Capitol Multimedia, Inc. Capitol Multimedia, Inc. Production Capabilities CMI Titles CMI Corporate Register
In July 1995, the Company entered into a worldwide licensing and distribution agreement (the "Agreement") for six of its children's edutainment titles for the Windows and Macintosh CD-ROM platforms with Davidson & Associates, Inc. ("Davidson"), a leading distributor of multimedia educational and entertainment software for both the home and school markets. Under the Agreement, the Company is developing six interactive storybooks based on folk tales from countries around the world. The titles are part of a Davidson line of products known as Magic Tales. Davidson is responsible for product testing, replication, manufacturing, packaging, sales, marketing, distribution, customer support, and warranty obligations. After recovery of certain out-of-pocket expenses, the Company and Davidson share in product net revenues. The first three titles, Baba Yaga and the Magic Geese, Imo and the King, and The Little Samurai, were released in Fall 1995. The three additional titles in the series, Liam Finds a Story, Sleeping Cub's Test of Courage, and The Princess and the Crab, are scheduled for release in Fall 1996.
On August 11, 1995, the Company sold certain assets, including the Company's interest in its InfoTravel and ShowMaster / ShowBuilder products, of its CD-i professional business to Philips Media, Inc. ("Philips") in consideration for all of Philips' 825,088 shares of Capitol Multimedia, Inc. Common Stock, a cash payment of $500,000, and minimum royalty guarantees of $750,000. As a result of the sale, the Company no longer provides CD-i services to the professional market.
In February 1996, the Company entered into a worldwide licensing and distribution agreement (the "Agreement") for two of its children's edutainment titles for the Windows and Macintosh CD-ROM platforms with Broderbund Software, Inc. ("Broderbund"), a leading distributor of children's software products. Under the Broderbund Agreement, the Company developed Gregory and the Hot Air Balloon and Darby the Dragon, two interactive adventure titles featuring feature friendly animal characters appealing to children ages 4-8. These titles are part of a Broderbund line of products known as StoryQuests and are scheduled for release in Summer 1996. Pursuant to the Agreement, Broderbund is responsible for product testing, replication, manufacturing, packaging, sales, marketing, distribution, customer support, and warranty obligations. After recovery of certain out-of-pocket expenses, the Company and Broderbund share in product net revenues.
Since the Company's August 11, 1995 sale of assets relating to its CD-i professional business, it has focused solely on the creation and development of consumer multimedia software products. Accordingly, the discussion and analysis of the Company's results of operations compares pro forma results for the year ended March 31, 1996 to pro forma results for the year ended March 31, 1995. The Company believes such comparison provides a more meaningful analysis of current and prior fiscal year results.
The composition of net sales for the years ended March 31, 1996 and 1995 are as follows:
| Software development revenues | $ 2,332,463 | $ 1,179,313 | 98% | $ 1,153,150 |
| Consumer software sales & royalties | 1,403,156 | 382,852 | 267% | 1,020,304 |
| CD-i licensing & distribution fees | 232,616 | 1,085,760 | (79%) | (853,144) |
| Total net sales | $ 3,968,235 | $ 2,647,925 | 50% | $ 1,320,310 |
During the last quarter of fiscal 1995, the Company discontinued CD-i consumer publishing activities and began developing titles for Philips on a work-for-hire basis. This strategy resulted in the increase in software development revenues during the year ended March 1996. The Company does not expect to perform any CD-i development services for Philips during fiscal year 1997. The Company does, however, expect increases in work-for-hire revenues from other customers including SSI to be greater than the decrease in software development revenue from Philips.
Consumer software sales and royalties increased during the year due primarily to the Fall 1995 release of Baba Yaga and the Magic Geese, Imo and the King, and The Little Samurai, three of the Company's interactive CD-ROM storybooks. The Company expects consumer software sales and royalties to increase substantially during fiscal year 1997 as a result of the release of Gregory and the Hot Air Balloon and Darby the Dragon in Summer 1996 and Liam Finds a Story, Sleeping Cub's Test of Courage, and The Princess and the Crab in Fall of 1996.
Historically, the Company received licensing and distribution fees from Philips as consideration for the exclusive right to distribute the Company's consumer CD-i titles. The decrease in these fees relates to a shift in strategy to developing titles for Philips on a work-for-hire basis rather than under licensing and distribution agreements. As a result of the Company's decision to discontinue CD-i consumer publishing activities, it does not expect to receive any material licensing and distribution fees in future periods.
The level of net sales in any quarter realized by the Company is principally dependent on the percentage of completion of work-for-hire projects and the number of orders shipped for published products. Sales derived from the Company's published products are typically highest in the Company's second and third quarters ending in September and December each year due primarily to the increased demand for products for the calendar year-end holiday selling season. Quarterly results may also fluctuate as a result of product mix, the number and timing of new product completions, and product returns.
Research and development decreased $331,000 or 14% to $2,031,000 for the year ended March 1996. This decrease relates to the March 1995 write-off of $747,000 in assets resulting from the Company's decision to discontinue publishing consumer titles for the CD-i and Sega-CD platforms, offset by a $382,000 increase relating to the elimination of capitalizing software development costs. The Company expects research and development to increase during fiscal year 1997 as a result of an expansion of its development and production capabilities; however, the Company does not expect research and development as a percentage of net sales to materially change.
