FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ______ TO ______
COMMISSION FILE NO. 0-22545
DSI TOYS, INC.
(Exact name of Registrant as specified in its charter)
TEXAS 74-1673513
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
1100 WEST SAM HOUSTON PARKWAY NORTH
HOUSTON, TEXAS 77043
(Address of principal executive offices) (Zip Code)
Registrant's telephone number including area code: (713) 365-9900
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
As of November 10, 2000, 9,066,365 shares of common stock, par value $.01
per share, of DSI Toys, Inc. were outstanding.
TABLE OF CONTENTS
PAGE
PART I - FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
Consolidated Balance Sheet as of September 30, 2000, and
December 31, 1999.................................................1
Consolidated Statement of Operations for the Three Months and
Nine Months Ended September 30, 2000, and October 31, 1999........2
Consolidated Statement of Cash Flows for the Nine Months Ended
September 30, 2000, and October 31, 1999..........................3
Consolidated Statement of Shareholders' Equity......................5
Notes to Consolidated Financial Statements..........................6
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS...............................................9
PART II - OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS..................................................14
Item 5. OTHER INFORMATION..................................................14
Item 6. EXHIBITS AND REPORTS ON FORM 8-K...................................14
Signatures................................................................ 15
i
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
DSI TOYS, INC.
CONSOLIDATED BALANCE SHEET
SEPTEMBER 30, DECEMBER 31,
2000 1999
--------------- ---------------
(Unaudited)
ASSETS
Current Assets:
Cash ..................................................................................... $ 407,445 $ 478,970
Restricted cash .......................................................................... 150,000 150,000
Accounts receivable, net ................................................................. 12,229,008 3,408,059
Inventories .............................................................................. 11,216,274 5,695,240
Prepaid expenses ......................................................................... 2,633,142 1,383,644
Deferred income taxes .................................................................... 825,260 314,000
--------------- ---------------
Total current assets ............................................................ 27,461,129 11,429,913
Property and equipment, net .................................................................. 2,724,927 2,000,215
Deferred income taxes ........................................................................ 902,000 902,000
Other assets ................................................................................. 607,798 695,237
Goodwill, net ................................................................................ 9,882,873
--------------- ---------------
$ 41,578,727 $ 15,027,365
=============== ===============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable and accrued liabilities ................................................. $ 14,028,104 $ 3,769,286
Current portion of long-term debt ........................................................ 3,687,534 1,313,787
Current portion of long-term debt due to a related party ................................. 1,688,433
Income taxes payable ..................................................................... 901,546 428,727
--------------- ---------------
Total current liabilities ....................................................... 20,305,617 5,511,800
Long-term debt ............................................................................... 7,504,778 2,393,236
Long-term debt due to a related party ........................................................ 4,667,725
Deferred income taxes ........................................................................ 133,340 133,340
--------------- ---------------
Total liabilities ............................................................... 32,611,460 8,038,376
Shareholders' equity:
Preferred stock, $.01 par value, 5,000,000 shares authorized,
none issued or outstanding
Common stock, $.01 par value, 35,000,000 shares authorized, 9,066,365 and
8,719,000 shares issued; 9,066,365 and
8,533,157 shares outstanding ........................................................ 90,664 87,190
Additional paid-in capital ............................................................... 5,173,465 4,934,919
Common stock warrants .................................................................... 102,500 102,500
Accumulated other comprehensive loss ..................................................... (41,150) (12,626)
Retained earnings ........................................................................ 3,641,788 3,436,401
--------------- ---------------
8,967,267 8,548,384
Less: Treasury stock, 185,843 shares, at cost ........................................... (1,559,395)
--------------- ---------------
Total shareholders' equity ...................................................... 8,967,267 6,988,989
--------------- ---------------
$ 41,578,727 $ 15,027,365
=============== ===============
See accompanying notes to consolidated financial statements.
