10-Q 1 d51085_10-q.txt FORM 10-Q FORM 10-Q Securities and Exchange Commission Washington D.C. 20549 QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal quarter ended: May 31, 2002 Commission file number: 0-18066 CHELL GROUP CORPORATION (Exact name of registrant as specified in its charter) New York 11-2805051 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 14 Meteor Drive Toronto, Ontario, Canada M9W 1A4 (Address of principal executive offices) (Zip Code) (416) 675-6666 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes |X| No |_| Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of July 15, 2002: 17,924,913 shares of common stock, par value US$.0467 per share. CHELL GROUP CORPORATION AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL INFORMATION FOR THE NINE MONTHS ENDED MAY 31, 2002 PART I - FINANCIAL INFORMATION Item 1. Financial Statements: Page ---- Consolidated Balance Sheets - as at May 31, 2002 (unaudited) and August 31, 2001 1 Consolidated Statements of Operations For the Three Months and Nine Months Ended May 31, 2002 and May 31, 2001 (unaudited) 2 Consolidated Statements of Cash Flows - For the Nine Months Ended May 31, 2002 and May 31, 2001 (unaudited) 3 Notes to Consolidated Financial Statements 4 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 12 PART II - OTHER INFORMATION Item 1. Legal Proceedings 19 Item 2. Changes in Securities 19 Item 3. Defaults Upon Senior Securities 19 Item 4. Submission of Matters to a Vote of Security Holders 19 Item 5. Other information 19 Item 6. Exhibits and Reports on Form 8-K 20 SIGNATURES 22 2 CHELL GROUP CORPORATION CONSOLIDATED BALANCE SHEETS AS AT MAY 31, 2002 AND AUGUST 31, 2001 (Expressed in Canadian dollars)

The accompanying notes are an integral part of these statements 1 CHELL GROUP CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (Expressed in Canadian dollars - unaudited)

The accompanying notes are an integral part of these statements 2 CHELL GROUP CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED MAY 31, 2002 AND MAY 31, 2001 (Expressed in Canadian dollars - unaudited)

The accompanying notes are an integral part of these statements 3 CHELL GROUP CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE NINE MONTHS ENDED MAY 31, 2002 AND MAY 31, 2001 (UNAUDITED) Note 1. Basis of Presentation The accompanying financial statements for the interim periods are unaudited and reflect all adjustments (consisting only of normal recurring adjustments) which are, in the opinion of management, necessary for a fair presentation of the financial position and operating results for the periods presented. These financial statements should be read in conjunction with the financial statements and notes thereto, together with Management's Discussion and Analysis of Financial Condition and Results of Operations, contained in the Annual Report on Form 10-K of Chell Group Corporation (the "Company") (Commission No.:0-18066), filed with the Securities and Exchange Commission on November 30, 2001. The results of operations for the Nine Months ended May 31, 2002 are not necessarily indicative of the results to be expected for the full fiscal year ending August 31, 2002. Note 2. General The financial statements of the Company for the three and nine months ended May 31, 2002 (the "2002 Third Fiscal Quarter" and "2002 First Three Fiscal Quarters"), include the operations of the Company's wholly-owned subsidiaries Chell Merchant Capital Group Inc. ("CMCG"), Chell.com (USA) Inc., NTN Interactive Network Inc. ("NTNIN"), 3484751 Canada Inc., GalaVu Entertainment Network Inc. ("GalaVu"), and discontinued operations from NTNIN's wholly-owned subsidiary Magic Lantern Communications Ltd. ("Magic"), which was sold effective in March 2002. The financial statements also include the operations of Logicorp Data Systems Ltd. and Logicorp Service Group Ltd., which will be together referred to as "Logicorp". Logicorp was purchased effective in January 2002. The financial statements of the Company for the three and nine months ended May 31, 2001 (the "2001 Third Fiscal Quarter" and "2001 First Three Fiscal Quarters"), include the operations of the Company's wholly-owned subsidiaries CMCG, Chell.com (USA), NTNIN, 3484751 Canada Inc., GalaVu and NTNIN's wholly-owned subsidiary Magic. Discontinued operations are the results of NTNIN's wholly-owned subsidiaries Interlynx, which was sold effective in July 2001, and Magic, which was sold effective in March 2002. Prior period's figures have been restated (see note 11) and may have been reclassified to be consistent with any reclassifications in the current period. 4 Note 3. Business Segment Data for the three and Nine Months ended May 31, 2002 and May 31, 2001

5 Note 4. Earnings per share Earnings per share were calculated in accordance with Statement of Financial Accounting Standards No. 128. The following table sets forth the computation of basic and diluted earnings per share for the three months and nine months ended May 31, 2002 and May 31, 2001:

Note 5. Business Acquisition/Disposition Effective January 1, 2002, the Company acquired 100% of Logicorp Data Systems Ltd., Logicorp Service Group Ltd., 123557 Alberta Ltd. and 591360 Alberta Ltd. (collectively " Logicorp") for a purchase price of $13,880,968 calculated on a discounted basis. Logicorp is a Canadian systems integrator handling all aspects of IT systems integration and solutions development, including network integration and management, desktop support, hardware/software procurement, systems architecture design and consulting. The acquisition was recorded using the purchase method of accounting and, accordingly the purchase price has been allocated as set out below: $ ------------------------------------------------ Goodwill 13,429,307 Net tangible assets 451,661 ------------------------------------------------ 13,880,968 ------------------------------------------------ The purchase price was satisfied by $1,500,000 in cash, the issuance of two non-interest bearing promissory notes with a maturity value of $2,300,000 and the issuance of 5,355,000 exchangeable shares of CMCG. These shares are exchangeable on a one for one basis for the Common shares of the Company. The first promissory note with a maturity value of $1,800,000 is due June 30, 2002. Prior to payment of the first promissory note, the Company can elect to adjust the purchase price by substituting the $1,800,000 note for an 6 interest-free promissory note in the amount of $2,040,000 one half of which would be due June 30, 2002 and the second half would be due December 31, 2002. The second promissory note has a maturity value of $500,000 and is due March 31, 2003. In addition, the purchase price may be adjusted upwards because the Company is required to pay an amount by which the earnings before taxes, interest, depreciation and amortization (EBITDA) of Logicorp exceeds $1,000,000 for the year ended December 31, 2002. The purchase price may be adjusted downward by three times the amount that EBITDA for this period is less than $1,000,000. The purchase price could be further adjusted on June 30, 2002, in the event that the weighted average closing stock price of the Company's common shares for the 10 trading days prior to June 30, 2002 was less than US$1.00. The weighted average closing stock price was greater than US$1.00 during this period and accordingly, no adjustment to the purchase price is required. The operating results of Logicorp are included in the Company's consolidated statements of operations from the effective date of acquisition. Pro forma information The following pro forma information on results of operations assumes that Logicorp was purchased at the beginning of each period presented.

