight with gaming on June 1, 1998. A second aircraft was added in mid-October.
The commencement of gaming operations on an airline requires the successful installation on the airline's aircraft of an IFE system. The Company currently does not manufacture, provide, install or service IFE systems. The Company understands that in the past, several airlines have experienced difficulties with the installation and testing of IFE systems, but based on discussions among the Company, various airlines and the IFE system providers, the Company believes that IFE systems are becoming more reliable.
On January 13, 1998, IEL completed the acquisition of all the outstanding capital stock of Inflight Interactive Limited ("IIL") in exchange for 500,000 shares of the Company's $.01 par value common stock (the "Common Stock"). IIL is a United Kingdom developer and provider of amusement games to the airline industry. The games are marketed under the name Sky Plan and are operating on a number of airlines, including Air China, American Airlines Cathay Pacific, Continental, Egypt Air, Lauda Air, Malaysia Airlines, and Virgin Atlantic. The purchase agreement provides for the Company to issue up to 250,000 additional shares of Common Stock to the previous owners of IIL upon achievement of certain milestones regarding implementation of the Company's Sky Games gaming software with an international airline to be designated by the parties. The acquisition was accounted for using the purchase method.
Recent Developments
On November 12, 1998, the Company announced that it had been unable to attract the additional capital necessary for continued development of its Sky Games inflight gaming business and that it had discontinued all operations associated with the Sky Games product line and planned to conduct an orderly disposition of all the assets related to the Sky Games product. The Company stated that it would refocus its business efforts to concentrate exclusively on its Sky Play PC games, non-gaming inflight customers and business. All employees were terminated as of November 13, 1998. Some former employees have been retained on a part-time contract basis to continue operations and support the Sky Play product. On December 22, 1998, the company announced that it would also seek bids for its Sky Play amusement game business.
Following these announcements, the company received a series of communications from shareholders representing approximately 43% of the company's shares stating a clear interest in seeing that the company retain its assets and continue its operations. The Company subsequently ceased the sale of assets. Although Sky Games is not currently operational, the Company continues to operate the Sky Play business.
On March 22, 1999 SIA notified the Company that it was terminating the agreements related to Sky Games.
Gordon Stevenson resigned as President and CEO and subsequently resigned from the company's Board of Directors. Due to an increase in the number of shares outstanding upon conversion of a portion of the Company's Class B Series A Preference Shares, Harrah's ownership percentage has decreased to a level that entitles them to one seat on the Board of Directors. Accordingly, Harrah's representatives Charles Atwood and Judy Wormser have resigned from the Board. Quinten Dreesmann, Laurence Geller, Phillip Gordon, and Amnon Shiboleth have also resigned from the Board of Directors.
The Product
The Sky Games system is a self-contained, computerized gaming system that enables airline passengers to play popular casino-style games at their seats. Airlines can add gaming to aircraft fitted with compatible IFE equipment with only nominal retrofitting cost and little or no aircraft downtime.
The Sky Games software was designed and written in layers. This layered approach effectively insulates the top-level applications (gaming software) from the specifics of the underlying hardware. The first level of software is composed of device and system drivers. Where the hardware is unique to the specific system, the drivers are provided by the hardware supplier. As additional layers of software are added, the interface becomes less hardware specific. The goal is to reach a level of abstraction sufficiently removed from the hardware details so that the application software needs to have little, or perhaps no, direct knowledge of the hardware that is supporting the operating environment. This top-level interface is the Application Programming Interface ("API"). The IEL software is written to the Microsoft Windows API. The service integrator will provide an API or APIs that will extend the Windows API by providing access to IFE specific functions. Any Intel based platform that can support Microsoft Windows will provide the necessary operating environment for the gaming software.
In order to operate the Sky Games system in commercial settings, the Company must provide additional hardware and software systems necessary to properly record and account for gaming activities by patrons. The Company designed accounting and financial control systems for the management of inflight gaming operations. Inflight gaming transactions were conducted through major credit cards. The major credit card companies have developed rules for the use of their cards in connection with inflight gaming wherein, presently, the maximum purchase of gaming credits on a credit card is U.S. $350 and winnings are capped at U.S. $3,500.
Sky Play offers airlines the choice of up to 18 amusement games. Unlike Nintento-style games, which are designed to keep the player challenged and interested over long periods of time, and which generally require player skill developed over a period of time, IEL has selected and developed the Sky Play amusement games which have very simple rules, are already well known or easy to learn and are very simple to play.
The Company has been granted federal registration of the Sky Games logo and the slogan "We Make Time Fly" by the U.S. Patent and Trademark Office. In addition, the Company has applied for registration of the Sky Casinos International logo and the marks "Sea Games International" and "Sky Play." At this time the Company has not applied for any patents. Upon completion of successful testing results, an assessment will be made of the Company's gaming systems and designs and patent applications may be filed where appropriate. The Company's proprietary software is copyrighted and contains security features designed to "lock" the software if it is tampered with.
The Industry
The Boeing Company's 1999 Current Market Outlook forecast passenger traffic growth of 4.7% annually over the next 20 years. The report noted that, to meet that growth, airlines are expected to add over 20,000 airplanes worth more than $1.38 trillion to their fleets. Boeing estimates that approximately 26% of these new aircraft will be intermediate and large aircraft which IEL believes will represent a substantial market for IFE systems and inflight content.
Industry statistics indicate that gaming, in general, is gaining increased market acceptance in many regions of the world and that U.S. casino revenue increased from U.S. $8.9 billion in 1991 to U.S. $22.8 billion in 1996. North Americans account for only a portion of the worldwide gaming industry. Casino gambling, for example, also exists in Australia, the Bahamas, Canada, Denmark, Chile, Germany, Great Britain, Malaysia, Monaco, the Netherlands, Puerto Rico, South Africa, Switzerland, Turkey and Uruguay. The U.S. Department of Transportation estimated in March, 1996, that the potential inflight gaming revenue for non-U.S. airlines is approximately $480 million per year.
The Company anticipates that the IFE industry will grow rapidly over the next three to five years as airlines commit to interactive IFE hardware based on improved product reliability and demonstrated revenue generation. Accordingly, the Company is committed to building its core business by focusing initially on the airline market but also investigating the potential of other venues such as cruise ships, ferry boats, trains and hotel rooms.
Competition
The Company has had two primary competitors for its inflight gaming systems, including InterGame and Interactive Flight Technologies, Inc. ("IFT"). InterGame installed its system on Lauda Air in March 1998. IFT launched inflight gaming with Swissair in January 1997. IFT has subsequently announced that it would sell its inflight gaming business to The Network Connection, Inc. and exit the business. These companies may have significantly greater financial and technical resources than the Company, and there can be no assurance that the Company will be able to compete effectively with such companies if it reenters the inflight gaming business. The Company believes that in the event inflight gaming and related activities become more established, additional competitors with alternate approaches are likely to enter the business. Other inflight offerings, such as shopping and movies, could also be considered as indirect competition.
The Company has several competitors for its amusement games most of whom are small companies like IEL. The Company believes that it is the only provider of amusement games to the airline industry with games operational on more than one IFE platform.
Market and Marketing
In the very competitive airline market, airlines are seeking a distinctive, competitive edge to attract and retain paying customers. Entertainment and service systems are forming a part of airlines' current business strategy.
The Company's primary target market for Sky Games has been Asian and Pacific Rim airlines whose passengers, with certain exceptions, generally have a broad cultural acceptance of gaming. The Company believes that the Latin American and European markets may also hold strong potential. Gaming is prohibited on the aircraft of U.S. commercial air carriers and on all flights to and from the United States.
The Company believes that the principal benefits of its product to the airlines will be the ability to enhance entertainment offerings to passengers and airline participation in a potential revenue stream. IFE systems are capital intensive; however, providing passenger service and comfort, especially for first and business class travelers, is a major area of competition for airlines.
The target market for Sky Play has been domestic and foreign airlines which have committed to the purchase of or installed IFE systems.
Manufacturing
As a software producer and operator, the Company has no manufacturing capability. The Company's software is designed to interface with in-cabin hardware, including onboard computers, file servers, distribution and communication systems, manufactured by various suppliers for the airlines.
Sky Games System Acquisition
On November 7, 1991, the Company entered into an agreement, with subsequent amendments, with Sky Games International, Inc. ("SGII") to purchase technology, proprietary rights and prototypes of the casino games known as "Sky Games." The purchase price of the assets was 300,000 shares of the Company's $.01 par value common stock (the "Common Stock") issued to SGII at a deemed price of $1.65 per share, plus an additional 3,000,000 shares of Common Stock held in escrow to be released on the basis of one share for each U.S. $1.78 of net cash flow generated from the assets over a ten-year period (the "Performance Shares"). Of the 3,000,000 shares, 2,000,000 were issued to SGII and 1,000,000 shares to Anthony Clements, an advisor to and director of the Company. The Performance Shares are held in escrow by Montreal Trust Company of Canada.
As of April 30, 1997, the holders of the Performance Shares have agreed with the Company to tender such shares to the Company when and if they are released from the escrow, and the Company has agreed to cancel such shares. The holders of the Performance Shares have also granted an irrevocable proxy to a bank which has irrevocably agreed not to vote such shares. Since the Performance Shares are subject to cancellation and may not be voted, management of the Company does not consider the Performance Shares to be outstanding.