1
DSI TOYS, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
---------------------------------- ----------------------------------
SEPTEMBER 30, OCTOBER 31, SEPTEMBER 30, OCTOBER 31,
2000 1999 2000 1999
--------------- --------------- --------------- ---------------
Net Sales .............................................. $ 29,915,591 $ 22,466,132 $ 50,412,558 $ 41,040,770
Cost of goods sold ..................................... 20,483,673 15,700,115 35,391,788 29,687,767
--------------- --------------- --------------- ---------------
Gross profit ........................................... 9,431,918 6,766,017 15,020,770 11,353,003
Selling, general and administrative expenses ........... 6,832,944 3,898,396 13,794,519 8,644,167
--------------- --------------- --------------- ---------------
Operating income ....................................... 2,598,974 2,867,621 1,226,251 2,708,836
Interest expense ....................................... (372,883) (233,238) (1,046,628) (486,228)
Other income ........................................... 86,800 37,998 141,295 82,082
--------------- --------------- --------------- ---------------
Income before income taxes ............................. 2,312,891 2,672,381 320,918 2,304,690
Provision for income taxes ............................. (832,640) (985,944) (115,531) (901,350)
--------------- --------------- --------------- ---------------
Net income ............................................. $ 1,480,251 $ 1,686,437 $ 205,387 $ 1,403,340
=============== =============== =============== ===============
BASIC EARNINGS PER SHARE
Earnings per share ................................ $ 0.16 $ 0.20 $ 0.02 $ 0.19
=============== =============== =============== ===============
Weighted average shares outstanding ............... 9,066,365 8,533,157 9,049,023 7,500,335
=============== =============== =============== ===============
DILUTED EARNINGS PER SHARE
Earnings per share ................................ $ 0.16 $ 0.19 $ 0.02 $ 0.18
=============== =============== =============== ===============
Weighted average shares outstanding ............... 9,118,553 8,703,569 9,097,094 7,610,291
=============== =============== =============== ===============
See accompanying notes to consolidated financial statements.
2
DSI TOYS, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
NINE MONTHS ENDED
------------------------------------
SEPTEMBER 30 OCTOBER 31
2000 1999
--------------- ---------------
Cash flows from operating activities:
Net income .......................................................................... $ 205,387 $ 1,403,340
Adjustments to reconcile net income to net cash
used by operating activities:
Depreciation and amortization ................................................... 1,151,937 474,096
Amortization and write-off of
debt discount and issuance costs ............................................. 19,457 30,108
Amortization of goodwill ........................................................ 385,011
Provision for doubtful accounts ................................................. (25,210) 45,358
Loss on abandonment or sale of equipment ........................................ 32,173 628
Deferred income taxes ........................................................... (511,260) 357,729
Changes in assets and liabilities:
Accounts receivable .......................................................... (7,872,548) (5,441,038)
Inventories .................................................................. (5,483,265) (3,618,059)
Income taxes receivable/payable .............................................. 472,819 552,684
Prepaid expenses ............................................................. (1,400,056) (80,851)
Accounts payable and accrued liabilities ..................................... 7,166,187 961,505
--------------- ---------------
Net cash used in operating activities ..................................... (5,859,368) (5,314,500)
Cash flows from investing activities:
Cash used for acquisition of Meritus ............................................... (884,033)
Capital expenditures ............................................................... (1,160,092) (677,776)
Proceeds from sale of equipment .................................................... 3,787
Decrease (increase) in other assets ................................................ 56,586 (53,852)
--------------- ---------------
Net cash used in investing activities ..................................... (1,987,539) (727,841)
Cash flows from financing activities:
Net borrowing under revolving lines of credit ..................................... 5,072,213 931,473
Net borrowings on long-term debt ................................................... 2,279,234 15,314
Net borrowings of long-term debt due to related party .............................. 4,800,000
Payments of assumed Meritus debt ................................................... (4,382,541)
Net proceeds from issuance of common stock ......................................... 4,911,737
Debt and stock issue refunds (costs) ............................................... 35,000 (85,433)
--------------- ---------------
Net cash provided by financing activities ................................. 7,803,906 5,773,091
Effect of exchange rate changes on cash .................................................. (28,524) (26,824)
--------------- ---------------
Net decrease in cash ..................................................................... (71,525) (296,074)
Cash and cash equivalents, beginning of period ........................................... 478,970 554,197
--------------- ---------------
Cash and cash equivalents, end of period ................................................. $ 407,445 $ 258,123
=============== ===============
See accompanying notes to consolidated financial statements.