7 Sale of Magic Lantern Commencing in the second fiscal quarter, the Company began negotiations to sell Magic Lantern and its subsidiaries. Effective March 18, 2002, the Company completed this sale for cash consideration of $1,850,000. The Company's financial statements have been restated to reflect Magic as a discontinued operation for all periods presented. Summarized operating results of Magic's discontinued operations are as follows:

Note 6. Convertible Debenture During the 2002 third fiscal quarter, the convertible debenture held by CALP II Limited Partnership ("CALP II") on behalf of Canadian Advantage Limited Partnership ("CALP") and Advantage (Bermuda) Fund Ltd. ("ABFL") was exchanged for a note payable to CALP in the amount of US$1,365,100 and a note payable to ABFL in the amount of US$504,900. These notes provide for payment of principal and interest at the rate of 10% per annum on August 31, 2006. The notes are secured by a general security agreement against the assets of the Company in priority to all other claims subject to the existing security of the Bank of Montreal and the CIBC. The Company entered into an agreement with CALP to convert the principal amount of the note plus accrued interest into Common Stock at the rate of US$0.80 pursuant to which CALP received 1,314,000 shares of the Company. CALP will receive an additional 442,145 shares upon the approval of the Company's shareholders. The Company also entered into an agreement with ABFL to convert the principal amount of the note plus accrued interest into Common Stock at the rate of US$0.80 pursuant to which ABFL received 486,000 shares of the Company. ABFL will receive an additional 163,533 shares upon the approval of the Company's shareholders. 8 Note 7. Convertible Promissory Notes The Company has issued 8% convertible notes in the amount of $6,587,622 under a private placement memorandum. These notes are due August 9, 2002. On April 9, 2002 all of the holders of the notes signed commitments to voluntarily convert the notes at US$0.95 per share. This conversion is subject to shareholder approval. The conversion of these notes will result in the issuance of approximately 4,389,000 shares, diluting the current common stockholders. Note 8. Beneficial Conversion Feature Convertible Promissory Notes The beneficial conversion feature of the 8% promissory notes issued in the 2002 third fiscal quarter has been recognized by recording additional paid in capital and interest expense for the three months ended May 31, 2002. The amount of the beneficial conversion and interest expense was calculated as of the date the holders of the notes committed to converting the notes into common shares, as the difference between the conversion price and the fair value of the common stock into which the notes are convertible. The Company recognized beneficial conversion interest expense and corresponding additional paid in capital in the amount of approximately $2,637,000 for the three months ending May 31, 2002. Notes Payable to CALP and ABFL The beneficial conversion feature of the notes payable to CALP and ABFL that were converted to common shares in the third fiscal quarter has been recognized by recording additional paid in capital and interest expense for the three months ended May 31, 2002. The amount of the beneficial conversion and interest expense was calculated as of the date the agreement to convert the notes was signed, as the difference between the conversion price and the fair value of the common stock into which the notes are convertible. The Company recognized beneficial conversion interest expense and corresponding additional paid in capital in the amount of approximately $3,131,000 for the three months ending May 31, 2002. Note Payable to Chanana The beneficial conversion feature of the note payable to Chanana that was converted to common shares in the third fiscal quarter has been recognized by recording additional paid in capital and interest expense for the three months ended May 31, 2002. The amount of the beneficial conversion and interest expense was calculated as of the date of the agreement to convert the notes to common shares, as the difference between the conversion price and the fair value of the common stock into which the notes are convertible. The Company recognized beneficial conversion interest expense and corresponding additional paid in capital in the amount of approximately $521,000 for the three months ending May 31, 2002. 9 Note 9. Subsequent Event Pursuant to an oral hearing before a Nasdaq Listings Qualifications Panel, a determination was made to delist the Company's securities from the Nasdaq Stock Market effective with the open of business June 27, 2002. The Company disagrees with this determination and intends to appeal to the extent available by law. Note 10. New Accounting Pronouncements In August 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-lived Assets (SFAS 144), that is applicable to financial statements issued for fiscal years beginning after December 15, 2001. The new rules on asset impairment supersede SFAS 121, Accounting for the impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, and portions of Accounting Principles Board Opinion 30, "Reporting the Results of Operations." This Standard provides a single accounting model for long-lived assets to be disposed of and significantly changes the criteria that would have to be met to classify an asset as held-for-sale. Classification as held-for-sale is an important distinction since such assets are not depreciated and are stated at the lower of fair value and carrying amount. This Standard also requires expected future operating losses