FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(X ) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED
OCTOBER 31, 1996.
-----------------
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD
FROM TO .
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COMMISSION FILE NUMBER
0-18288
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DIRECT CONNECT INTERNATIONAL INC.
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(Exact name of registrant as specified in its charter)
Delaware 22-2705223
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
266 Harristown Road
Glen Rock, New Jersey 07452
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(Address of principal executive (Zip Code)
offices)
Registrant's telephone number, including area code - (201) 445-2101
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
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Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of October 31, 1996: 9,062,066
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DIRECT CONNECT INTERNATIONAL INC. AND SUBSIDIARY
INDEX
PART I. FINANCIAL INFORMATION PAGE NO
Item 1. Financial Statements
Condensed Consolidated
Balance Sheets -
October 31, 1996 and
April 30, 1996 3
Condensed Statements
Of Consolidated
Operations - Three
Months Ended October 31,
1996 and October 31, 1995 and 4
Six Months Ended October 31,
1996 and October 31, 1995
Condensed Statements
Of Consolidated Cash
Flows - Six Months
Ended October 31, 1996
and October 31, 1995 5
Notes to Financial Statements 6
Item 2. Management's Discussion
and Analysis of Results
of Operations and
Financial Condition 7 - 15
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports
on Form 8-K 16
Signatures 17
2
PART 1. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Direct Connect International Inc. and Subsidiary
Consolidated Balance Sheets
ASSETS
October 31, 1996 April 30, 1996
---------------- --------------
(Unaudited)
Current assets
Cash and cash equivalents $52,865 $67,886
Accounts receivable 12,361 20,652
Due from Kidsview, Inc. 302,765 194,117
Notes receivable-officers 124,631 111,355
Investments 54,171 54,171
Prepaid financing costs and other expenses 35,356 69,075
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Total current assets 582,149 517,256
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Property and equipment, at cost
Furniture and fixtures 43,912 42,543
Molds, tools and dies 267,498 267,498
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311,410 310,041
Less: accumulated depreciation 247,913 234,813
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63,497 75,228
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Investment in Glasgal 1,896,871 2,111,151
Investment in Evolutions Inc. 1,875,000 75,000
Deferred Income taxes 809,287 809,287
Security deposits 700 700
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4,581,858 2,996,138
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Total assets $5,227,504 $3,588,622
========== ==========
LIABILITIES and STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable $326,870 $947,512
Accrued expenses and taxes payable 315,587 49,825
Notes payable-officers and stockholders 463,813 461,716
Notes payable-other, current portion 1,876,696 1,411,424
Investment, warrants to sell Glasgal 300,000 300,000
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Total current liabilities 3,282,966 3,170,477
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Stockholders' equity
Convertible preferred stock:
Authorized 5,000,000 shares, $.001
par value; issued and outstanding-
5,000,000 shares 5,000 5,000
Common stock:
Authorized 15,000,000 shares, $.001
par value; issued and outstanding-
9,062,066 shares 9,062 9,062
Capital in excess of par value 5,104,449 5,104,449
Accumulated deficit (3,119,802) (4,646,195)
Unrealized loss on investments (54,171) (54,171)
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Total stockholders' equity 1,944,538 418,145
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Total liabilities and stockholders'
equity $5,227,504 $3,588,622
========== ==========
3
Direct Connect International Inc. and Subsidiary
Consolidated Statements of Operations
For The For The
Three Months Ended Six Months Ended
------------------ ----------------
October 31 October 31 October 31 October 31
1996 1995 1996 1995
---- ---- ---- ----
(Unaudited) (Unaudited)
Revenues:
Sales $259,838 $778,664 $431,587 $899,139
Costs and expenses
Cost of goods sold 124,713 742,186 288,190 806,135
Royalties/licensing fees 6,881 110,691 22,690 120,916
Product development cost 6,000 1,174 12,000 1,174
Advertising and promotion 4,539 15,004 4,539 80,885
Depreciation 6,549 12,916 13,100 31,120
General and administrative
expenses 316,370 1,093,219 551,034 1,418,412