3
DSI TOYS, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS (CONTINUED)
(UNAUDITED)
NINE MONTHS ENDED
------------------------------------
SEPTEMBER 30, OCTOBER 31,
2000 1999
--------------- ---------------
Supplemental disclosure of cash flow information:
Acquisition of Meritus:
Property, plant and equipment acquired .................................................. $ (748,730)
Accounts receivable and other assets acquired ........................................... (838,564)
Liabilities assumed ..................................................................... 7,475,172
Note payable issued to the Reilings ..................................................... 1,690,000
Common stock issued (including treasury shares) ......................................... 1,801,415
Goodwill resulting from Meritus acquisition ............................................. (10,263,327)
--------------- ---------------
Net cash paid for Meritus acquisition ................................................... $ (884,034)
=============== ===============
See accompanying notes to consolidated financial statements.
4
DSI TOYS, INC.
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(Unaudited)
ACCUMULATED
COMMON STOCK ADDITIONAL OTHER
------------------- PAID-IN COMPREHENSIVE RETAINED TREASURY
SHARES AMOUNT CAPITAL WARRANTS INCOME EARNINGS STOCK TOTALS
--------- -------- ------------- ---------- --------------- ---------- ------------- ----------
Balance, January 31, 1999 8,719,000 $ 87,190 $ 21,162,568 $ 102,500 $ 14,296 $ 2,155,410 $ (22,660,592) $ 861,372
Comprehensive income:
Net income 1,280,991 1,280,991
Foreign currency
translation adj.
net of tax (26,922) (26,922)
----------
Comprehensive income: 1,254,069
Issuance of 2,458,491
common shares from
the treasury (15,479,229) 20,479,229 5,000,000
Options exercised (518,189) 621,968 103,779
Stock issuance cost (230,231) (230,231)
--------- -------- ------------- ---------- --------------- ---------- ------------- ----------
Balance, December 31, 1999 8,719,000 $ 87,190 $ 4,934,919 $ 102,500 $ (12,626) $ 3,436,401 $ (1,559,395) $ 6,988,989
Comprehensive loss:
Net loss (1,276,913) (1,276,913)
Foreign currency
translation adj.
net of tax (12,036) (12,036)
----------
Comprehensive loss (1,288,949)
Issuance of 347,365
common shares and
185,843 shares from
the treasury 347,365 3,474 238,546 1,559,395 1,801,415
--------- -------- ------------- ---------- --------------- ---------- ------------- ----------
Balance, March 31, 2000 9,066,365 $ 90,664 $ 5,173,465 $ 102,500 $ (24,662) $ 2,159,488 $ 7,501,455
Comprehensive loss:
Net income 2,049 2,049
Foreign currency
translation adj.
net of tax 22,086 22,086
----------
Comprehensive income: 24,135
--------- -------- ------------- ---------- --------------- ---------- ------------- ----------
Balance, June 30, 2000 9,066,365 $ 90,664 $ 5,173,465 $ 102,500 $ (2,576) $ 2,161,537 $ 7,525,590
Comprehensive loss:
Net income 1,480,251 1,480,251
Foreign currency
translation adj.
net of tax (38,574) (38,574)
----------
Comprehensive income: 1,441,677
--------- -------- ------------- ---------- --------------- ---------- ------------- ----------
Balance September 30, 2000 9,066,365 $ 90,664 $ 5,173,465 $ 102,500 $ (41,150) $ 3,641,788 $ 8,967,267
========= ======== ============= ========== =============== ========== ============= ==========
See accompanying notes to consolidated financial statements.
5
DSI TOYS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of DSI Toys,
Inc. and its wholly-owned subsidiaries (the "Company") have been prepared in
accordance with accounting principles generally accepted in the United States of
America for interim financial information and with the instructions to Form
10-Q. Accordingly, they do not include all of the information and footnotes
required by accounting principles generally accepted in the United States of
America for complete financial statements and should be read in conjunction with
the financial statements and notes thereto appearing in the Company's Annual
Report on Form 10-K for the fiscal year ended December 31, 1999.
In the opinion of the Company's management, all adjustments necessary for a
fair presentation of the results of operations for all periods reported have
been included. Such adjustments consist only of normal recurring items.