Although the Company does not anticipate any significant change at its St. Petersburg, Russia facility, the current political and economic future of Russia is uncertain. Economic conditions in Russia, including lower wage rates and lower standards of living, allow the Company to transact business in St. Petersburg at a relatively low cost structure. Changes in the political, social, or economic stability, or significant changes in the exchange rate of the Russian Ruble, could result in increased research and development costs and significant delays in the completion of new products. Any such changes could have a material adverse affect on the Company's operating results and/or financial condition.
Since April 1995, the Company has not capitalized any software development costs as a result of the uncertainty regarding the realizability of such costs. Accordingly, amortization of capitalized software costs decreased $2,616,000 or 100% for the year ended March 1996. The Company does not expect to capitalize any software development costs in the foreseeable future.
The Company did not capitalize any portion of its depreciation relating to software development costs during fiscal year 1996. This change, offset by certain assets reaching full depreciable values, resulted in an increase of $17,000 or 15% to $132,000 for the year ended March 1996. The Company expects depreciation to increase during fiscal year 1997 as a result of an expansion of its development and production capabilities; however, the Company does not expect depreciation as a percentage of net sales to materially change.
General and administrative decreased $710,000 or 34% to $1,394,000 for the year ended March 1996 due to decreases of $217,000 relating to the expiration of consulting contracts, $293,000 resulting from a decrease in product advertising associated with the Company's fiscal year 1995 CD-ROM and Sega CD title releases, and $200,000 in efficiencies associated with the acquisition of Animation Magic, Inc. in February 1995.
A significant portion of the Company's operating expenses are fixed, and planned expenditures in any given quarter are based on sales and revenue forecasts. Accordingly, if products are not completed and/or shipped on schedule and net sales do not meet the Company's expectations in any given quarter, operating results and financial condition could be adversely affected.
Interest and other income consists primarily of interest income earned on the Company's cash and short-term investments and note receivable. However, the $63,000 or 18% decrease in interest and other income for the year ended March 1996 relates primarily to a reduction in the recognition of revenue for services provided to the Company as partial consideration for the sale of post-production assets in June 1993.
In April 1994, the Company sold its 25% ownership interest in a CD-i software title, recognizing a gain of approximately $47,000 on the transaction.
The $16,000 in income taxes for the year ended March 1996 represents alternative minimum tax liabilities on income earned during the period. The Company's effective tax rate of 2% differed from the statutory rate due to partial recognition of deferred tax assets which were fully reserved at March 1995. The Company has fully reserved deferred tax assets of $3,508,000 at March 1996 and expects its effective tax rate to remain at 2% during fiscal 1997.
The Company's primary sources of liquidity are its cash, cash equivalents, and short-term investments. During the year ended March 1996, cash, cash equivalents, and investments increased $859,000 or 25% to $4,324,000. This increase relates to $500,000 in proceeds from the sale of CD-i professional assets in August 1995, the collection of a $300,000 note receivable in November 1995, and $108,000 in cash generated from operations.
Long-term notes and guaranteed royalties receivable increased $323,000 or 35% to $1,244,000 at March 1996. $250,000 of the increase represents a minimum royalty guarantee due November 1997 resulting from the Company's sale of certain CD-i professional assets in August 1995. The additional $73,000 increase is attributable to accrued interest on an $800,000 long-term note receivable due July 1998.
Capitalized software costs and goodwill decreased $161,500 and $601,000 or 100% as a result of the Company's sale of certain CD-i professional assets in August 1995.
Accounts payable and accrued liabilities decreased $649,000 or 79% to $173,000 at March 1996 primarily as a result of a decrease in trade accounts and royalties payable of $237,000, and payments of $200,000 and $180,000 for intellectual property rights acquired in connection with the development of titles for Philips on a work-for-hire basis and management consulting fees and salaries, respectively.
The Company acquired 825,088 shares of its common stock and recognized a gain of $2.5 million in connection with its sale of certain CD-i professional assets to Philips Media, Inc. in August 1995.
The Company will use its working capital to finance ongoing operations and fund the expansion of its development and production capabilities. Management expects its existing cash and short-term investments, cash generated from operations, and the collection of a $500,000 minimum royalty guarantee in November 1996 will be sufficient to meet the Company's expected liquidity and capital needs for the coming year.
At March 31, 1996, the Company had outstanding Series A Warrants to purchase 408,200 shares of Common Stock at $5.72 per share. These warrants expire March 31, 1997, subject to extension by the Company. Pursuant to the redemption provision in the Warrant Agreement, the Company has the option of redeeming the warrants on an "all or nothing basis," and, given favorable market conditions, may do so. Exercise of these warrants would generate approximately $2,335,000 in cash.
The Company continues to consider investments in or acquisitions of compatible businesses. However, there can be no assurance that the Company will make investments in or enter into business combinations with other entities. In the event that the Company engages in such transactions, it may require additional financial resources.
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