The Amalgamations
Effective as of December 30, 1994, the Company, through SGIH, and Harrah's Interactive Investment Company ("HIIC") completed the formation of Old IEL as a joint venture corporation incorporated as an exempted company under the Bermuda Act. At the same time, (i) Old IEL entered into a management agreement (the "Management Agreement") with Harrah's Interactive Entertainment Company (the "Manager"), (ii) the prior consulting agreement between Harrah's and SGIC was terminated, (iii) SGIC assigned all right, title and interest in the Sky Games system and related trademarks and trade names to the Company, and (iv) the Company licensed the Sky Games system and certain related trademarks and trade names to Old IEL. In connection with the Amalgamations, the contractual agreements with the affiliates of Harrah's were terminated.
The ownership interests of the Company and HIIC in Old IEL were 80% and 20%, respectively, prior to the Amalgamations. The Company and HIIC had funded a total of $5 million to Old IEL. Additional capital, if not available from third parties, was to have been provided by the Company and HIIC in proportion to their shareholdings. The Executive Committee of Old IEL was to determine whether additional capital was to be provided as equity or debt. Under the shareholders agreement, each party had certain options with respect to the other party's stock. The shareholders agreement was terminated effective June 17, 1997.
The Manager had been granted and had assumed broad responsibility for managing the business of Old IEL, including completing the development of and improving the Sky Games software and all other systems, marketing to airlines and customers and day-to-day gaming operations. The Management Agreement had a two-year term, but could have been renewed at the Manager's option for successive two-year terms up to a maximum term of 10 years. The Manager had a right of first negotiation on a renewal agreement. Management fees were dependent on the amount of gross revenues with a maximum fee of 7.5% of gross revenues and a minimum monthly fee of $10,000. Old IEL was required to pay all operating costs (including capital expenditures) of the business, which included the cost of services and goods provided by the Manager and its affiliates under the Management Agreement.
The Manager could have declared a default under the Management Agreement if IEL, SGIH, any of SGIH's affiliates or any of their officers, directors or employees committed any act that the Manager determined could have affected any gaming license or approval (whether or not any regulatory action was commenced or threatened) held by the Manager, any of its affiliates, Old IEL, SGIH or any of SGIH's affiliates.
The Amalgamations were consummated on June 17, 1997, and, in conjunction with the Amalgamations, the Management Agreement was terminated, and management of the Company assumed direct responsibility for day to day operations. The Company also entered into a Continuing Services Agreement with Harrah's for certain services.
The Company had exclusively licensed Old IEL to use certain of the Sky Games trademarks, trade names and other trade rights. This license was replaced in the Amalgamations by a similar license to Harrah's for use of the Company's software, as it existed on June 17, 1997, in traditional casino venues owned, operated or managed by Harrah's. The license is royalty-free, worldwide and non-terminable.
In 1994, the Company terminated certain contractual rights previously granted to BEA in connection with the development of an earlier generation product for inflight gaming use. In connection with this termination, the Company issued a U.S. $2,500,000 convertible promissory note due March 30, 1997. The unpaid balance of the note, including accrued interest, was exchanged for Redeemable Convertible Class A Preference Shares in the Company on June 16, 1997.
Major Customers
The Company's Sky Play customers include Air China, American Airlines, Cathay Pacific Airways, Continental, Egypt Air, Lauda Air, Malaysia Airlines and Virgin Atlantic Airways. The two largest customers account for approximately 40% of Sky Play revenue.
Employees
All employees were terminated as of November 13, 1998. Some former employees have been retained on a part-time contract basis to continue operations and support the Sky Play product. As of July 30, 1999 the Company had no employees.
Item 2.
Item 2. Properties
Not applicable.
Item 3.
Item 3. Legal Proceedings
The Company is not currently a party to any material pending legal proceedings.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable
PART II
Item 5.
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Since March 25, 1999, the Company's Common Stock has been traded on the OTC Bulletin Board under the symbol "IELSF." From July 8, 1997 until March 24, 1999, the Company's Common Stock was traded on the Nasdaq SmallCap Market under the symbol "IELSF." From March 1, 1994 until July 8, 1997, the Company's shares traded on the Nasdaq SmallCap Market under the symbol "SKYGF."
On October 5, 1998, the Company was notified by Nasdaq that the Company's shares had failed to maintain a bid price greater than or equal to $1.00 per share for the prior thirty consecutive trading days and were subject to delisting effective January 5, 1999. Maintenance of a $1.00 stock price is required for continued listing of the Company's Common Stock on The Nasdaq SmallCap Market. The Company delayed the delisting by requesting a hearing before a Nasdaq panel. The hearing was held on February 26, 1999 at which time the company requested an extension to May 31, 1999 following the company's annual meeting at which the shareholders would have been asked to approve a reverse stock split designed to bring the company back into compliance. The delisting of March 24, 1999 reflects the hearing panel's decision not to grant that extension. According to written notice received by the company, "the Panel noted that the Company has failed to comply with the minimum bid price requirement... In addition, the Panel lacked confidence in the Company's ability to sustain compliance with the minimum bid price requirement subsequent to the effectuation of a reverse stock split, particularly in light of the floating rate' convertible preferred stock currently outstanding." The company filed an appeal of the delisting but subsequently withdrew the appeal, since it believed it would not be able to maintain other Nasdaq SmallCap listing requirements.
The table below sets forth, for each fiscal quarter within the last two years, the reported high and low closing prices of the Common Stock as reported by the Nasdaq SmallCap Market.
As of May 12, 1998, there were 245 shareholders of record. Since certain of the shares of Common Stock are held by brokers or other nominees, the number of record holders may not be representative of the number of beneficial holders. The Company believes there are approximately 2,600 beneficial holders of the Company's Common Stock.
The Company has not paid any cash dividends on its Common Stock and does not anticipate paying any such dividends in the foreseeable future.
In June, 1997, the company issued 2,737 Class A Preference Shares in exchange for a promissory note in the amount of $2,737,000. During 1998, the Company and the holder agreed that the Company would redeem the Class A Preference Shares in installments beginning June 30, 1998. As of August 31, 1998, the Company had redeemed 500 shares at their redemption price of $1,000 per share. The Company was unable to redeem additional shares. As of June 10, 1999, 2,237 Class A Preference Shares remained outstanding and were convertible into 19,552,221 shares of Common Stock on that date. If the Class A Preference Shares are converted into Common Stock, HIIC has the right to receive additional shares of Common Stock at $0.01 per share. As of June 10, 1999, HIIC would be entitled to receive 2,397,303 shares. The actual number of shares of Common Stock issuable upon conversion may be higher or lower and is based on a discount to the 20 day average of the mean closing bid and ask price of the Company's Common Stock and is inversely proportional to the market price of the Company's Common Stock i.e. if the average share price decreases, the number of shares of Common Stock issuable increases. Dividends on the Class A Preference Shares have been paid through September 30, 1998 and are in arrears for subsequent periods.
In October 1997, the Company completed an agreement with an investor for the private placement of 925,747 shares of Common Stock for an aggregate purchase price of $3.0 million. $1.5 million (approximately $1,352,000 net of offering expenses), ("Tranche A"), was received upon closing while the remaining $1.5 million ("Tranche B") was to be funded upon and was contingent upon completion of the first flight with the Company's software available in all seats of a Singapore Airlines aircraft prior to April 22, 1998. For each five shares of Common Stock purchased and held for a minimum of six months, the investor was to have received one warrant for the purchase of additional shares. Warrants were to be exercisable at a price of $3.8125 per share for 18 months from their issue. As of April 2, 1998 the Company and the investor agreed to amended terms under which 50% of the remaining portion ($750,000) was funded immediately while the other 50% was to be funded under the terms of the original agreement. The subscription price for the Common Stock purchased in Tranche B was revised to $2.62125. Warrants issuable under Tranche A will not be issued. However, for each of the 286,123 Common Shares purchased in Tranche B, 0.85 of a warrant to purchase Common Stock will be issued after a six month holding period for the Common Stock purchased in Tranche B. The warrants, if issued, will have an exercise price of $2.62125 and a term of 18 months. The first $750,000 was funded under the amended terms; however, the flight required for funding of the second $750,000 did not take place prior to April 22, 1998. Subsequently, IEL and the investor agreed to a $750,000 purchase on the same terms. This additional investment was consummated on June 5, 1998.
On December 17, 1997, the Company issued 1,000 shares of Series A Convertible Preference Shares of the Company's Class B Preferred Stock for a total consideration of $1,000.000. The Class B Series A Preference Shares are convertible into a number of shares of Common Stock, determined by dividing the stated value of $1,000 per share by the lesser of: $3.2038 (the "Fixed Conversion Price") and a price (the "Floating Conversion Price") calculated as 85% of the average of the three lowest closing bid prices for the Common Stock during the thirty trading days occurring immediately prior to, but not including, the conversion date. Dividends are cumulative and may be paid, at the option of the Company and with prior notice, in additional shares of Common Stock at an annual dividend rate of 8%. Warrants for the purchase of 61,718 shares of Common Stock were issued in connection with the issuance of the Series A Class B Convertible Preference Shares. The warrants, which have an exercise price of $3.2038, are exercisable beginning June 17, 1998 and expire on December 17, 1999. Under the agreement, the Company had the option of selling a second tranche with 123,432 warrants for
an aggregate purchase price of $2,000,000 following the installation of the Company's gaming software on an SIA aircraft and the availability of the software to paying passengers in the entire cabin. The Company's option with respect to the second tranche, was set to expire on June 17, 1998. Upon agreement of the parties, funding of the second tranche was deferred until a registration statement for resale of Common Stock issued upon conversion of the Series A Class B Preference Shares had been declared effective by the SEC. The registration statement was declared effective on July 15, and the additional funding of $2,000,000 was completed on July 24, 1998. The original purchasers of the company's Class B Series A Convertible Preference Shares converted 600 of the shares into Common Stock, retained 120 shares, and have sold the remaining 2,280 of the convertible preference shares in private sales. As of June 10, 1999, 1,280 shares of the Class B Series A Preference Shares had been submitted for conversion into 28,550,710 shares of Common Stock. All Common Stock issuable upon the conversions has been issued except for 3,492,426 shares which the Company lacks the authority to issue since issuance would cause the Company to exceed its maximum authorized capital. Subsequent to the conversions, the holders of the Class B Series A Preference Shares agreed to amend the conversion terms so that the Floating Conversion Price will not be less than $0.25 per share. Assuming that shareholders of the Company approve an increase in the authorized capital of the Company, a total of 1,720 shares of the Class B Series A Preference Shares will be outstanding. As of June 10, 1999 these 1,720 Class B Series A Preference Shares were convertible into 6,880,000 shares of Common Stock. The actual number of shares of Common Stock issued upon conversion may be higher or lower and is based on a discount to the average of the lowest three closing bid prices of the Company's Common Stock during the last 30 trading days and is inversely proportional to the market price of the Company's Common Stock i.e. a lower market price would result in a greater number of shares of Common Stock being issued upon conversion.