from discontinued operations to be displayed in the period(s) in which the losses are incurred, rather than as of the measurement date as presently required. The Company is currently assessing the potential impact of SFAS 144 on the operating results and financial position. In June 2001, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards No. 141, Business Combinations, and No. 142, Goodwill and Other Intangible Assets, effective for fiscal years beginning after December 15, 2001. Under the new rules, business combinations can no longer be reflected by using the pooling of interests method of accounting and goodwill (and intangible assets deemed to have indefinite lives) will no longer be amortized but will be subject to annual impairment tests in accordance with the Statements. Other intangible assets will continue to be amortized over their useful lives. The Company will apply the new rules on accounting for goodwill and other intangible assets beginning in the first quarter in the year beginning September 1, 2002 (Fiscal 2003). During fiscal 2003, the Company will perform the first of the required impairment tests of goodwill and indefinite lived intangible assets as of September 1, 2002 and has not yet determined what the effects of these tests will be on the earnings and financial position of the Company. 10 Note 11. Restatement of financial statements In Fiscal 2001, the Company sold its wholly-owned subsidiary, Interlynx. In Fiscal 2002, the Company sold its wholly-owned subsidiary Magic Lantern Communications, and its associated subsidiaries; Sonoptic Technologies Inc. and Tutorbuddy Inc. The Company's financial statements have been restated to reflect Interlynx and Magic Lantern as discontinued operations for all periods presented (See Note 5). Note 12. Changes in share capital During the Nine Months ended May 31, 2002, the following transactions resulted in the issuance of 8,896,674 common shares of the Company. The acquisition of Logicorp resulted in the issuance of 5,355,000 exchangeable shares of CMCG. These shares are exchangeable on a one for one basis for the common shares of the Company and are held in escrow pending shareholder approval. In addition 3,026,986 shares were issued as payment for debt, 52,500 for services rendered and 265,000 were issued for funds raised. Also during the Nine Months ended May 31, 2002, options totaling 197,188 were exercised resulting in the issuance of additional 197,188 common shares of the Company. 11 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Introduction The financial statements of the Company and the information contained in this Management's Discussion and Analysis of Financial Condition and Results of Operations are expressed in Canadian dollars. General We are engaged in the business of providing interactive entertainment services, systems integration products and services and merchant capital services. Our core businesses are interactive entertainment services provided by our NTN Interactive Network subsidiary and the merchant capital services provided through our Merchant Capital Group subsidiary. GaluVu is a technology-based entertainment provider of interactive in-room entertainment systems to hotels across Canada. Interactive entertainment services also involve, for example electronic sports trivia games played on computer units installed in bars, pubs and restaurants. System integration products and services are provided by our Logicorp subsidiary. Logicorp is a Western Canadian Network Infrastructure provider, specializing in Server-Based Computing solutions, Managed Services - using Computer Associates' Unicentre, Network design, delivery, administration, and support Procurement services, Warranty/Off-Warranty [W/OW] hardware support services, and Information Storage technologies. Logicorp's primary focus is high-performance computer systems for the corporate market. The firm provides solutions to mid-range and large corporations, as well as the government, education and medical markets. In addition, the business of merchant capital services involves our investment in and acquisition of significant but undervalued operating companies or technologies, to which we then apply management experience, in an effort to appreciate the value of those companies. Our main business strategy is to operate or invest in companies that represent the latest in technological innovations. We apply our expertise, industry contacts, and market foresight to these companies in order to create shareholder value. Results of Operations for the Three Months ended May 31, 2002 The Company's total revenues for the 2002 Third Fiscal Quarter were $20,639,179, compared to $3,492,739 for the 2001 Third Fiscal Quarter, an increase of $17,146,440 or 490.9%. Revenues from product sales for the 2002 Third Fiscal Quarter were $16,727,313. There are no comparative figures for the 2001 Third Fiscal Quarter as the revenues arose from the purchase of Logicorp in January 2002. Revenues from service sales for the 2002 Third Fiscal Quarter were $1,055,794. There are no comparative figures for the 2001 Third Fiscal Quarter as the revenues arose from the purchase of Logicorp in January 2002. 