Less: management fees (164,658) 0 (419,658) 0
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300,394 1,975,190 471,895 2,458,642
-------- --------- --------- ---------
Operating income (loss) (40,556) (1,196,526) (40,308) (1,559,503)
Gain on sale of assets and
product lines 0 1,034,494 0 1,034,494
Gain on sale of securities 696,885 1,426,135 1,613,820 1,426,135
Interest income 707 7,033 772 14,199
Other income 1,094 0 3,372 0
Interest expense (25,510) (44,557) (51,263) (193,277)
------- ------- ------- --------
Income before income taxes 632,620 1,226,579 1,526,393 722,048
Deferred income taxes 0 644,436 0 644,436
------- --------- --------- ---------
Net income $632,620 $1,871,015 $1,526,393 $1,366,484
======== ========== ========== ==========
Income per share $0.04 $0.12 $0.10 $0.09
===== ===== ===== =====
4
Direct Connect International Inc. and Subsidiary
Consolidated Statements of Cash Flows
For The Six Months Ended
------------------------
October 31, 1996 October 31, 1995
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(Unaudited)
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Cash flows from operating activities
Net income $ 1,526,393 $ 1,366,484
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation and amortization 13,100 31,120
Gain on sale of Glasgal stock (1,613,820) (1,426,135)
Financing fees-general and administrative expense 0 348,720
Decrease (increase) in assets
Accounts receivable-trade 8,291 (122,818)
Prepaid royalties 0 57,500
Prepaid financing costs and expenses 33,719 237,410
Inventories 0 32,297
Deferred income taxes 0 (644,436)
Increase (decrease) in liabilities
Accounts payable (620,642) 271,671
Accrued expenses and taxes payable 265,762 (3,160)
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Total adjustments (1,913,590) (1,217,831)
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Net cash provided by (used in)
operating activities (387,197) 148,653
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Cash flow from investing activities
Notes receivable-officers, increase (13,276) 258,790
Investment in Glasgal Communications, Inc. 1,828,100 1,871,066
Increase in Due from Kidsview, Inc. (108,648) 0
Decrease in Due from Kidsview, Inc. 0 244,337
Increase in Investment in Evolutions, Inc. (1,800,000) 0
Sale of molds, tools, and dies 0 69,977
Acquisition of property and equipment (1,369) (104,113)
Investment in security 0 (500,000)
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Net cash provided by (used in) investing activities (95,193) 1,840,057
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Cash flows from financing activities
Increase in notes payable-officers and stockholders 2,097 348
Increase in notes payable-other 1,624,129 (2,191,677)
Decrease in notes payable-other (1,158,857) 350,000
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Net cash provided by (used in) financing activities 467,369 (1,841,329)
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Net decrease in cash and cash equivalents (15,021) 147,381
Cash and cash equivalents at beginning of period 67,886 171,677
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Cash and cash equivalents at end of period $ 52,865 $ 319,058
=========== ===========
Supplemental disclosures of cash flow information
Cash paid during the six months for interest $ 51,263 $ 160,277
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5
DIRECT CONNECT INTERNATIONAL INC.
AND SUBSIDIARY
Notes to Financial Statements
1. In the opinion of management, the accompanying unaudited financial
statements contain all adjustments, consisting only of normal recurring
adjustments, necessary to present fairly (a) the financial position as
of October 31, 1996, (b) the results of operations for the three and
six months ended October 31, 1996 and October 31, 1995 and (c) changes
in cash flows for the three and six months ended October 31, 1996 and
October 31, 1995.
2. Refer to the audited financial statements for the fiscal year ended
April 30, 1996 for details of accounting policies and accounts, none of
which have changed significantly in composition since that date.
3. Financial results for the interim period ended October 31, 1996 may not
be indicative of the financial results for the fiscal year ending April
30, 1997.
4. The Company has available carry forward losses applicable to the
reduction of future Federal income taxes aggregating approximately
$4,869,000 at December 31, 1995 and which expire during the years 2003
to 2010.
5. The Company has made an investment in Evolutions, Inc. (EVO), an
apparel and toy products company, aggregating approximately $1,800,000
at October 31, 1996 for which the Company has received shares of EVO
common stock representing approximately 11% of EVO's outstanding common
stock.