As of February 20, 1998, the Company sold 300 shares of Series B Class B Convertible Preferred Stock at $1,000 per share. The Series B Class B Convertible Preferred Shares have the same dividend and conversion features as the Series A Class B Convertible Preferred Shares. The investor also received a warrant to purchase 18,515 shares of Common Stock at a price of $3.2038 for 18 months. As of June 10, 1999, 38 shares of the Series B Class B shares had been converted into 663,274 shares of Common Stock and 262 shares remained outstanding. As of June 10, 1999, the 262 outstanding Series B Class B Preference Shares were convertible into 2,465,882 shares of Common Stock. The actual number of shares of Common stock issued upon conversion may be higher or lower and is based on a discount to the average of the lowest three closing bid prices of the Company's Common Stock during the last 30 trading days and is inversely proportional to the market price of the Company Common Stock i.e. if the average share price decreases, the number of shares of Common Stock issued upon conversion will increase.
It is the Company's intent to renegotiate the conversion terms of the Class A Preference Shares and the Class B Series B Preference Shares in an attempt to eliminate the floating conversion price.
Item 6.
Item 6. Selected Financial Data
(in thousands except per share and share data)
- -------- (1) Excludes Performance Shares
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Overview
Interactive Entertainment Limited ("IEL" or the "Company"), formerly known as Sky Games International Ltd. ("SGI"), is a Bermuda exempted company which was incorporated on January 28, 1981. The Company's activities have been focused on providing inflight gaming software and services by developing, implementing and operating a computer-based interactive video entertainment system of gaming and other entertainment activities on, but not limited to, the aircraft of international commercial air carriers.
On December 30, 1994, the Company entered into a Shareholders Agreement with SGI Holding Corporation Limited ("SGIH"), a wholly-owned subsidiary of SGI, and an affiliate of Harrah's Entertainment, Inc. ("Harrah's"), to form a corporation then known as Interactive Entertainment Limited ("Old IEL"), the result of which was that Old IEL became owned 80% by SGIH and 20% by Harrah's. Pursuant to a management agreement, (the "Management Agreement"), Old IEL was managed by an affiliate of Harrah's.
At a Special General Meeting of shareholders held on June 16, 1997, pursuant to a Plan and Agreement of Merger and Amalgamation dated May 13, 1997, (the "Amalgamation Agreement"), Old IEL was merged into SGIH and then into SGI (the "Amalgamations"). Prior to the Amalgamations, Harrah's owned 20% of the capital stock of Old IEL and did not own any capital stock or other securities of SGI and had no representatives on the Board of Directors. As a result of the amalgamation of Old IEL and SGIH and the termination of the Management Agreement, the outstanding shares of Old IEL common stock held by Harrah's were converted into
5,879,040 shares of $.01 par value common stock of the Company (the "Common Stock"). Harrah's also received 1,007,875 shares of Common Stock upon conversion of a loan, (the "Harrah's Loan"), made to Old IEL. Harrah's therefore became the largest shareholder of the Company holding approximately 38.6% of the outstanding shares at the time of the amalgamation.
Pursuant to the Amalgamation Agreement, Harrah's was provided with the right to appoint persons to the Board and to specified committees in a number generally proportionate to their share holdings calculated on a "fully diluted" basis as defined in the Company's bye-laws. Additionally, Harrah's was provided with the right to approve specified significant corporate actions by the Company for as long as the ownership of Common Stock by Harrah's is in excess of 20% (10% in some cases) of the outstanding voting shares of Common Stock computed on a fully-diluted basis.
Upon consummation of the Amalgamations, SGI changed its name to Interactive Entertainment Limited.
The Company has yet to generate any significant operating revenues and has no assurance of future revenues. Its principal activities through December 31, 1998, consisted of developing, testing and marketing the inflight gaming software and marketing and supporting its amusement game software. As of December 31, 1998, IEL had a contract to provide its gaming software to Singapore Airlines, ("SIA"), which has various termination provisions. On March 22, 1999, SIA notified the Company that it was exercising its termination rights under the contract. The contract with Singapore Airlines was the Company's only contract to provide its gaming software to an airline. Gaming is prohibited on the aircraft of U.S. commercial air carriers and on all flights to and from the United States. Other countries may introduce similar prohibitions, which could limit the prospects for additional contracts. The Company continues to provide its amusement game software to Air China, American Airlines, Cathay Pacific Airways, Continental, Egypt Air, Lauda Air, Malaysia Airlines and Virgin Atlantic.
The Company does not believe that it has exposure to the "Year 2000 Problem." Software developed by the Company is compliant with dates in the year 2000. The Company uses commercial software produced by a variety of vendors and believes that all of its major systems are compliant.
On January 13, 1998, the Company completed the acquisition of all of the outstanding stock of Inflight Interactive Limited ("IIL") in exchange for 500,000 shares of the Company's Common Stock. IIL is a U. K. developer and provider of amusement games to the airline industry. IIL's games are currently operating on Air China, American Airlines, Cathay Pacific, Continental, Egypt Air, Lauda Air, Malaysia Airlines, and Virgin Atlantic. During 1998, the number of airline customers increased from five to seven, and the number of installed aircraft (excluding trials) increased from 54 to 79. The agreement also provides for the Company to issue up to 250,000 additional shares of Common Stock to the former owners of IIL upon achievement of certain milestones regarding implementation of the Company's software with an international airline to be designated by the parties.
Results of Operations
In April, 1997, the Board of Directors of the Company approved a change in the Company's fiscal year from the end of February to the end of December.
Twelve Months Ended December 31, 1998 and Ten Months Ended December 31, 1997
Revenue increased from zero to approximately $266,000. The revenue increase is due to the acquisition of IIL in January, 1998 and the associated revenues. Inflight gaming did not contribute significantly to revenues in 1998.
General and administrative expenses increased by approximately $306,000 primarily due to comparison of a twelve month period in 1998 to a ten month period in 1997.
Consulting and contract labor expenses decreased by $2.7 million. The 1997 period included an expense of $2.4 million for Grymyr consulting agreement.
Legal expenses decreased by $345,000. The 1997 period included high expenses related to the Amalgamations.
Interest expenses decreased by $4.3 million. Interest in 1998 was limited to interest paid on the Company's convertible debentures which were converted to Common Stock during the first quarter of the year. Interest in 1997 included $3.5 million for the beneficial conversion feature of the Harrah's Loan.
Depreciation and amortization expenses increased by $4.2 million. $496,000 of the increase is attributable to amortization of goodwill created with the January, 1998 purchase of IIL. $413,000 of the increase is attributable to amortization of the cost of development of the Company's gaming software which began in June, 1998 when the software was placed in service. The remainder of the increase is attributable to amortization of the excess of the purchase price over assets acquired when the Company purchased the minority interest in Old IEL previously owned by Harrah's; this was included for approximately six months during the 1997 period and for eleven months of the 1998 period.
The Company incurred $287,000 in expenses related to the closing of the Sky Games operations. This expense was primarily for severance payments to former employees.
Following the closing of the Sky Games operations, the Company wrote off $1.9 million for the value of the Singapore Airlines agreements and the remainder of the unamortized goodwill in the amount of $13.2 million related to the June, 1997 purchase of the minority interest in Old IEL. The Company also wrote down the carrying value of its software by $1.4 million.
Ten Months Ended December 31, 1997 and Twelve Months Ended February 28,
General and administrative expense increased by approximately $1.5 million. This includes an increase in payroll and related costs of approximately $307,000 due to increased staffing and an expense in the amount of $650,000 for the value of Company stock granted to Geller & Co. whose stock became vested following the Amalgamations. Accounting and audit fees increased by $93,000 as a result of increased reporting requirements following a change in the Company's status from a foreign private issuer. Travel expenses increased by $75,000 due to increased travel for marketing and product development. Recruiting and relocation expenses increased by $82,000 as a result of the Company building a permanent staff and reducing reliance on contractors. In conjunction with the Amalgamations, the Company purchased business insurance resulting in a cost of $79,000; the Company previously had no business insurance. Rent increased by $92,000 primarily as a result of relocation of operations from Harrah's corporate headquarters to dedicated leased space for the Company.
Expenses for consulting and contract labor increased by approximately $1.9 million. These expenses would have decreased by $500,000 except for the $2.4 million expense for the value of 586,077 shares of Common Stock issued to James P. Grymyr, a former director of the Company, in payment of a consulting agreement in the second quarter.
Legal expenses increased by approximately $411,000 due to the Amalgamations and increased financing and reporting activities of the Company.