12 Revenues from network services for the 2002 Third Fiscal Quarter were $1,464,890, compared to $1,743,131 for the 2001 Third Fiscal Quarter, a decrease of $278,241 or 16.0%. The decrease can be attributed to a decrease in event programming of $91,572 and a decrease of $186,669 in hospitality services, which can be attributed to a decrease in the number of Hospitality sites between the 2002 and 2001 Third Fiscal Quarters. Revenues from Pay-tv for the 2002 Third Fiscal Quarter were $1,385,281 compared to $1,750,918 for the 2001 Third Fiscal Quarter, a decrease of $365,637 or 20.9%. This decrease can be attributed to travel levels still being depressed as a result of September 11th. Total cost of sales for the 2002 Third Fiscal Quarter were $17,600,196, compared to $1,373,462 for the 2001 Third Fiscal Quarter, an increase of $16,226,734 or 1,181.4%. The increase is primarily the result of the addition of Logicorp's product and service cost of sales to the company. Product ($15,520,144) and service ($751,861) resulted in a total addition of $16,272,005 or almost 100% of the increase. Since Logicorp was added in January 2002, there are no comparative figures for the 2001 Third Fiscal Quarter. Network services cost of sales were $644,849 in the 2002 Third Fiscal Quarter, compared to $584,502 in the 2001 Third Fiscal Quarter, an increase of $60,347 or 10.3%. Pay-TV cost of sales were $683,342 in the 2002 Third Fiscal Quarter, compared to $788,960 in the 2001 Third Fiscal Quarter, a decrease of $105,618 or 13.4%. As a percentage of revenues, cost of sales increased in the 2002 Third Fiscal Quarter to 85.3% from 39.3% in the 2001 Third Fiscal Quarter. The increase in percentage is the resulting of lower margins from the Systems Integration segment. Total selling, general and administrative expenses for the 2002 Third Fiscal Quarter were $3,789,948, compared to $2,133,535 for the 2001 Third Fiscal Quarter, an increase of $1,656,413 or 77.6%. The increase can be attributed to a couple of items: there was a decrease in the merchant services segment of $427,918 resulting from decreased staffing costs and associated cost reductions; offset by increases in legal and accounting fees and the addition of Logicorp ($1,290,865) which was purchased during January 2002, thus resulting in no comparative figures. Total selling, general and administrative expenses for the 2002 Third Fiscal Quarter for Logicorp comprised the following major items: salaries of $758,763 and supplies and materials of $372,504. As a percentage of the Company's total revenues, selling, general and administration expenses decreased to 18.4% for the 2002 Third Fiscal Quarter from 61.1% for the 2001 Third Fiscal Quarter. Interest cost of beneficial conversion features for the 2002 Third Fiscal Quarter were $6,289,134, compared to nil for the 2001 Third Fiscal Quarter. The costs arose from the raising of funds required by The Company. There were no similar costs for the 2001 Third Fiscal Quarter. As a percentage of the Company's total revenues, Interest from beneficial conversion features increased to 30.5% for the 2002 Third Fiscal Quarter from 0.0% for the 2001 Third Fiscal Quarter. 13 Financing costs for the 2002 Third Fiscal Quarter were $2,424,091, compared to nil for the 2001 Third Fiscal Quarter. The costs arose from the raising of funds required by The Company. There were no similar costs for the 2001 Third Fiscal Quarter. As a percentage of the Company's total revenues, financing costs increased to 11.7% for the 2002 Third Fiscal Quarter from 0.0% for the 2001 Third Fiscal Quarter. Interest and bank charges for the 2002 Third Fiscal Quarter were $269,696, compared to $286,686 for the 2001 Third Fiscal Quarter, a decrease of $16,990 or 5.9%. The decrease results from a decreased level of high interest rate bearing debt. As a percentage of the Company's total revenues, interest and bank charges decreased to 1.3% for the 2002 Third Fiscal Quarter from 8.2% for the 2001 Third Fiscal Quarter. Total depreciation and amortization expense for the 2002 Third Fiscal Quarter was $548,827, compared to $480,014 for the 2001 Third Fiscal Quarter, an increase of $68,813 or 14.3%. This is primarily the result of the addition of Logicorp. The net loss from continuing operations for the 2002 Third Fiscal Quarter was $10,282,713 compared to net loss of $780,958 for the 2001 Third Fiscal Quarter, an increase of $9,501,755. The increase primarily resulted from the interest cost of beneficial conversion features ($6,289,134), increased financing costs ($2,424,091) and the decreased revenue experienced in network services and Pay-Tv, offset by the decrease in the merchant services segment of $427,918. As a result of all of the above, the net loss for the 2002 Third Fiscal Quarter was $10,945,346, compared to net loss of $2,300,221 for the 2001 Third Fiscal Quarter, an increase of $8,645,125. The increase primarily resulted from the interest cost of beneficial conversion features ($6,289,134), increased financing costs ($2,424,091), and the addition of Logicorp ($1,290,865) offset by a decrease in loss from discontinued operations of $1,157,868 and merchant services segment of $427,918. Results of Operations for the Nine Months ended May 31, 2002 The Company's total revenues for the 2002 First Three Fiscal Quarters were $36,280,068, compared to $10,408,666 for the 2001 First Three Fiscal Quarters, an increase of $25,871,402 or 248.6%. Revenues from product sales for the 2002 First Three Fiscal Quarters were $25,789,442. There are no comparative figures for the 2001 First Three Fiscal Quarters as the revenues arose from the purchase of Logicorp in January 2002. Revenues from service sales for the 2002 First Three Fiscal Quarters were $1,614,037. There are no comparative figures for the 2001 First Three Fiscal Quarters as the revenues arose from the purchase of Logicorp in January 2002. Revenues from network services for the 2002 First Three Fiscal Quarters were $4,739,199, compared to $5,287,461 for the 2001 First Three Fiscal Quarters, a decrease of 14 $548,262 or 10.4%. The decrease can be attributed to a decrease in event programming of $173,280 