6
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
Net Sales
Net sales for the three and six month periods ended October 31, 1996 amounted to
$259,838 and $431,587, respectively, as compared to $899,139 and $778,664,
respectively, for the same periods in the prior fiscal year.
The Company intends to develop additional product lines; however, there can be
no assurance that it will be able to do so on a commercially viable basis. If
such product lines are so developed, the Company may be required to sell or
license such product lines, depending on, among other factors, its financial
resources.
At October 31, 1996, the Company did not have a backlog of confirmed orders from
its customers.
Gross Profit
Gross Profit percentage for the three months ended October 31, 1996 was 52% as
compared to 5% for the three months ended October 31, 1995. Gross Profit
percentage for the six months ended October 31, 1996 was 33% as compared to 10%
for the six months ended October 31, 1995. Such increase for the three and six
months ended October 31, 1996 did not require any adjustments, such as credits
and other charges, which were included in the three months and six months ended
October 31, 1995.
Royalties/Licensing Fees
Royalties/Licensing fees are variable expenses which increase as sales increase.
For the three and six month periods ended October 31, 1996, the Company paid
approximately $6,881 (or 3% of sales) and $22,690 (or 5% of sales),
respectively, as compared to $110,691 (or 14% of sales) and $120,916 (or 13% of
sales) for the three and six month periods ended October 31, 1995, respectively.
The decrease in royalties was primarily attributable to the decrease in sales.
In order to match revenues with expenses, minimum royalty guarantees are treated
as prepaid expenses and are charged against income as the related products are
sold. For fiscal 1996, the Company is not obligated to make minimum royalty
payments pursuant to any license agreements.
Other Income
Other income amounted to approximately $698,686 and $1,617,964 for the three and
7
six months ended October 31, 1996 as compared to approximately $2,467,000 and
$2,474,000 for the three and six months ended October 31, 1995. This decrease
for the three and six months ended October 31, 1996 is due to the sale of shares
of Glasgal stock by the Company in the prior periods and the gain in the sale of
assets and product line in the 1995 period.
General and Administrative Expenses
Advertising and promotion expenses amounted to $4,539 and $4,539 for the three
and six month periods ended October 31, 1996 as compared to $15,004 and $80,885,
respectively, for the three and six month periods ended October 31, 1995. This
decrease was due to the sale of product lines in 1995.
For the three and six months ended October 31, 1996, the Company earned a
management fee of $164,658 and $419,658, respectively, which covers the monthly
reimbursement of the costs incurred by the Company in connection with its
operations as it relates to supporting the product lines which were sold. Set
forth below are the principal components.
General and administrative expenses for the three and six month periods ended
October 31, 1996 were $316,370 and $551,034, respectively, as compared to
$1,093,219 and $1,418,412, respectively, for the three month and six month
periods ended October 31, 1995. Included in such amount for the three month and
six month periods ended October 31, 1996 were commissions of $ 0 and $8,469,
respectively, as compared to $38,688 and $45,451, respectively, for the three
month and six month periods ended October 31, 1995. This decrease resulted
primarily from the decline in the amount of sales upon which commissions are
based. Professional fees were $59,100 and $71,149, respectively, for the three
and six month periods ended October 31, 1996 as compared to $56,473 and $94,852,
respectively, for the three and six month periods ended October 31, 1995. This
decrease for the six months ended October 31, 1996 was due primarily to having
incurred no professional fees in connection with the sale of certain assets and
product lines and investment securities and financing activities. Letter of
credit and foreign office expenses amounted to $10,344 and $23,343,
respectively, for the three month and six month periods ended October 31, 1996
as compared to $24,720 and $26,764, respectively, for the three month and six
month periods ended October 31, 1995. This decrease was due primarily to the
decline in purchases resulting from the decrease in sales and the decline in the
cost of goods purchased.
For the three and six month periods ended October 31, 1996, salaries were
$138,288 and $247,563, respectively, as compared to $414,857 and $508,290,
respectively, for the three and six month periods ended October 31, 1995. Such
decrease was due to a reduction in the number of employees in the three and six
months ended October 31, 1996 and lower salary levels for certain employees in
such periods.