Interest expense, including amortization of finance fees on Company debt, totaled $4,478,000 for the ten month period ending December, 1997 and $300,000 for the twelve month period ending February, 1997. The expense for the current period is composed of $3.5 million for the beneficial conversion feature of the Harrah's loan, interest on convertible debentures and amortization of finance fees related to the debentures, while the prior period expense is related to interest on the convertible note due to B/E Aerospace ("BEA"). The remainder of the convertible debentures were converted into Common Stock during the first quarter of 1998, and any unamortized finance fees as of December 31, 1997 were expensed.
Depreciation and amortization expenses increased by $4.6 million due to amortization of the excess of the purchase price over assets acquired when the Company purchased the minority interest in Old IEL previously owned by Harrah's. There were no comparable expenses in the prior period.
Write-down of assets for the ten months ended December 31, 1997 includes an adjustment of $449,000 in the value of real estate and other assets owned by the Company's wholly-owned subsidiary, Creator Island Equities, Inc. These assets were sold in November, 1997 at the approximate book value following the adjustment. In December, 1997 the Company wrote off the remaining $210,000 book value of inventory owned by SGIC. The inventory consisted of parts for a computer gaming system that had previously been in development with BEA. The $1.3 million write-down of assets for the twelve months ended February 28, 1997 includes the write-off of $138,000 in notes receivable owed to SGIC, the forgiveness of $550,000 in debt to SGIC in connection with an agreement to cancel the Performance Shares, and interim write-downs of $442,000 on the Creator Island Equities real estate and $210,000 on the SGIC inventory. Following the write-down and disposition of assets, the Company has no significant remaining assets that are not strategic to its current business objectives.
An extraordinary expense of $1,824,000 was recorded during the 1997 period for early extinguishment of the note due to BEA when it was exchanged for the Class A Preference Shares. There was no extraordinary expense in the prior period.
Liquidity and Capital Resources
At December 31, 1998 the Company had a working capital deficit of approximately $330,000. The Company's primary source of funding has been through sales of its equity and securities convertible into Common Stock. It is not likely that the Company will be able to continue operations without additional capital.
In June, 1997, the company issued 2,737 Class A Preference Shares in exchange for a promissory note in the amount of $2,737,000. During 1998, the Company and the holder agreed that the Company would redeem the Class A Preference Shares in installments beginning June 30, 1998. As of August 31, 1998, the Company had redeemed 500 shares at their redemption price of $1,000 per share. The Company was unable to redeem additional shares. As of June 10, 1999, 2,237 Class A Preference Shares remained outstanding and were convertible into 19,552,221 shares of Common Stock on that date. If the Class A Preference Shares are converted into Common Stock, HIIC has the right to receive additional shares of Common Stock at $0.01 per share. As of June 10, 1999, HIIC would be entitled to receive 2,397,303 shares. The actual number of shares of Common Stock issuable upon conversion may be higher or lower and is based on a discount to the 20 day average of the mean closing bid and ask price of the Company's Common Stock and is inversely proportional to the market price of the Company's Common Stock i.e. if the average share price decreases, the number of shares of Common Stock issuable increases. Dividends on the Class A Preference Shares have been paid through September 30, 1998 and are in arrears for subsequent periods.
In October 1997, the Company completed an agreement with an investor for the private placement of 925,747 shares of Common Stock for an aggregate purchase price of $3.0 million. $1.5 million (approximately $1,352,000 net of offering expenses), ("Tranche A"), was received upon closing while the remaining $1.5 million ("Tranche B") was to be funded upon and was contingent upon completion of the first flight with the Company's software available in all seats of a Singapore Airlines aircraft prior to April 22, 1998. For each five shares of Common Stock purchased and held for a minimum of six months, the investor was to have received one warrant for the purchase of additional shares. Warrants were to be exercisable at a price of $3.8125 per share for 18 months from their issue. As of April 2, 1998 the Company and the investor agreed to amended terms under which 50% of the remaining portion ($750,000) was funded immediately while the other 50% was to be funded under the terms of the original agreement. The subscription price for the Common Stock purchased in Tranche B was revised to $2.62125. Warrants issuable under Tranche A will not be issued. However, for each of the 286,123 Common Shares purchased in Tranche B, 0.85 of a warrant to purchase Common Stock will be issued after a six month holding period for the Common Stock purchased in Tranche B. The warrants, if issued, will have an exercise price of $2.62125 and a term of 18 months. The first $750,000 was funded under the amended terms; however, the flight required for funding of the second $750,000 did not take place prior to April 22, 1998. Subsequently, IEL and the investor agreed to a $750,000 purchase on the same terms. This additional investment was consummated on June 5, 1998.
On December 17, 1997, the Company issued 1,000 shares of Series A Convertible Preference Shares of the Company's Class B Preferred Stock for a total consideration of $1,000.000. The Class B Series A Preference Shares are convertible into a number of shares of Common Stock, determined by dividing the stated value of $1,000 per share by the lesser of: $3.2038 (the "Fixed Conversion Price") and a price (the "Floating Conversion Price") calculated as 85% of the average of the three lowest closing bid prices for the Common Stock during the thirty trading days occurring immediately prior to, but not including, the conversion date. Dividends are cumulative and may be paid, at the option of the Company and with prior notice, in additional shares of Common Stock at an annual dividend rate of 8%. Warrants for the purchase of 61,718 shares of Common Stock were issued in connection with the issuance of the Series A Class B Convertible Preference Shares. The warrants, which have an exercise price of $3.2038, are exercisable beginning June 17, 1998 and expire on December 17, 1999. Under the agreement, the Company had the option of selling a second tranche with 123,432 warrants for an aggregate purchase price of $2,000,000 following the installation of the Company's gaming software on an SIA aircraft and the availability of the software to paying passengers in the entire cabin. The Company's option with respect to the second tranche, was set to expire on June 17, 1998. Upon agreement of the parties, funding of the second tranche was deferred until a registration statement for resale of Common Stock issued upon conversion of the Series A Class B Preference Shares had been declared effective by the SEC. The registration statement was declared effective on July 15, and the additional funding of $2,000,000 was completed on July 24, 1998. The original purchasers of the company's Class B Series A Convertible Preference Shares converted 600 of the shares into Common Stock, retained 120 shares, and have sold the remaining 2,280 of the convertible preference shares in private sales. As of June 10, 1999, 1,280 shares of the Class B Series A Preference Shares had been submitted for conversion into 28,550,710 shares of Common Stock. All Common Stock issuable upon the conversions has been issued except for 3,492,426 shares which the Company lacks the authority to issue since issuance would cause the Company to exceed its maximum authorized capital. Subsequent to the conversions, the holders of the Class B Series A Preference Shares agreed to amend the conversion terms so that the Floating Conversion Price will not be less than $0.25 per share. Assuming that shareholders of the Company approve an increase in the authorized capital of the Company, a total of 1,720 shares of the Class B Series A Preference Shares will be outstanding. As of June 10, 1999 these 1,720 Class B Series A Preference Shares were convertible into 6,880,000 shares of Common Stock. The actual number of shares of Common Stock issued upon conversion may be higher or lower and is based on a discount to the average of the lowest three closing bid prices of the Company's Common Stock during the last 30 trading days and is inversely proportional to the market price of the Company's Common Stock i.e. a lower market price would result in a greater number of shares of Common Stock being issued upon conversion.
As of February 20, 1998, the Company sold 300 shares of Series B Class B Convertible Preferred Stock at $1,000 per share. The Series B Class B Convertible Preferred Shares have the same dividend and conversion features as the Series A Class B Convertible Preferred Shares. The investor also received a warrant to purchase 18,515 shares of Common Stock at a price of $3.2038 for 18 months. As of June 10, 1999, 38 shares of the Series B Class B shares had been converted into 663,274 shares of Common Stock and 262 shares remained outstanding. As of June 10, 1999, the 262 outstanding Series B Class B Preference Shares were convertible into 2,465,882 shares of Common Stock. The actual number of shares of Common stock issued upon conversion may be higher or lower and is based on a discount to the average of the lowest three closing bid prices of the Company's Common Stock during the last 30 trading days and is inversely proportional to the market price of the Company Common Stock i.e. if the average share price decreases, the number of shares of Common Stock issued upon conversion will increase.
It is the Company's intent to renegotiate the conversion terms of the Class A Preference Shares and the Class B Series B Preference Shares in an attempt to eliminate the floating conversion price.
Until the Company receives sufficient cash flow from operations, additional funding will be required to allow the Company to continue operations during 1999. Absent sufficient cash flow from operations, the short-term viability of the Company and the Company's ability to continue its operations is directly dependent upon the completion of significant additional financing. If adequate funds are not available from operations or additional sources of funding, the Company's business will suffer a material adverse effect.
Forward-Looking Information
This Form 10-K contains forward-looking statements that include, among others, statements concerning the Company's plans to implement its software products, commence generating revenue from certain of its products, expectations as to funding its capital requirements, the impact of competition, future plans and strategies, statements which include the words "believe," "expect," and "anticipate" and other statements of expectations, beliefs, anticipated developments and other matters that are not historical facts. These statements reflect the Company's views with respect to such matters. Management cautions the reader that these forward-looking statements are subject to risks and uncertainties that could cause actual events or results to materially differ from those expressed or implied by the statements.
Item 8.
Item 8. Financial Statements and Supplementary Data
Financial Statements and Supplementary Data are provided as an exhibit to Item 14.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Not applicable
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
Directors
See the information set forth in the sections of the Proxy Statement entitled "Election of Directors" and "Section 16(a) Beneficial Ownership Reporting Compliance," which sections are incorporated herein by reference.
Executive Officers
See the information set forth in the section of the Proxy Statement entitled "Executive Officers and Significant Employees," which section is incorporated herein by reference.