offset by an increase of $63,060 in advertising sponsorship. The revenues are decreasing due to a slight decrease in the number of Hospitality sites between the 2002 and 2001 First Three Fiscal Quarters. Revenues from Pay-tv for the 2002 First Three Fiscal Quarters were $4,121,842 compared to $5,047,393 for the 2001 First Three Fiscal Quarters, a decrease of $925,551 or 18.3%. This decrease can be attributed to travel levels still being depressed as a result of September 11th. Total cost of sales for the 2002 First Three Fiscal Quarters were $28,912,643, compared to $3,972,511 for the 2001 First Three Fiscal Quarters, an increase of $24,940,132 or 627.8%. The increase is primarily the result of the addition of Logicorp's product and service cost of sales to the company. Product ($23,810,616) and service ($1,249,215) resulted in a total addition of $25,059,831 or almost 100% of the increase. Since Logicorp was added in January 2002, there are no comparative figures for the 2001 First Three Fiscal Quarters. Network services cost of sales were $1,867,954 in the 2002 First Three Fiscal Quarters, compared to $1,790,031 in the 2001 First Three Fiscal Quarters, an increase of $77,923 or 4.4%. Pay-TV cost of sales were $1,984,858 in the 2002 First Three Fiscal Quarters, compared to $2,182,480 in the 2001 First Three Fiscal Quarters, a decrease of $197,622 or 9.1%. As a percentage of revenues, cost of sales increased in the 2002 First Three Fiscal Quarters to 79.7% from 38.2% in the 2001 First Three Fiscal Quarters. Total selling, general and administrative expenses for the 2002 First Three Fiscal Quarters were $8,609,523, compared to $10,712,469 for the 2001 First Three Fiscal Quarters, a decrease of $2,102,946 or 19.6%. The decrease can be attributed to a couple of items: there was a decrease in the merchant services segment of $4,169,360 resulting from decreased staffing costs and associated cost reductions; offset by an increase resulting from the addition of Logicorp $2,114,196 which was purchased during January 2002, thus resulting in no comparative figures. Total selling, general and administrative expenses for the 2002 First Three Fiscal Quarters for Logicorp comprised the following major items; salaries of $1,280,610 and supplies and materials of $570,471. As a percentage of the Company's total revenues, selling, general and administration expenses decreased to 23.7% for the 2002 First Three Fiscal Quarters from 102.9% for the 2001 First Three Fiscal Quarters. Interest cost of beneficial conversion features for the 2002 First Three Fiscal Quarters were $6,831,701, compared to nil for the 2001 First Three Fiscal Quarters. The costs arose from the raising of funds required by the Company. There were no similar costs for the 2001 First Three Fiscal Quarters. As a percentage of the Company's total revenues, Interest cost of beneficial conversion features increased to 18.8% for the 2002 First Three Fiscal Quarters from 0.0% for the 2001 First Three Fiscal Quarters. 15 Financing costs for the 2002 First Three Fiscal Quarters were $2,424,091, compared to nil for the 2001 First Three Fiscal Quarters. The costs arose from the raising of funds required by The Company. There were no similar costs for the 2001 First Three Fiscal Quarters. As a percentage of the Company's total revenues, financing costs increased to 6.7% for the 2002 First Three Fiscal Quarters from 0.0% for the 2001 First Three Fiscal Quarters. During the 2001 First Three Fiscal Quarters, Chell Merchant Capital Group Inc. vacated certain leased space and as a result the Company wrote off the net book value of the related leasehold improvements in the amount of $355,560. There were no similar transactions in the 2002 First Three Fiscal Quarters. Interest and bank charges for the 2002 First Three Fiscal Quarters were $963,651, compared to $566,801 for the 2001 First Three Fiscal Quarters, an increase of $396,850 or 70.0%. The increase can be attributed to interest now being incurred for full three fiscal quarters compared to a partial three fiscal quarters. These items were not present for the entire 2001 First Three Fiscal Quarters. As a percentage of the Company's total revenues, interest and bank charges decreased to 2.7% for the 2002 First Three Fiscal Quarters from 5.4% for the 2001 First Three Fiscal Quarters. Total depreciation and amortization expense for the 2002 First Three Fiscal Quarters was $1,686,775, compared to $1,775,804 for the 2001 First Three Fiscal Quarters, a decrease of $89,025 or 5.0%. This decrease is primarily the result of some assets becoming fully depreciated. The net loss from continuing operations for the 2002 First Three Fiscal Quarters was $13,148,316, compared to net loss of $6,974,479 for the 2001 First Three Fiscal Quarters, a increase of $6,173,837. The increase primarily resulted from the interest cost of beneficial conversion features ($6,831,701), increased financing costs ($2,424,091) and the decrease in revenue from Network Services and Pay-Tv, offset by the decrease in the merchant services segment of $4,169,360. As a result of all of the above, the net loss for the 2002 First Three Fiscal Quarters was $14,665,693, compared to net loss of $9,012,763 for the 2001 First Three Fiscal Quarters, an increase of $5,652,930. The increase primarily resulted from the interest cost of beneficial conversion features ($6,831,701), increased financing costs ($2,424,091), and the decrease in revenue from Network Services and Pay-Tv, offset by a decreases in loss from discontinued operations of $520,907 and merchant services segment of $4,169,360. Liquidity and Capital Resources At May 31, 2002, the Company had a working