Travel and entertainment expenses increased to $37,506 and $66,630 for the three
and six month periods ended October 31, 1996 as compared to $19,662 and $38,137
8
for the three and six month periods ended October 31, 1995. This increase
resulted from the Company's efforts to expand sales.
LIQUIDITY AND CAPITAL RESOURCES
During the next twelve months, the Company in addition to meeting its operating
needs will have notes payable, as discussed below, in the amount of
approximately $2,340,000 becoming due. The Company does not believe that it will
be able to pay these obligations out of operating revenues, and, accordingly, it
will have to seek additional financing or sell assets to do so. The Company
anticipates funding its obligations from two principal sources. First, the
Company intends to develop additional product lines which would be promoted and
marketed in a manner similar to the manner in which the Company has utilized for
its Zoo Borns and Tea Bunnies product lines which involved the transfer of such
product lines to Evolutions, Inc. (EVO) as decribed herein. Second, the Company
owns approximately 1,178,333 shares of common stock of Glasgal Communications,
Inc. (Glasgal) and may, from time to time, sell a portion of such shares. For
additional information regarding prior dispositions of Glasgal shares, see the
description of such transactions contained herein. There can be no assurance
that the Company will be able to develop additional product lines, obtain such
financing or sell assets, in which event such obligations will have a material
adverse effect upon the Company's operations. The Company expects to support its
operations over the next five months through funds generated from its management
contract with EVO as described herein. At October 31, 1996, the Company had a
cash and cash equivalent balance of $52,865 as compared to $67,886 at October
31, 1995.
For the six months ended October 31, 1996 the Company used cash from operations
in the amount of $387,197 as compared to providing $148,653 from operations for
the six months ended October 31, 1995. The Company obtained $467,369 from its
financing activities for the six months ended October 31, 1996 as compared to
using approximately $1,841,000 for the six months ended October 31, 1995. The
amount for 1996 resulted primarily from borrowings using the Company's Glasgal
shares as collateral. The amount for 1995 resulted primarily from the payment of
notes payable amounting to $2,192,000 and the issuance of new notes aggregating
$350,000.
For the six months ended October 31, 1996, the Company used $95,193 from its
investing activities. Included in that amount were proceeds received in the
amount of $1,828,100 from the sale of 221,667 shares of Glasgal stock. Also
included in that amount was cash used to increase the Company's investment in
Evolutions Inc. by $1,800,000 and to increase the Company's advances from
Kidsview, Inc. by $108,648.
In October 1995 the Company issued to two individual lenders promissory notes in
the aggregate principal amount of $350,000. Such notes are secured by a total of
200,000 shares of Glasgal common stock held by the Company and bear interest at
the rate of 10% per annum and became due on October 15, 1996. As an inducement
for the noteholders to make the $350,000 loan to the Company, the Company agreed
to deliver to such holders an aggregate of 19,440 shares of Glasgal common stock
9
held by the Company and to deliver to such holders (a) warrants to purchase for
a period of twenty-four months an aggregate of 19,440 shares of Glasgal common
stock held by the Company at an exercise price of $3.00 per share and (b)
warrants to purchase for a period of twenty-four months an aggregate of 38,880
shares of the Company's common stock at an exercise price of $ .20 per share.
The Company is negotiating with such noteholders regarding an extension for
repayment of the notes.
The Company in September 1995 entered into an agreement with EVO whereby the
Company transferred all rights and interests to its Zoo Borns product line, Tea
Bunnies product line and Kidsview name to a subsidiary of EVO for $750,000 and
shares of common stock of EVO equal to approximately 7% of EVO's then
outstanding common stock (valued at $75,000) with the right to receive
additional shares of common stock equal to approximately 15% of the outstanding
common stock of EVO based on certain performance levels of the Zoo Borns and Tea
Bunnies product lines over the next three years.