Item 11.
Item 11. Executive Compensation
See the information set forth in sections of the Proxy Statement entitled "Executive Compensation," "Summary Compensation Table," and "Option Grants in the Last Fiscal Year" which sections are incorporated herein by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
See the information set forth under "Security Ownership by Directors, Officers and Five Percent (or More) Shareholders" as set forth in the Proxy Statement and incorporated herein by reference.
Item 13.
Item 13. Certain Relationships and Related Transactions
See the information set forth in the section of the Proxy Statement entitled "Certain Relationships and Related Transactions," which section is incorporated herein by reference.
PART IV
Item 14.
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) Exhibits
1. Financial Statements
Consolidated Balance Sheets at December 31, 1998 and December 31, 1997.
Consolidated Statements of Operations for: Twelve Months Ended December 31, 1998 Ten Months Ended December 31, 1997 Twelve Months Ended February 28, 1997
Consolidated Statements of Shareholder's Equity February 29, 1996 through December 31, 1998
Statements of Cash Flow Twelve Months Ended December 31, 1998 Ten Months Ended December 31, 1997 Twelve Months Ended February 28, 1997
Notes to Consolidated Financial Statements
2. Financial Statement Schedule
3. Other Exhibits
*Confidential treatment has been granted. **Submitted herewith.
(b) Reports Filed on Form 8-K
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Interactive Entertainment Limited
/s/ Michael A. Irwin By: _________________________________ Assistant Secretary Dated: August 19, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant in the capacities and on the dates indicated.
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors Interactive Entertainment Limited
We have audited the accompanying balance sheet of Interactive Entertainment Limited as of December 31, 1998, and the related statements of operations, shareholders' equity, and cash flows for the year ended December 31, 1998. These financial statements are the responsibility of the company's management. Our responsibility is to express an opinion on these financial statements based on our audit. The consolidated financial statements of Interactive Entertainment Limited and subsidiaries for the 10 month period ended December 31, 1997 were audited by other auditors whose report dated February 11, 1998 expressed an unqualified opinion on those statements.
We conducted our audit in accordance with generally accepted audited standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principle used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Company as of December 31, 1998, and the results of operations and cash flows for the year ended December 31, 1998 in conformity with generally accepted accounting principles.
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the financial statements, the Company has limited operations, products, or facilities, and requires significant resources to implement its plan of operations that raises substantial doubt about its ability to be a going concern. Management's plans in regard to these matters are also described in Note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
BUCKLEY DODDS Chartered Accountants
Vancouver, BC August 6, 1999
INTERACTIVE ENTERTAINMENT LIMITED
CONSOLIDATED BALANCE SHEETS
(Unaudited)
INTERACTIVE ENTERTAINMENT LIMITED
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
INTERACTIVE ENTERTAINMENT LIMITED
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
INTERACTIVE ENTERTAINMENT LIMITED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
INTERACTIVE ENTERTAINMENT LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--NATURE OF OPERATIONS
The Company is a Bermuda exempted company which, in June 1997, changed its name from Sky Games International Ltd. ("SGI") to Interactive Entertainment Limited. The Company's activities have been focused on providing inflight gaming and entertainment software and services by developing, implementing and operating or licensing computerized video gaming and other entertainment software on, but not limited to the aircraft of international commercial air carriers. Gaming software has been marketed using the name Sky Games(TM), and the entertainment software is marketed using the name Sky Play.
The Company entered into a contract to provide its gaming software to one international airline, Singapore Airlines ("SIA"). SIA has selected the Matsushita Avionics Systems Corporation ("MASC") hardware platform and operating system for its interactive entertainment system. Following an extensive series of integration tests, laboratory tests and aircraft trials, SIA launched the first flight with gaming on June 1, 1998 on one aircraft. A second aircraft was added in mid-October. On November 12, 1998, the Company announced that it had been unable to attract the additional capital necessary for continued development of its Sky Games inflight gaming business and that it had discontinued all operations associated with the Sky Games product line and would begin to liquidate assets related to the Sky Games business. The Company also announced that it would refocus its business efforts to concentrate exclusively on its Sky Plan entertainment games business. All employees were terminated as of November 13, 1998. On December 22, 1998, the Company announced that it would also entertain bids for the Sky Play business. In March, 1999 the Company received notification from SIA that it was electing to terminate the contract.
Subsequently, the original purchasers of the Company's Class B Series A Convertible Preference Shares (the "Preference Shares") sold a total of 2,280 of the Preference Shares in private sales. 680 shares of the Preference Shares were converted by the various new holders into approximately 22.1 million shares of the Company's $0.01 par value common stock ("Common Stock") representing in excess of 47% of the total common shares outstanding. The new holders of the Preference Shares expressed concern at the direction of the Company and requested that liquidation of the Sky Games assets be discontinued. Seven of the ten members of the Board of Directors resigned from the Board.
The Company is currently earning sufficient revenue and generating sufficient cash flow from the Sky Play operations to meet its current operating expenses. Shareholders will elect a full Board of Directors at the next annual meeting to determine the future direction of the Company. In this regard, management expects the future direction will include expansion of the Sky Play operations, and may include marketing of the Sky Games gaming software and expansion into other related markets utilizing its technology. This is contingent on the raising of sufficient resources to expand the Company's operations, products and facilities.
On January 13, 1998, the Company completed the acquisition of all the outstanding capital stock of Inflight Interactive Limited ("IIL") in exchange for 500,000 shares of Common Stock. IIL is a United Kingdom developer and provider of amusement games to the airline industry. The games are marketed under the name Sky Play and are currently operating on a number of airlines, including Air China, American Airlines, Cathay Pacific, Continental, Egyptair, Lauda Air, Malaysia Airlines and Virgin Atlantic.
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Cash and Cash Equivalents
The Company considers cash on hand, deposits in banks and short-term investments with maturities of three months or less as cash and cash equivalents.
Software Development
All software production costs have been capitalized until the software was available for general release to customers, in accordance with the provisions of Statement of Financial Accounting Standards No. 86,
INTERACTIVE ENTERTAINMENT LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed. Amortization of the software costs over a three year period started in June, 1998 upon release of the software to SIA.
Property and Equipment
The Company's property and equipment is recorded at cost and depreciated using the straight-line and declining balance methods over its estimated economic life which is generally three to five years.
Additions and improvements that materially extend the useful lives are capitalized, while repairs and maintenance costs are expensed as incurred. Depreciation expense was approximately $214,000, $111,000 and $88,000 for the year ended December 31, 1998, the ten month period ended December 31, 1997 and the twelve month period ended February 28, 1997, respectively.
Goodwill
The goodwill, which arose from the acquisition of IIL is being amortized on a straight-line basis over three years. Management regularly evaluates whether or not the future undiscounted cash flows are sufficient to recover the carrying amount of this asset. Additionally, management continually monitors such factors as the competitive environment and advances in the computer software and hardware industries. If the estimated future undiscounted cash flows are not sufficient to recover the carrying amount of this assets and, accordingly, an impairment has occurred, management intends to write down the carrying amount to its estimated fair value based on discounted cash flows. The amount of amortization expense recorded for the period from the date of acquisition (January 13, 1998) through December 31, 1998 totaled approximately $496,000.
Impairment of Long-Lived Assets
In accordance with Statement of Financial Accounting Standard No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of, management continually evaluates whether events or changes in circumstances indicate that the carrying amount of long-lived assets may not be recoverable. Based on management's evaluations, and as discussed below, significant impairments of long-lived assets occurred during the year ended December 31, 1998.
The goodwill, which arose from the acquisition of the minority interest of Old IEL discussed in Note 3, was being amortized on a straight-line basis over three years. During the year ended December 31, 1998, management determined that, with the cessation of gaming operations, the future undiscounted cash flows were not sufficient to recover the carrying amount of this asset and, accordingly, an impairment had occurred and unamortized goodwill in the amount of $13.2 million was written off.
In conjunction with the acquisition of the minority interest of Old IEL, the Company allocated approximately $1,856,000 of the purchase price to the value of the agreement with Singapore Airlines. This amount was to be amortized on a straight-line basis over the term of the agreement. The agreement was for an initial three year term which was to begin upon the earlier of (a) nine months from the date of the first successful commercial installation of the software or (b) upon installation of the software in eight aircraft. Management determined that, with the cessation of gaming operations, the value of the contract was impaired and the value was written off.
The Company also allocated a portion of the purchase price of the acquisition of the minority interest of Old IEL to the value of the Company's software. Additional direct development costs were also incurred for a total cost of $2.5 million. Upon the cessation of inflight gaming, it was determined that an impairment had occurred since the future cash flows were not sufficient to recover the carrying amount of the asset. Since a portion of the asset continues to have value for the Company's continuing operations future cash flows were re-estimated resulting in a write down of $1.4 million.
Stock-Based Compensation
The Company accounts for employee stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, (APB No. 25) and related interpretations.
INTERACTIVE ENTERTAINMENT LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Loss Per Share
In 1997, the Financial Accounting Standards Board issued Statement No. 128, Earnings per Share (SFAS No. 128). SFAS No. 128 replaced the calculation of primary and fully diluted earnings per share with basic and diluted earnings per share. Unlike primary earnings per share, basic earnings per share excludes any dilutive effects of options, warrants and convertible securities. Diluted earnings per share is very similar to the previously reported fully diluted earnings per share. For the periods ended December 31, 1998, December 31, 1997, February 28, 1997, there is no difference between basic and diluted loss per share as all stock options, warrants, convertible debentures and convertible preferred stock are antidilutive for the periods presented. All loss per share amounts for all periods have been presented, and where appropriate, restated to conform to the SFAS No. 128 requirements.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect amounts reported in the financial statements and accompanying notes and in determining the impairment of long-lived assets. Actual results could differ from those estimates.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries: Sky Games International Corp. (a Nevada corporation), Creator Island Equities Inc., (a Yukon Territory corporation), IEL (Singapore) Pte. Ltd. (a Singapore corporation), and, since January 13, 1998, Inflight Interactive Limited (a U.K. corporation). For periods prior to the acquisition of the minority interest in Old IEL discussed in Note 3, the consolidated financial statements also include the accounts of SGI Holding Corporation Ltd. and the Company's 80% ownership of Old IEL. All material intercompany transactions have been eliminated in consolidation.