capital deficit of $2,924,235, an increase of $2,104,190 from working deficit of $5,028,425 at August 31, 2001. For the 2002 First Three Fiscal Quarters, the Company had a net increase in cash of $1,790,782 compared to a net decrease of $1,165,402 in the 2001 First Fiscal Half. 16 Cash used in operating activities for the 2002 First Fiscal Half was $3,611,336, compared to $3,249,925 used in operating activities in the 2001 First Fiscal Half. In 2002, the major items that contributed to cash being used in operating activities were as follows: the net loss with non-cash expenses added back of $4,493,001, the increase in inventory of $651,414, the increase in other accounts receivable of $346,980 and the decrease in accounts payable and accrued liabilities of $410,867. The major item that contributed to cash being provided by operating activities was the decrease in accounts receivable of $1,956,874. In 2001, the major items that contributed to cash being used in operating activities were as follows: net loss with non-cash expenses added back of $4,906,836, increases in income taxes receivable and prepaids of $11,940 and $33,757 respectively. The major sources of operating funds included decreases in short-term investments of $250,209 and accounts receivable of $402,293, an increase in other accounts payable and accrued liabilities of $419,333 and a decrease in net assets from discontinued operations of $527,185. Cash provided by investing activities in the 2002 First Three Fiscal Quarters was $23,041 compared to the $2,837,661 used in investing activities in the 2001 Three Fiscal Quarters, an increase of $2,860,702. In the 2002 First Three Fiscal Quarters, $326,959 of property and equipment was purchased compared to $846,851 in the 2001 First Three Fiscal Quarters, a decrease of $519,892. In the 2002 First Three Fiscal Quarters, $1,500,000 was used in the purchase of Logicorp (note 5), where in the 2001 First Three Fiscal Quarters, a $1,689,710 deposit on purchase occurred, a decrease of $189,710. In addition, a $1,850,000 increase due to sale of Magic Lantern (note 5) compared to a $301,000 increase in notes receivable occurred in the 2001 Three Fiscal Quarters. Cash provided by financing activities in the 2002 First Three Fiscal Quarters was $5,379,077, compared to the $4,922,184 provided in the 2001 First Three Fiscal Quarters. During the 2002 Second Fiscal Quarter the Company issued promissory notes in the amount $6,587,622 under a private placement memorandum. The Company is in the process of raising additional capital under its private placement memorandum. It is anticipated that such funds raised will be converted to equity. These funds will allow the Company to realize its acquisition strategy and to repay its loan obligations. In addition, in the 2002 Third Fiscal Quarter the Company has negotiated the conversion of approximately $2,954,600 owing to CALP and ABFL to equity. The Company's subsidiaries operating in the entertainment and systems integration segments create liquidity sufficient to fund their operations. Management believes that the current negotiations for terms and financing will be successful and that Company will have the required liquidity for its planned operating activities in the current year. Inflation The rate of inflation has had little impact on the Company's operations or financial position during the Nine Months ended May 31, 2002 and May 31, 2001 and inflation is not expected to have a significant impact on the Company's operations or financial position during the 2002 Fiscal Year. 17 The Company pays a number of its suppliers, including its licensor and principal supplier, NTN Communications, Inc., in US dollars. Therefore, fluctuations in the value of the Canadian dollar against the US dollar will have an impact on its gross profit as well as its net income. If the value of the Canadian dollar falls against the US dollar, the cost of sales of the Company will increase thereby reducing its gross profit and net income. Conversely, if the value of the Canadian dollar rises against the US dollar, its gross profit and net income will increase. Forward-Looking Statements The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements made by or on behalf of Chell Group Corporation. Chell Group Corporation and its representatives may from time to time make written or oral forward-looking statements, including statements contained in this report and in our other filings with the SEC. These statements use words such as "believes", "expects", "intends", "plans", "may", "will", "should", "anticipates" and other similar expressions. All statements which address operating performance, events or developments that Chell Group Corporation expects or anticipates will occur in the future are forward-looking statements within the meaning of the Private Securities Litigation Reform Act. The forward-looking statements are and will be based on management's then current views and assumptions regarding future events and operating performance. Chell Group Corporation cannot assure that anticipated results will be achieved since actual results may differ materially because of risks and uncertainties. Chell Group Corporation does not undertake to revise these statements to reflect subsequent developments. 18 PART II - OTHER INFORMATION Item 1. Legal Proceedings None. Item 2. Changes in Securities None. Item 3. Defaults Upon Senior Securities None. Item 4. Submission of Matters to a Vote of Security Holders None Item 5. Other Information None. 19 Item 6. Exhibits and Reports on Form 8-K (a) Exhibits The following list sets forth the applicable exhibits (numbered in accordance with Item 601 of Regulation S-K) required to be filed with this Quarterly Report on Form 10-Q: Exhibit Number Title ------- ----- 3.1 Certificate of Incorporation, as amended to date. 3.2 By-Laws, as amended to date. 10.1 License Agreement, dated March 23, 1990, between NTN Communications, Inc. and NTN Interactive Network Inc.