As an inducement for EVO to enter into this agreement, the Company issued to EVO
warrants to purchase 350,000 shares of common stock of the Company at exercise
prices of $ .10 per share with respect to 100,000 shares and $ .20 per share
with respect to 250,000 shares. In anticipation of consummating the agreement,
EVO and the Company entered into a lending arrangement under which the Company
signed a promissory note in March 1995 for $750,000 with interest at the annual
rate of 12%. Such note was secured by 133,973 shares of Glasgal stock held by
the Company and by an interest in certain accounts receivable and was due on
September 1, 1996. In July and August 1995, the Company also borrowed from EVO
an aggregate of $350,000 with interest at the annual rate of 12%. Such
obligations were secured by certain accounts receivable and were due on October
31, 1995. Upon consummation of the agreement, all these obligations were
cancelled.
The Company recognized a gain of approximately $1,034,000 as a result of this
transaction.
As part of the agreement, the Company is managing these product lines and is
receiving an amount equal to its monthly operating costs, up to $100,000, for
such period of time as the Company is managing such product lines. The Company
is providing the services of Peter Schneider, President of the Company, for such
management. This management arrangement may be extended for up to two additional
years depending on certain performance levels of such product lines. For the six
months ended October 31, 1996, the Company received fees from EVO in connection
with this management arrangement amounting to $419,658.
On May 28, 1996, the Company established a margin account with the brokerage
firm of Cowen & Company (Cowen). In that connection, the Company delivered
300,000 shares of common stock of Glasgal held by the Company to Cowen and
borrowed $500,000 against such account.
On June 10, 1996, the Company sold (at $9.00 per share) 115,000 shares of common
stock of Glasgal held by the Company in its margin account. The Company received
net proceeds from such sale aggregating approximately $1,000,000. The Company
10
used approximately one-half of the proceeds to pay off its margin loan of
approximately $500,000. In October 1996, the Company placed in its margin
account an additional 20,000 shares of common stock of Glasgal held by the
Company.
The net proceeds from the transactions referred to above (approximately
$1,000,000) was invested in common stock of EVO at $2.50 per share, and warrants
exercisable at $3.50 per share to purchase common stock of EVO. The Company in
August 1996 also made an additional equity investment in EVO of approximately
$800,000 on the same terms, which included the transfer by the Company of
106,667 shares of Glasgal common stock held by the Company, in EVO common stock
and warrants to purchase common stock. As an inducement for such investments,
the Company received additional warrants to purchase 400,000 additional shares
of EVO common stock exercisable at $2.50 per share.
To expand its business, the Company will have to seek additional financing and
there can be no assurance that it will be able to obtain such financing. No
assurance can be given as to the number of outstanding warrants, which represent
a potential source of funds, that will be exercised. The Company is exploring
alternatives to utilizing its equity investments in connection with financing
its operations and developing new products.
In order to arrive at the completed stage, the Company's products must go
through the following processes: product concept and design, product development
and engineering, pre-production approval and product manufacture and
distribution.
In order to supplement its cash flow, the Company, on March 6, 1991, entered
into loan agreements with several investors whereby the Company borrowed an
aggregate of $282,000 for six months with interest at the semiannual rate of
14.5%. As part of such transaction, the Company issued to such investors, in a
private placement, an aggregate of 17,000 shares of its common stock, on a
restricted basis, for an aggregate consideration of approximately $22,000. In
October 1991, the Company paid off $32,000 (plus accrued interest) with respect
to such loans. At such time the Company renegotiated the balance of such loans
(plus accrued interest) and issued new notes, maturing in one year, amounting to
approximately $290,000 including interest thereon at the annual rate of 10%. In
September 1992 the Company delivered 200,000 shares of common stock to one of
such investors in exchange for the contemplated cancellation of substantially
all the balance of such loans. The Company under the terms of this arrangement
remains contingently liable for the prior obligation depending on the future
stock price and salability of the shares. The investor has been unable to sell
the shares for a price of at least $1.625 and, accordingly, the shares can be
returned to the Company. The Company is obligated to pay such investor the value
of the note, plus accrued interest, aggregating approximately $395,100 at
October 31, 1996. If the Company is unable to pay this obligation out of
operating revenues, it will have to seek additional financing or sell a portion
of its equity holdings in Glasgal to do so. There can be no assurance that the
Company will be able to obtain such financing or sell such equity, in which
event this obligation would have a material adverse effect upon the Company's
operations.