Comprehensive Income
The Company adopted SFAS No. 130 Reporting Comprehensive Income effective January 1, 1998. SFAS No. 130 established standards for the reporting and display of comprehensive income and its components in a full set of general purpose financial statements. The requirements of SFAS No. 130 include: (a) classifying items of other comprehensive income by their nature in a financial statement and (b) displaying the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in capital in the equity section of the balance sheet. The Company's comprehensive income (loss) is substantially equivalent to net income (loss) for the twelve months ended December 31, 1998, the ten months ended December 31, 1997 and the twelve months ended February 28, 1997.
Segment Reporting
In 1998, the Company adopted SFAS No. 131 Disclosures about Segments of an Enterprise and Related Information effective for fiscal years beginning after December 15, 1997. This statement requires financial statements to disclose information about products and services, geographic areas and major customers based on a management approach. The management approach requires disclosing financial and descriptive information about an enterprise's reportable operating segments based on reporting information the way management organizes the segments for making decisions and assessing performance. It also eliminates the requirement to disclose additional information about subsidiaries that were not consolidated. For the year ending December 31, 1998, the adoption had no material impact to the Company's disclosure information and its results of operations.
INTERACTIVE ENTERTAINMENT LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Foreign Currency Translation
Foreign currency assets and liabilities are translated into United States dollars at the exchange rate prevailing at the balance sheet date. Revenue and expenses are translated at the average exchange rate during the year. Translation gains and losses are not material.
Revenue Recognition
Revenue for Sky Games was recognized at the end of each month upon accumulation of monthly gaming totals and calculation of the settlement with Singapore Airlines. Revenue for Sky Play is recognized each month upon the invoicing of customers.
NOTE 3--ACQUISITION OF MINORITY INTEREST
Prior to June 17, 1997, the Company operated its principal business activities through its indirectly 80%-owned subsidiary, Interactive Entertainment Limited ("Old IEL"). The remaining 20% of Old IEL was held by an affiliate of Harrah's Entertainment, Inc. (which, together with its affiliates, is referred to herein as "Harrah's"). Harrah's also managed the operations of Old IEL pursuant to a management agreement effective December 30, 1994, (the "Management Agreement").
Effective June 17, 1997, pursuant to a Plan and Agreement of Merger and Amalgamation dated May 13, 1997, Old IEL was merged into the Company (the "Amalgamation"). As part of the Amalgamation, the Management Agreement with Harrah's was terminated. Harrah's received a total of 5,879,040 shares of the Company's $.01 par value common stock (the "Common Stock") in exchange for its 20% ownership interest in Old IEL and as consideration for the termination of the Management Agreement.
The Amalgamation has been accounted for under the purchase method. The shares issued to Harrah's were valued at $26,255,793 based on the average quoted market price of the Company's Common Stock when the Amalgamation was announced, or $4.466 per share. The total value of the shares issued was allocated among the assets acquired, including the Company's agreement with Singapore Airlines and the Company's software under development. This transaction represents a non-cash transaction for purposes of the Consolidated Statements of Cash Flows.
Prior to the Amalgamation, Harrah's had agreed, pursuant to a funding agreement, to loan up to $1,000,000 (the "Harrah's Loan") to Old IEL. Upon closing of the Amalgamation, the outstanding principal and accrued interest of the Harrah's Loan converted automatically into 1,007,875 shares of Common Stock at $1.00 per share. Since the Harrah's Loan was convertible into Common Stock at less than the current market, a beneficial conversion feature was included in the Harrah's Loan. This beneficial conversion feature was valued at $3,466,000 and has been included in interest expense for the ten months ended December 31, 1997.
NOTE 4--CONVERTIBLE DEBENTURES
During the ten months ended December 31, 1997, the Company issued $2,163,250 of 8% convertible debentures due in 1999. At December 31, 1997, $1,633,250 of the debentures had been converted into 808,520 shares of Common Stock. The outstanding balance of convertible debentures as of December 31, 1997 totaled $530,000.
Subscription dates ranged from July 7 through September 29, 1997. The debentures were convertible at the lower of 85% of the average of the closing bid prices of the Common Stock for the five trading days immediately preceding the execution by the subscriber of its individual subscription for debentures or 77.5% of the average of the closing bid prices of the Common Stock for the five trading days immediately preceding the date of conversion.
INTERACTIVE ENTERTAINMENT LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The debentures contained a feature that provided for conversion into Common Stock at a price below the current market at the time of issue. The value of this beneficial conversion feature, totaling approximately $628,000, was capitalized in other assets with a corresponding increase to additional paid- in capital. Placement fees of $149,000 incurred upon sale of the debentures were also capitalized. The value of the conversion feature and the placement fees were amortized to interest expense over the original life of the debenture. Any unamortized amount was expensed upon conversion of the debenture. At December 31, 1997, the unamortized deferred interest charge and unamortized placement fees of $148,000 were included in other assets. The last portion of the debentures were converted into Common Stock during the first quarter of 1998.
NOTE 5--LEASES
The Company leased certain facilities under an operating lease expiring April 30, 1999. Total lease and rent payments amounted to $105,600, $139,000, and $38,000, for the twelve month period ended December 31, 1998, the ten month period ending December 31, 1997 and the twelve month periods ending February 28, 1997, respectively.
NOTE 6--EMPLOYEE BENEFITS
On July 1, 1997, the Company established an employee savings plan that qualifies under Section 401(k). All employees of the Company may participate after completion of one year of service by deferring from 1 percent to 16 percent of their eligible compensation. There is no provision for Company contributions to the Plan.
NOTE 7--SHAREHOLDERS' EQUITY
In December 1994, the Company discontinued an engineering and marketing arrangement with B/E Aerospace, Inc. ("BEA"). As part of the termination, the Company issued to BEA a promissory note in the original principal amount of $2.5 million at 12% per annum. On February 28, 1997, an agreement was reached with BEA to exchange the note in the amount of $2,737,000, including accrued and unpaid interest, for Class A Preference Shares at $1,000 per share. The exchange for 2,737 Class A Preference Shares was completed in June, 1997. During 1998, the Company and BEA agreed that the Company would redeem the Class A Preference Shares in installments beginning June 30, 1998. As of August 31, 1998, the Company had redeemed 500 shares at their redemption price of $1,000 per share. The Company was unable to redeem additional shares.
The Class A Preference Shares are convertible at any time into a number of shares of Common Stock, determined by dividing $1,000 per share of Class A Preference Shares, plus any accrued and unpaid dividends thereon by: (i) prior to February 28, 1999, a conversion price equal to 70% of the average mean of the closing bid and ask prices of the Common Stock for the 20 trading days prior to the conversion (the "Market Price"); (ii) after February 28, 1999 and prior to August 31, 1999, a conversion price equal to 65% of the Market Price; and (iii) after August 31, 1999, a conversion price equal to 60% of the Market Price. Dividends on the Class A Preference Shares are cumulative and payable quarterly at an annual dividend rate of 9%. The Company, at its option, may redeem the Class A Preference Shares, in whole or in part, at any time and from time to time, at a redemption price of $1,000 per share plus any accrued and unpaid dividends thereon. The Company is not required to redeem the Class A Preference Shares. Upon liquidation, holders of the Class A Preference Shares will be entitled to repayment of an amount equal to $1,000 per share plus accrued and unpaid dividends, prior to any distributions to holders of Common Stock. Dividends on the Class A Preference Shares were $228,305 in 1998 of which $50,756 for the fourth quarter remained unpaid and in arrears at year end. The Class A Preference Shares do not have any voting rights. As of June 10, 1999, 2,237 Class A Preference Shares remained outstanding and were convertible into 19,552,221 shares of Common Stock on that date. If the Class A Preference Shares are converted into Common Stock, HIIC has the right to receive additional shares of Common
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Stock at $0.01 per share. As of June 10, 1999, HIIC would be entitled to receive 2,397,303 shares. The actual number of shares of Common Stock issuable upon conversion may be higher or lower and is based on a discount to the 20 day average of the mean closing bid and ask price of the Company's Common Stock and is inversely proportional to the market price of the Company's Common Stock i.e. if the average share price decreases, the number of shares of Common Stock issuable increases.
Since the Preference Shares were convertible into Common Stock at less than the market value at the time of issue, a beneficial conversion feature existed requiring that the Preference Shares be valued at the market value of the underlying Common Stock. Since the resulting valuation of the Preference Shares exceeded the balance of the note, an extraordinary expense of approximately $1,824,000 was incurred during the ten months ended December 31, 1997 for early extinguishment of the note.
As part of the Amalgamation, Harrah's entered into the "Registration and Preemptive Rights Agreement" under which, among other things, Harrah's has the right to receive additional shares of Company Stock at $.01 per share in order to maintain their ownership percentage in the Company in the event that the Class A Preference Shares held by BEA are converted into Common Stock. Had BEA elected to convert the Preference Shares into Common Stock as of the June 17, 1997 Amalgamation date, Harrah's would have received an additional 573,483 shares. The actual number of shares that would be issued to Harrah's in the event of conversion by BEA depends on a number of factors including, among others, the number of shares issued to BEA upon conversion, the number of "fully diluted" shares of Common Stock outstanding at the time of any such conversion and Harrah's ownership of Common Stock at the time of any such conversion. The value of any such shares of Common Stock issued to Harrah's will be accounted for as an adjustment to the purchase price incurred in the Amalgamation when and if such shares are issued.