+ 10.2 Stock Purchase Agreement, dated as of October 4, 1994, between NTN Canada Inc. and NetStar Enterprises Inc. (formerly, Labatt Communications Inc.). + Option, dated as of October 4, 1994, registered in the name of NetStar Enterprises Inc. (formerly, Labatt Communications Inc).+ 10.4 Designation Agreement dated as of October 4, 1994, among Networks North Inc. (formerly know as NTN Canada, Inc.), NTN Interactive Network Inc. and NetStar Enterprises Inc. (formerly Labatt Communications Inc.). + 10.15 Asset Purchase Agreement, dated September 10, 1999, by and between 1373224 Ontario Limited, Networks North Inc. and Arthur Andersen Inc., to acquire the property and assets of GalaVu Entertainment Inc., from the person appointed by the court of competent jurisdiction as the receiver or receiver and manager of the property, assets and undertaking of GalaVu. + 10.16 Promissory Note, dated September 10, 1999, by and between 1373224 Ontario Limited, as Debtor, and the Holder, as Creditor. + 10.17 General Security Agreement, dated September 10, 1999, by and between 1373224 Ontario Limited, to acquire the property and assets of GalaVu Entertainment Inc., from the person appointed by the court of competent jurisdiction as the receiver or receiver and manager of the property, assets and undertaking of GalaVu. + 10.18 Securities Pledge Agreement, dated September 10, 1999, by and between 1373224 Ontario Limited to acquire the property and assets of GalaVu Entertainment Inc., from the person appointed by the court of competent jurisdiction as the receiver or receiver and manager of the property, assets and undertaking of GalaVu. + 10.23 Bill of Sale, dated September 13, 1999, by and between 1373224 Ontario Limited to acquire the property and assets of GalaVu Entertainment Inc., from the person appointed by the court of competent jurisdiction as the receiver or receiver and manager of the property, assets and undertaking of GalaVu. + 10.24 Covenant of Networks North Inc., dated September 13, 1999, to allot and issue and pay to the Bank in writing 100,000 common shares of NETN. + 10.25 Agreement and Plan of Merger and Reorganization, dated November 21, 2001, by and among Chell Group Corporation, Chell Group Corporation, in trust for Chell SSI Acquisition Corp., and Stardrive Solutions Inc. + 20 10.26 Share Purchase Agreement, dated December 13, 2001, by and among Chell Group Corporation, Chell Merchant Capital Group, Inc., Melanie Johannesen, Randy Baxandall, Morris Chynoweth, Elaine Chynoweth, the Johannesen Family Trust, the Baxandall Family Trust, the Merc Family Trust, Logicorp Data Systems Ltd., 123557 Alberta Ltd., Logicorp Service Group Ltd. and 591360 Alberta Ltd. + 11. List of Subsidiaries 22. Computation of Earnings Per Share (see note 4). + Incorporated by reference. See Exhibit Index. (b) Reports on Form 8-K The Company filed a Current Report on Form 8-K (Date of Report: February 20, 2002) with the Commission on March 7, 2002, reporting the notification by Nasdaq to the Company that it had determined to deny the Company's request for continued listing on the Nasdaq SmallCap Market (the "Determination"), the Company's notice to Nasdaq of its intention to appeal same, and the scheduling of a Nasdaq Hearing to review the Determination. The Company filed an Amended Current Report on Form 8-KA (Date of Report: February 20, 2002) with the Commission on March 8, 2002, reporting Nasdaq notification to the Company that it had determined to deny the Company's request for continued listing on the Nasdaq SmallCap Market (the "Determination"), the Company's notice to Nasdaq of its intention to appeal same, and the scheduling of a Nasdaq Hearing to review the Determination. The Company filed a Current Report on Form 8-K (Date of Report: March 15, 2002) with the Commission on March 18, 2002, reporting the close of the Share Purchase Agreement, dated December 13, 2001, by and among Chell Group Corporation, Chell Merchant Capital Group, Inc., Melanie Johannesen, Randy Baxandall, Morris Chynoweth, Elaine Chynoweth, the Johannesen Family Trust, the Baxandall Family Trust, the Merc Family Trust, Logicorp Data Systems Ltd., 123557 Alberta Ltd., Logicorp Service Group Ltd. and 591360 Alberta Ltd. The Company filed an Amended Current Report on Form 8-KA (Date of Report: March 15, 2002) with the Commission on March 19, 2002, reporting the close of the Share Purchase Agreement, dated December 13, 2001, by and among Chell Group Corporation, Chell Merchant Capital Group, Inc., Melanie Johannesen, Randy Baxandall, Morris Chynoweth, Elaine Chynoweth, the Johannesen Family Trust, the Baxandall Family Trust, the Merc Family Trust, Logicorp Data Systems Ltd., 123557 Alberta Ltd., Logicorp Service Group Ltd. and 591360 Alberta Ltd. The Company filed an Amended Current Report on Form 8-KA (Date of Report: March 15, 2002) with the Commission on March 21, 2002, reporting the close of the Share Purchase Agreement, dated December 13, 2001, by and among Chell Group Corporation, Chell Merchant Capital Group, Inc., Melanie Johannesen, Randy Baxandall, Morris Chynoweth, Elaine Chynoweth, the Johannesen Family Trust, the Baxandall Family Trust, the Merc Family Trust, Logicorp Data Systems Ltd., 123557 Alberta Ltd., Logicorp Service Group Ltd. and 591360 Alberta Ltd. The Company filed a Current Report on Form 8-K (Date of Report: March 18, 2002) with the Commission on April 3, 2002, reporting a Share Purchase Agreement dated as of March 18, 2002 by and among the Company through, NTN Interactive Network, Inc, a wholly owned subsidiary of the Company, Magic Vision Media, Inc., NTN Interactive, Network, Inc. and Magic Lantern Communications Ltd., a wholly owned subsidiary of Chell Group Corporation. 