11
Given the nature of the Company's business, the length of the typical product
cycle in the toy business, the need to respond rapidly to developments in the
marketplace and to, if necessary, make rapid changes in product lines and
strategic plans to meet the rapid changes in the marketplace, the Company's
planning historically has been limited to approximately a twelve month
time-frame at any given time. It is anticipated that the Company will continue
to operate in a similar fashion in the future. Accordingly, analyses of long
term liquidity and capital requirements are not meaningful.
In 1992, the Company, in order to regain listing on the NASDAQ Small Cap System,
to provide for operating requirements and in contemplation of a possible change
in the nature of the Company's business, completed a private placement of
securities in October 1992, in which investors subscribed for 100 Units, each
Unit consisting of 50,000 shares of Convertible Preferred Stock and 25,000 1992
Warrants to purchase shares of Common Stock, for a total of $3,000,000. Such
private placement was closed in two stages, the first of which involved the
purchase of 52-1/2 Units and closed in July 1992, with the balance of the Units
offered (47-1/2 Units) being purchased in October 1992. As a result of the
consummation of such private placement, (a) the Redeemable Class A Warrant
exercise price has been adjusted from $1.00 per share to $ .53 per share and the
number of shares of Common Stock issuable upon exercise of Redeemable Class A
Warrants has been increased from 3,438, 900 shares to 6,488,517 shares of Common
Stock so that each holder of a Redeemable Class A Warrant will be able to
purchase 1.8868 shares of Common Stock for $1.00 upon exercise of each Warrant
and (b) the Redeemable Class B Warrant exercise price has been adjusted from
$1.50 per share to $ .75 per share and the number of shares of Common Stock
issuable upon exercise of Redeemable Class B Warrants has been increased from
1,719,450 shares to 3,438,900 shares of Common Stock so that each holder of a
Redeemable Class B Warrant will be able to purchase one share of Common Stock
per warrant upon exercise of such Warrant.
In November 1992, the Company signed a merger agreement with Glasgal, a
privately held company which provides network design, hardware and software,
carrier facilities and support services for organizations in a diverse range of
industries. The Company and Glasgal terminated the proposed merger agreement in
December 1993 and entered into a stock purchase agreement described below.
In November 1992, the Company, in contemplation of the Glasgal merger, entered
into a loan agreement with Glasgal whereby the Company loaned Glasgal
$1,000,000, due on December 31, 1993, as extended, at an annual interest rate
equal to two percent above the prime rate. An aggregate of $400,000 (also due on
December 31, 1993 as extended) was loaned to Glasgal in March, June, August and
September 1993. All the loans were secured by 50.1% of the stock of Glasgal held
by Ralph Glasgal, Glasgal's principal stockholder, and a second priority
security interest in, among other things, Glasgal's accounts receivable,
inventory and equipment. The purpose of this loan was to satisfy partially
Glasgal's short-term cash needs pending the proposed merger with the Company
(which was not consummated - see below), which cash needs Glasgal estimated to
12
be between $2.1million and 2.6 million. These short-term cash needs related
specifically to (i) Glasgal's financing of the implementation of its business
plan, (ii) its financing of an increased level of inventory, (iii) a reduction
in the average age of its trade payables, (iv) its financing of the shortfall
between a prior mortgage and a new bridge loan, and (v) to meet certain balance
sheet requirements of prospective new lenders.
In order to provide for additional working capital, to meet expenses related to
the Glasgal merger, and to be in position to assist Glasgal in solving its
immediate cash flow problems in contemplation of the merger, the Company entered
into lending arrangements with several individuals under which the Company
issued notes aggregating $780,000 plus interest thereon at the annual rate of 8%
in private placements pursuant to an exemption from registration under Section
4(2) of the Securities Act of 1933, as amended (the Act). Such notes matured
between December 31, 1993, as extended, and December 31, 1995. At October 31,
1996, such notes amounted to approximately $812,000 including accrued interest
thereon. As an inducement for making such loans, it was intended that the
holders would have an opportunity to convert such notes into equity securities
when the Company next undertook a private placement, the terms of which had not
been determined, provided that the holders met suitability requirements thereof.