On December 17, 1997, the Company issued 1,000 shares of Series A Convertible Preference Shares of the Company's Class B Preferred Stock for a total consideration of $1,000,000. The Class B Series A Preference Shares are convertible into a number of shares of Common Stock, determined by dividing the stated value of $1,000 per share by the lesser of: $3.2038 (the "Fixed Conversion Price") and a price (the "Floating Conversion Price") calculated as 85% of the average of the three lowest closing bid prices for the Common Stock during the thirty trading days occurring immediately prior to, but not including, the conversion date. Dividends are cumulative and may be paid, at the option of the Company and with prior notice, in additional shares of Common Stock at an annual dividend rate of 8%. Warrants for the purchase of 61,718 shares of Common Stock were issued in connection with the issuance of the Series A Class B Convertible Preference Shares. The warrants, which have an exercise price of $3.2038, are exercisable beginning June 17, 1998 and expire on December 17, 1999. Under the agreement, the Company had the option of selling a second tranche with 123,432 warrants for an aggregate purchase price of $2,000,000 following the installation of the Company's gaming software on an SIA aircraft and the availability of the software to paying passengers in the entire cabin. The Company's option with respect to the second tranche, was set to expire on June 17, 1998. Upon agreement of the parties, funding of the second tranche was deferred until a registration statement for resale of Common Stock issued upon conversions of the Series A Class B Preference Shares had been declared effective by the SEC. The registration statement was declared effective on July 15, and the additional funding of $2,000,000 was completed on July 24, 1998. The original purchasers of the company's Class B Series A Convertible Preference Shares converted 600 of the shares into Common Stock, retained 120 shares, and have sold the remaining 2,280 of the convertible preference shares in private sales. As of June 10, 1999, 1,280 shares of the Class B Series A Preference Shares had been submitted for conversion into 28,550,710 shares of Common Stock. All Common Stock issuable upon the conversions has been issued except for 3,492,426 shares which the Company lacks the authority to issue since issuance would cause the Company to exceed its maximum authorized capital. Subsequent to the conversions, the holders of the Class B Series A Preference Shares agreed to amend the conversion terms so that the Floating Conversion Price will not be less than $0.25 per share. Assuming that shareholders of the Company
INTERACTIVE ENTERTAINMENT LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
approve an increase in the authorized capital of the Company, a total of 1,720 shares of the Class B Series A Preference Shares will be outstanding. As of June 10, 1999 these 1,720 Class B Series A Preference Shares were convertible into 6,880,000 shares of Common Stock. The actual number of shares of Common Stock issued upon conversion may be higher or lower and is based on a discount to the average of the lowest three closing bid prices of the Company's Common Stock during the last 30 trading days and is inversely proportional to the market price of the Company's Common Stock i.e. a lower market price would result in a greater number of shares of Common Stock being issued upon conversion.
In October 1997, the Company completed an agreement with an investor for the private placement of 925,747 shares of Common Stock for an aggregate purchase price of $3.0 million, $1.5 million (approximately $1,352,000 net of offering expenses), ("Tranche A"), was received upon closing while the remaining $1.5 million ("Tranche B") was to be funded upon and was contingent upon completion of the first flight with the Company's software available in all seats of a Singapore Airlines aircraft prior to April 22, 1998. For each five shares of Common Stock purchased and held for a minimum of six months, the investor was to have received one warrant for the purchase of additional shares. Warrants were to be exercisable at a price of $3.8125 per share for 18 months from their issue. As of April 2, 1998 the Company and the investor agreed to amended terms under which 50% of the remaining portion ($750,000) was funded immediately while the other 50% was to be funded under the terms of the original agreement. The subscription price for the Common Stock purchased in Tranche B was revised to $2.62125. Warrants issuable under Tranche A will not be issued. However, for each of the 286,123 Common Shares purchased in Tranche B, 0.85 of a warrant to purchase Common Stock will be issued after a six month holding period for the Common Stock purchased in Tranche B. The warrants, if issued, will have an exercise price of $2.62125 and a term of 18 months. The first $750,000 was funded under the amended terms; however, the flight required for funding of the second $750,000 did not take place prior to April 22, 1998. Subsequently, IEL and the investor agreed to a $750,000 purchase on the same terms. This additional investment was consummated on June 5, 1998.
During the ten months ended December 31, 1997, the Company changed the par value of the Common Stock from C$.01 (Canadian dollars) to $.01 (United States dollars). The change in par value did not affect any of the existing rights of shareholders and has been recorded as an adjustment to additional paid-in capital and Common Stock.
As of December 31, 1998, potential issuance of Common Stock pursuant to stock option plans and warrants totaled 3,742,761 shares. As of June 10, 1999, an additional 34,787,832 shares would be required for the convertible preferred stock and preemptive rights agreements.
NOTE 8--STOCK OPTIONS
The Company follows APB No. 25 in accounting for its employee stock options. Under APB No. 25, no compensation expense is recognized because the exercise price of the Company's incentive employee stock options is equal to or greater than the market price of the underlying stock on the date of grant.
Prior to February 28, 1995, the Directors of the Company issued stock options to employees and directors under individual agreements between the Company and the individuals. Exercise prices and terms were determined by the Board of Directors. At December 31, 1998, no stock options issued prior to February 28, 1995 are outstanding.
During the year ended February 29, 1996, the Company established and the Company's shareholders subsequently approved the 1996 Stock Program for the then upper management, directors and major shareholders of the Company. Under this plan, the Company could grant options to purchase up to 1,500,000 shares of Common Stock at prices not less than the fair market value of the stock on the day of grant. The 1,130,000 options issued under the 1996 Stock Program are exercisable upon the grant date and expire during 2001 through 2002. No further grants under the 1996 Stock Program will be made by the Company.
INTERACTIVE ENTERTAINMENT LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The Company adopted on December 6, 1996, a Directors Stock Ownership Plan covering 500,000 shares of Common Stock pursuant to which all directors holding office at December 10th of each year will automatically be granted options for 10,000 shares of Common Stock at the trading price on such day. On October 17, 1997, the Board of Directors of the Company approved an amendment changing the grant date from December 10 to the date of the first meeting of the Board of Directors following the Company's Annual General Meeting of shareholders. The 240,000 options granted under this plan are exercisable upon the grant date and expire ten years after the grant date.
Effective June 16, 1997, the Company established a Management Incentive Plan (the "MIP") by authorizing the issuance of options for 4,070,105 shares of Common Stock. The Compensation Committee of the Board of Directors has the authority to determine the allocation and vesting requirements for such options issued under the MIP. The exercise price of stock options granted under the MIP is the market price of the Common Stock on the date of the grant. A total of 1,200,000 options will vest specifically on the earlier of sustaining certain stock price levels or ten years from the date of the grant. The remaining 390,341 options outstanding under this plan vested upon employees remaining with the Company for a specified period of time. Approximately 1.4 million non-vested options held by employees were canceled during 1998 following termination of employees.
A summary of the Company's stock option activity and related information follows:
Exercise prices for stock options outstanding at December 31, 1998, ranged from $0.970 to $4.13. The weighted average remaining life of the outstanding stock options is approximately 6 years.
Pro forma information regarding net loss and loss per share is required by Statement of Financial Accounting Standards No. 123, Accounting for Stock- Based Compensation (SFAS No. 123) and has been determined as if the Company had accounted for its employee stock options under the fair value method. The fair value for these options at the date of grant was estimated using a Black- Scholes option pricing model with the following weighted average assumptions for the year ended December 31, 1998, the ten months ended December 31, 1997 and the year ended February 28, 1997, respectively: volatility factor of the expected market value of the Company's Common Stock of 2.808, 0.715 and 0.715; weighted average expected life of the options of 5 years for each period; risk-free interest rate of 5.75% for each period; and no dividend payments.
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require
INTERACTIVE ENTERTAINMENT LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The Company's pro forma information follows:
Because SFAS No. 123 applies only to stock-based compensation awards for the fiscal year ended February 29, 1996 and future years, the pro forma disclosures under SFAS No. 123 are not likely to be indicative of future disclosures until the disclosures reflect all outstanding, nonvested awards.
NOTE 9--STOCK WARRANTS
As of December 31, 1998, the Company had outstanding stock warrants for 782,420 shares of its Common Stock as follows:
NOTE 10--INCOME TAXES
As a Bermuda exempted company, the Company is not currently subject to income tax filing requirements in Bermuda. The Company operates in the U.S. as a branch of a foreign corporation. As a foreign corporation with a U.S. trade or business, the Company will be subject to tax in the U.S. on the income earned that is effectively connected with that trade or business. Tax carryforward in taxable jurisdictions have not been determined. Deferred tax assets, if any, would be fully reserved. Other than the tax associated with the U.S. earned interest income, there are no income tax provisions, benefits, liabilities or assets reflected in the accompanying financial statements.
INTERACTIVE ENTERTAINMENT LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 11--WRITE-DOWN OF ASSETS
The following assets were written down to a nominal or current value in the period due to impairment in the assets value: (See Note 2, Impairment of Long- Lived Assets).