21 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. CHELL GROUP CORPORATION Dated: July 15, 2002 By: /s/ Stephen McDermott --------------------------------------- Stephen McDermott, Chief Executive Officer (Duly Authorized Officer) Dated: July 15, 2002 By: /s/ Don Pagnutti --------------------------------------- Don Pagnutti, President and Chief Financial Officer Dated: July 15, 2002 By: /s/ Mark Truman --------------------------------------- Mark Truman, Controller and Chief Accounting Officer 22 CHELL GROUP CORPORATION FORM 10-Q May 31, 2002 EXHIBIT INDEX Exhibit Number Description of Exhibit Location ------- ---------------------- -------- 3.1 Certificate of Incorporation, as amended to date +1, Exh. 3.1 3.2 By-Laws, as amended to date +1, Exh. 3.2 10.1 License Agreement, dated March 23, 1990, between NTN Communications, Inc. and NTN Interactive Network Inc. +2, Exh. 10.9 10.2 Stock Purchase Agreement, dated October 1, 1996, among Connolly-Daw Holdings Inc., 1199846 Ontario Ltd., Douglas Connolly, Wendy Connolly and NTN Interactive Network Inc., minus Schedules thereto +3, Exh. 10.1 10.4 Designation Agreement dated as of October 4, 1994, among Networks North Inc. (formerly known as NTN Canada, Inc.), NTN Interactive Network Inc. and NetStar Enterprises Inc. (formerly Labatt Communications Inc.) +4, Exh. C 10.15 Asset Purchase Agreement, dated September 10, 1999, by and between 1373224 Ontario Limited, Networks North Inc. and Arthur Andersen Inc., to acquire the property and assets of GalaVu Entertainment Inc., from the person appointed by the court of competent jurisdiction as the receiver or receiver and manager of the property, assets and undertaking of GalaVu. +5, Exh. 10.1 10.16 Promissory Note, dated September 10, 1999, by and between 1373224 Ontario Limited, as Debtor, and the Holder, as Creditor. +5, Exh. 10.2 10.17 General Security Agreement, dated September 10, 1999, by and between 1373224 Ontario Limited, to acquire the property and assets of GalaVu Entertainment Inc., from the person appointed by the court of competent jurisdiction as the receiver or receiver and manager of the property, assets and undertaking of GalaVu.+5, Exh. 10.3 10.18 Securities Pledge Agreement, dated September 10, 1999, by and between 1373224 Ontario Limited to acquire the property and assets of GalaVu Entertainment Inc., from the person appointed by the court of competent jurisdiction as the receiver or receiver and manager of the property, assets and undertaking of GalaVu+5, Exh. 10.4 10.23 Bill of Sale, dated September 13, 1999, by and between 1373224 Ontario Limited to acquire the property and assets of GalaVu Entertainment Inc., from the person appointed by the court of competent jurisdiction as the receiver or receiver and manager of the property, assets and undertaking of GalaVu.+5, Exh. 10.9 23 10.24 Covenant of Networks North Inc. for valuable consideration to allot and issue and pay to the Bank in writing 100,000 common shares of NETN. +5, Exh. 10.10 10.25 Agreement and Plan of Merger and Reorganization, dated November 21, 2001, by and among Chell Group Corporation, Chell Group Corporation, in trust for Chell SSI Acquisition Corp., and Stardrive Solutions Inc. +6 10.26 Share Purchase Agreement, dated December 13, 2001, by and among Chell Group Corporation, Chell Merchant Capital Group, Inc., Melanie Johannesen, Randy Baxandall, Morris Chynoweth, Elaine Chynoweth, the Johannesen Family Trust, the Baxandall Family Trust, the Merc Family Trust, Logicorp Data Systems Ltd., 123557 Alberta Ltd., Logicorp Service Group Ltd. and 591360 Alberta Ltd. +7 11 Computation of earnings per share (see Note 4) 22 List of Subsidiaries +1, Exh. 22 ++1 All exhibits so indicated are incorporated herein by reference to the exhibit number listed above in the Annual Report on Form 10-K of the Company, for its fiscal year ended August 31, 1996 (File No. 0-18066), filed on December 16, 1996. ++2 All exhibits so indicated are incorporated herein by reference to the exhibit number listed above in the Annual Report on Form 10-K of NTN Communications, Inc., for its fiscal year ended December 31, 1990 (File No. 2-91761-C), filed on April 1, 1991. ++3 All exhibits so indicated are incorporated herein by reference to the exhibit number listed above in the Current Report on Form 8-K of the Company (Date of Report: October 2, 1996) (File No. 0-18066), filed on October 17, 1996. ++4 All exhibits so indicated are incorporated herein by reference to the exhibit number listed above in the Current Report on Form 8-K of the Company (Date of Report: October 4, 1994) (File No. 0-18066), filed on October 18, 1994. ++5 All Exhibits so indicated are incorporated herein by reference to the exhibit listed above in the Company's 8-K (Date of Report: September 13, 1999) (File No. 0-18066), filed on September 29, 1999. ++6 All Exhibits so indicated are incorporated herein by reference to the exhibit listed above in the Company's 8-K (Date of Report: November 21, 2001) (File No. 0-18066) filed on December 6, 2001. ++7 All Exhibits so indicated are incorporated herein by reference to the exhibit listed above in the Company's 8-K (Date of Report: December 13, 2001) (File No. 0-18066) filed on December 28, 2001. ++ Filed electronically pursuant to Item 401 of Regulation S-T. 24

CHELL GROUP CORP 10-Q