The Company believes that all of such holders either were officers of the
Company or relatives of officers of the Company who in all cases were deemed to
be suitable investors or other individuals who had preexisting personal
relationships with officers or directors of the Company and, in addition, would
have been deemed "accredited investors" as such term is defined in Rule 501 of
Regulation D under the Act if an exemption had been sought under Regulation D.
In view of the Company's default in payment of its obligations under the notes
and its inability of afford the noteholders an opportunity to convert such notes
into equity securities, several of the noteholders have recently contacted the
Company and have threatened to commence litigation against the Company to
enforce the Company's obligations under the notes. The Company intends either to
pay off the obligations or to convert the notes (including accrued interest
thereon) into Common Stock at a rate of five shares of Common Stock per dollar
subject to stockholder approval of an increase in authorized shares of Common
Stock in connection with a proposed meeting of stockholders. There can be no
assurance that the Company will be able to effectuate such payment or
conversion. Litigation by noteholders to enforce the notes would materially
adversely affect the Company's operations.
In addition, the Company in February 1993 accepted a subscription from an
unaffiliated non-U.S. investor to purchase 1,500,000 shares of Common Stock, in
a private placement, for an aggregate consideration of $300,000. The Company
believes that such private placement did not result in any further adjustments
of any outstanding warrants, options or convertible stock.
The Company, after termination of the Glasgal merger, entered into a common
stock purchase agreement (the "Agreement") with Glasgal governing certain equity
investments which the Company has made, and in the future intends to make, in
Glasgal common stock. Pursuant to the Agreement, in January 1994 the Company
converted outstanding indebtedness of Glasgal owed to the Company into equity of
Glasgal which, upon consummation of the Glasgal merger with Sellectek
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Incorporated, resulted in the Company owning approximately 28% of the
outstanding shares of Glasgal or 18.5% on a fully diluted basis. In addition,
the Agreement gives Glasgal the right to require the Company to purchase an
additional number of shares of common stock of Glasgal equal to 13.5% of the
then outstanding shares (the "Additional Shares"), or 10% on a fully diluted
basis, for an aggregate of approximately $8.4 million after giving effect to
certain warrant solicitation fees (the "Additional DCI Investment"). Glasgal may
require this purchase if, and then only to the extent that, the Company receives
proceeds from the exercise of existing Company warrants. There can be no
assurance that any or all of such warrants will be exercised. The Company has
issued warrants to the public to purchase 6,448,517 shares of Common Stock at $
.53 per share, warrants to purchase 3,438,900 shares of Common Stock at $ .75
per share, and warrants to purchase 2,500,000 shares of Common Stock at $1.00
per share. Such warrants will expire in 1997, as extended. The Company has the
right to retain the first $500,000 of warrant exercise proceeds; however, such
amount must be used by the Company to purchase shares of Common Stock of Glasgal
if the aggregate amount of warrant exercise proceeds applied to the purchase of
Glasgal common stock, after the earlier of the expiration of exercise of all
warrants or 24 months after the effectiveness of the registration statement
covering the Common Stock underlying the warrants, is less than $8.4 million. In
view of the fact that, at the present time and throughout 1996, the price of the
Common Stock has been substantially below the exercise price of the warrants, it
is impossible to predict the timing of exercise of any of the outstanding
warrants, or if such warrants will ever be exercised. The Company anticipates
such an event will not arise for at least two years and that, should such
eventuality arise, the Company will attempt to meet such obligation either
through loans (which may be secured by all or a portion of its Glasgal equity),
equity financings or some combination thereof. If Glasgal does not require the
Additional DCI Investment, the Company may still purchase, on the same terms, up
to one-half of the Additional Shares.