NOTE 12--RELATED PARTY TRANSACTIONS
Pursuant to the Management Agreement, Harrah's managed Old IEL. The Management Agreement provided for Harrah's to receive a management fee equal to the greater of $10,000 per whole fiscal month, as defined, or a percentage of gross revenues, as defined. The Management Agreement was terminated June 17, 1997, in conjunction with the Amalgamation. Management fees totaled $0, $36,000, and $120,000 for the twelve month period ending December 31, 1998, the ten month period ending December 31, 1997, and the twelve month period ending February 28, 1997, respectively.
Under the terms of the Management Agreement, the Company transferred cash to Harrah's for payments made on the Company's behalf to support its operations, including accounts payable, payroll and capital expenditures. The net transfers for the twelve month period ending December 31, 1998, the ten month period ending December 31, 1997 and the twelve month period ending February 28, 1997 totaled $0, $143,000, and $1,085,000, respectively.
The Company was charged a fee by Harrah's for administrative services (including legal, accounting, information technology and office occupancy). This arrangement ended with termination of the Management Agreement. The Company was charged approximately $ 0, $150,000, and $523,000, and during the twelve month period ended December 31, 1998, the ten month period ended December 31, 1997, and the twelve month period ended February 28, 1997, respectively.
On June 17, 1997, the Company entered into a Continuing Services Agreement with Harrah's under which Harrah's provides certain telecommunications, computer systems support and consulting services to the Company. The Company incurred a cost of approximately $124,000 and $101,000 during the twelve month period ended December 31, 1998 and the ten month period ending December 31, 1997, respectively.
Effective June 5, 1997, the Company entered into a lease (the "Sublease Agreement") with Harrah's for the office space occupied by the Company. The Sublease Agreement is for a period of 23 months at a monthly cost of approximately $11,000. Payments under this Sublease Agreement aggregate to approximately $132,000 in 1998 and $44,000 in 1999. In conjunction with the Sublease Agreement and with the Amalgamation, the Company purchased certain leasehold improvements, computer hardware, computer software and office equipment from Harrah's. The total purchase price was approximately $42,000.
INTERACTIVE ENTERTAINMENT LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
During 1996, the Company entered into a sublicense agreement with Harrah's, which provides the Company with rights to use an immediate authorization credit/debit system that Harrah's is developing. The Company reimbursed Harrah's for a portion of the development costs which totaled $70,000 and $180,000 for the ten months ended December 31, 1997 and the year ended February 28, 1997, respectively.
On June 17, 1997, in conjunction with the Amalgamation, the Company entered into a Software License Agreement with Harrah's (the "License Agreement"). The License Agreement is a non-exclusive, fully-paid, perpetual, world-wide license to Harrah's and its affiliates to use the Company's gaming technology in non-competitive uses in traditional casino venues owned, operated or managed by Harrah's affiliates. The License Agreement includes source codes for all software, but neither party to the License Agreement has any obligations to share or provide any improvements or modifications with the other party. There was no additional consideration paid by Harrah's for the License Agreement.
The Company paid approximately $291,000 and $335,000 during the ten months ended December 31, 1997 and the twelve months ended February 28, 1997, respectively, to directors and companies with common directors for management and consulting services and for reimbursement of expenses.
On April 30, 1997, the Company entered into a Consulting Agreement with James P. Grymyr, then a director of the Company, whereby Mr. Grymyr would provide consulting services to the Company as requested by the Company from time to time. Under the terms of the Consulting Agreement, the Company has issued to Mr. Grymyr 586,077 shares of Common Stock as consideration for all such consulting services both past and future. The Company expects any future consulting services to be minimal. The value of the stock (approximately $2.4 million) is included in the Statements of Operations for the ten months ended December 31, 1997, as consulting and contract labor.
Geller & Co., of which Laurence Geller is Chairman, performed consulting services for the Company pursuant to a retainer agreement that commenced in February, 1996 and terminated August 14, 1997. Geller & Co. was paid a monthly retainer of $5,000. Pursuant to Geller & Co.'s retainer, a grant of options for 200,000 shares of Common Stock with an exercise price of $3.00 and a term of ten years was also made to Geller & Co. On May 29, 1997, the Company granted an additional 1,000,000 options with the same terms above to Geller & Co. for Laurence Geller's services as Chairman of the Board. In addition, Geller & Co. received 200,000 shares of Common Stock that vest upon the closing of a major financing. The Board has determined that the Amalgamation which occurred June 17, 1997 constituted a major financing, and, consequently, the 200,000 share success fee has vested and an expense of $650,000 was recognized. This amount is included on the Consolidated Statement of Operations as general and administrative expense. Mr. Geller was Chairman of the Board of Directors of the Company from September 30, 1996 until February 23, 1999. The annual compensation of the Chairman of the Board is $100,000 and is unpaid until the Company generates revenue.
NOTE 13--AGREEMENT REGARDING REDEMPTION OF PERFORMANCE SHARES
When the Company acquired the rights to the inflight gaming software from Sky Games International, Inc. ("SGII") on November 7, 1991, a portion of the consideration was 3,000,000 shares of Common Stock which, according to then applicable requirements, were placed in escrow, to be released on the basis of one share for each U.S. $1.78 of net cash flow generated from the assets over a ten-year period (the "Performance Shares"). The Performance Shares were issued at a deemed price of $.1155 per share with 2,000,000 shares issued to SGII (87% of the outstanding stock of which was owned by James P. Grymyr, formerly a director of the Company, and his wife) and 1,000,000 shares were issued to Anthony Clements, a director of the Company. An additional 525,000 shares, which were issued to Dr. Rex E. Fortescue, formerly a director of the Company, are held in the escrow on the same terms and are also included as Performance Shares. Each of Messrs. Clements and Fortescue,
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
as of April 30, 1997, have agreed to allow the Company to redeem and cancel the Performance Shares when and if they are released from escrow for any reason whatsoever (the "Redemption Agreement"). As consideration for such agreement to tender the Performance Shares for cancellation by the Company in the event they are ever released from the escrow, the Company has issued to Messrs. Clements and Fortescue, 333,333 and 175,000 shares of Common Stock, respectively. SGII, as of April 30, 1997, has also agreed that it will tender the 2,000,000 Performance Shares which it holds for cancellation by the Company when and if such Performance Shares are released from escrow for any reason whatsoever. As consideration of such agreement, in February, 1997, the Company expensed the outstanding balance of a note made by SGII to the Company in the approximate amount of $550,000 and has issued to SGII 80,590 shares of Common Stock (the "Redemption and Cancellation Agreement"). In the event the Performance Shares are not released prior to six months after the end of the Company's financial year ending in the year 2002, the Performance Shares will automatically be canceled in accordance with the terms of the escrow agreement. The value of the 588,923 shares of Common Stock issued as consideration for the agreement was determined to be approximately $1,840,000 based on the closing price of the Company's Common Stock on the date the 588,923 shares were issued. This amount was included as additional purchase price for the acquisition of Harrah's 20% ownership interest in Old IEL.
Each of Messrs. Clements and Fortescue have the right to include the 508,333 shares of Common Stock issued in connection with the Redemption Agreement in certain registered offerings conducted by the Company prior to February 25, 1999. As part of the agreements to allow the redemption and cancellation of the Performance Shares, the holders of the Performance Shares have issued an irrevocable proxy to a bank which has agreed not to vote the Performance Shares at any General Meeting of Shareholders or otherwise. The irrevocable proxy and the agreement not to vote the Performance Shares will terminate upon the cancellation of the Performance Shares. The escrow agent is prohibited from canceling the Performance Shares under the escrow agreement.
The Performance Shares have no rights and, therefore, are excluded from per share calculations for all periods presented. Effective April 30, 1997, the Performance Shares were no longer considered outstanding for financial statement purposes.
NOTE 14--SUBSEQUENT EVENTS
On November 12, 1998, the Company announced that it had been unable to attract the additional capital necessary for continued development of its Sky Games inflight gaming business and that it had discontinued all operations associated with the Sky Games product line and planned to conduct an orderly disposition of all the assets related to the Sky Games product. The Company stated that it would refocus its business efforts to concentrate exclusively on its Sky Plan PC games, non-gaming inflight customers and business. All employees were terminated as of November 13, 1998. Some former employees have been retained on a part-time contract basis to continue operations and support the Sky Play product. On December 22, 1998, the company announced that it would also seek bids for its Sky Play amusement game business.
Following these announcements, the company received a series of communications from shareholders representing approximately 43% of the company's shares stating a clear interest in seeing that the company retain its assets and continue its operations. The Company subsequently ceased the sale of assets. Although Sky Games is not currently operational, the Company continues to operate the Sky Plan business.
On March 22, 1999 SIA notified the Company that it was terminating the agreements related to Sky Games.
Gordon Stevenson resigned as President and CEO and subsequently resigned from the company's Board of Directors. Due to an increase in the number of shares outstanding upon conversion of a portion of the Company's
INTERACTIVE ENTERTAINMENT LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Class B Series A Preference Shares, Harrah's ownership percentage has decreased to a level that entitles them to one seat on the Board of Directors. Accordingly, Harrah's representatives Charles Atwood and Judy Wormser have resigned from the Board. Quinten Dreesmann, Laurence Geller, Phillip Gordon, and Amnon Shiboleth have also resigned from the Board of Directors.
NOTE 15--QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Financial results by quarter are as follows:
- -------- (1) Due to the change in the Company's fiscal year end from the last day in February to December 31, the first quarter amounts represent the results of operations from March 1, 1997 to March 31, 1997. (2) Includes effect of the Amalgamation. (3) Loss on early extinguishment of debt.
INTERACTIVE ENTERTAINMENT LIMITED AND SUBSIDIARIES
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
YEAR ENDED DECEMBER 31, 1998, TEN MONTHS ENDED DECEMBER 31, 1997