In November 1993, the Company issued to several investors secured promissory
notes aggregating $500,000 with interest thereon at the annual rate of 8%. Such
notes were secured by all the assets of the Company and matured on September 30,
1994, as extended, and were paid off on October 6, 1994. As an inducement for
such investors to make such loan, the Company issued to such investors warrants,
which expire on November 23, 1998, to purchase an aggregate of 750,000 shares of
Common Stock at an exercise price of $ .05 per share, as adjusted. The proceeds
from such transaction were loaned to Glasgal to fulfill certain commitments to
Glasgal. Such loan to Glasgal was made on the same terms as the previous loans
to Glasgal referred to hereinabove. As an inducement to extend the maturity date
of such notes to September 30, 1994, the Company issued an aggregate of 500,000
additional warrants ("1994 Warrants") to the holders of such notes on the same
terms and conditions as the 1993 Warrants except that the exercise price of the
1994 Warrants is $ .20 per share.
On October 6, 1994, the Company consummated a lending arrangement with BW
Capital Corporation ("BW"), an independent lender organized to invest in
unregistered securities and small capitalization companies which was the largest
shareholder of Sellectek prior to its merger with Glasgal. The Company, which
was introduced to BW in connection with the Glasgal/Sellectek merger, has no
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relationship with BW other than in connection with such lending arrangement.
Under the terms of such arrangement, the Company issued to BW a secured
promissory note in the principal amount of $1,600,000 bearing interest at the
rate of 11% per annum (the "Note"). The Note was secured by collateral
consisting of 2,000,000 shares of Glasgal common stock owned by the Company and
all dividends and other distributions of any kind in respect of such shares. The
Note matured on October 6, 1995 and was subsequently paid. As an inducement for
BW to make such loan to the Company, the Company transferred to BW 270,000
shares of Glasgal common stock owned by the Company. The Company also paid an
investment banker, Brookehill Equities, $100,000 as compensation for its
services in connection with arranging the loan. Under the terms of the lending
arrangement, because the Note was not prepaid in full on or before July 6, 1995,
the Company transferred to BW an additional 270,000 shares of Glasgal common
stock owned by the Company. The Company used the proceeds from such loan to pay
off existing secured indebtedness aggregating $750,000 including $30,000 paid to
Joseph Salvani, the Company's Chairman, and for general corporate purposes.
Prior to entering into the lending arrangement with BW, the Company sought
alternative financing for several months and had discussions with other
potential sources of financing. In the opinion of management, the BW proposal
offered the Company the best financing terms of the limited alternatives then
available to the Company. In establishing the collateral for the loan, BW took
into account the fact that, notwithstanding a market price at that date of
approximately $4 per share for Glasgal common stock, in view of the fact that
the shares to be delivered as collateral were restricted and that the market for
Glasgal common stock generally was then illiquid, if it were forced to liquidate
the collateral it was unlikely that BW would realize an amount close to the
reported per share market value for such stock. From the Company's standpoint,
the BW Loan, while not on favorable terms, represented the best terms available
to the Company and management believed that it was in the best interest of the
Company to proceed with such borrowing in order to be able to develop its
product lines and to reduce outstanding debt that was then due.
Among the alternatives considered by the Company at the time of the BW loan was
the sale of a portion of its Glasgal stock. In view of the restrictions on the
transfer of such stock as well as the illiquidity of the market for the shares,
the Company's options with respect to any such sale were limited. The Company
did receive a verbal offer to purchase approximately two million shares of the
Glasgal common stock, to be accomplished through a private placement exempt from
registration under Regulation S under the Federal securities laws, at a price
per share of approximately $ .80. The Company rejected such an offer as less
favorable than the BW alternative. Similarly, the inducement fees incurred in
connection with the BW transaction, while onerous, viewed in the context of the
overall BW transaction, were deemed the best alternative available to the
Company in order for it to continue to fund the development of its toy business
and preserve as much of its Glasgal equity as possible.
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DEFERRED INCOME TAX ASSETS
Deferred income tax assets as of October 31, 1996 and April 30, 1996 have been
reduced to $809,287 by a valuation allowance of $983,802 due to uncertainties
concerning their realization.
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
Exhibits:
Financial Data Schedule
Reports on Form 8-K:
Form 8-K/A, dated August 19, 1996, regarding changes
in registrant's certifying accountant
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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.
DIRECT CONNECT INTERNATIONAL INC.
(Registrant)
Date: December 12, 1996 By /s/Peter L. Schneider
----------------- ---------------------
Peter L. Schneider
President and Chief
Operating Officer
Date: December 12, 1996 By /s/Barry A. Rosner
----------------- ------------------
Barry A. Rosner
Treasurer and Chief
Financial Officer
17