Management also believes that the Statement of Operations' three-month and nine
month comparisons of the calendar quarter and nine months' period ending
September 30, 2000, to its prior year fiscal quarter and nine months period
ending October 31, 1999, are not misleading. Recasting of the prior year
information to the calendar quarter ending September 30, 1999, would not be cost
effective and would not produce any materially different comparative operating
results.
The impact of the Company's change in its fiscal year-end, which was
apparent in the net sales and net income numbers for the quarter ending June 30,
2000, is no longer evident in the net sales and net income numbers for the
quarter ending September 30, 2000, and the impact for the nine month period
ending September 30, 2000, is minimal. ( "See Item 2 - Seasonality.")
The results of operations for the three months and nine months ended
September 30, 2000, are not necessarily indicative of the results expected for
the full year ending December 31, 2000.
2. ACCOUNTS RECEIVABLE
Accounts receivable consist of the following:
SEPTEMBER 30, 2000 DECEMBER 31, 1999
---------------- ------------------
Trade receivables............ $ 15,217,276 $ 5,405,587
Provisions for:
Discounts and markdowns.... (959,185) (728,910)
Return of defective goods.. (1,868,083) (1,082,408)
Doubtful accounts.......... (161,000) (186,210)
---------------- ------------------
Accounts receivable, net..... $ 12,229,008 $ 3,408,059
================ ==================
6
3. SEGMENT INFORMATION
Financial information for the nine months ended September 30, 2000, and
October 31, 1999, is as follows:
UNITED STATES HONG KONG CONSOLIDATED
------------------ ------------------ ------------------
Nine months ended September 30, 2000:
Net sales ................................................... $ 13,512,844 $ 36,899,714 $ 50,412,558
Operating income (loss) ..................................... (3,934,063) 5,160,314 1,226,251
Total assets at September 30, 2000 .......................... 32,037,354 9,541,373 41,578,727
Nine months ended October 31, 1999:
Net sales ................................................... $ 13,859,098 $ 27,181,672 $ 41,040,770
Operating income ............................................ 758,375 1,950,461 2,708,836
Total assets at October 31, 1999 ............................ 15,597,177 4,563,620 20,160,797
4. BUSINESS COMBINATION
On January 7, 2000, the Company acquired by way of a merger all of the
issued and outstanding stock of Meritus Industries, Inc. ("Meritus") in exchange
for (i) 600,000 unregistered shares of the Company's common stock, less 66,792
shares of the Company's common stock, which shares were initially held by the
Company and payable to Walter and Susan Reiling (the "Reilings") upon
satisfaction of certain post-closing conditions as set forth in the Closing and
Holdback Agreement between the parties; (ii) $884,034 in cash; and (iii) the
Company's Subordinated Secured Promissory Note for $1,690,000 paid to the
Reilings, who were the sole shareholders of Meritus. Based upon the final
accounting at the end of the holdback period (June 7, 2000), the post-closing
conditions were not satisfied and none of the held back (66,792) shares will be
paid to the Reilings. The market value of the shares issued was $1,081,415 and
was satisfied by the issuance of 347,365 shares of new stock and 185,843 shares
in treasury stock. The note, bearing interest at 10.0375% per annum, requires
quarterly principal and interest payments beginning April 1, 2000, and matures
on January 7, 2005. Contemporaneously with the merger, the Company satisfied
approximately $4.4 million of Meritus' debt.
The acquisition was accounted for utilizing the purchase method; therefore
the Company recorded the acquired assets at their estimated fair market value.
Goodwill generated by the transaction is being amortized over 20 years using the
straight-line method.
Commensurate with the merger, the Company borrowed $5,000,000 from MVII,
LLC, a California limited liability company controlled by E. Thomas Martin
("MVII"), evidenced by a promissory note dated January 7, 2000. The note bears
interest at a rate of prime plus 2%, matures on July 1, 2004, and is
subordinated to senior debt of the Company. The proceeds from the note were used
for the payment of the Meritus debt discussed above.
5. NOTES PAYABLE
As of September 30, 2000, the Company was not in compliance with certain
of the financial covenants under the revolving credit facility with Sunrock
Capital Corp. (the "Revolver"), and does not anticipate being in compliance with
the quarterly bank measurement of these covenants in the foreseeable future.
Sunrock Capital Corp. has executed a written waiver of these covenant violations
for the period ending September 30, 2000. Further, the Company and Sunrock
Capital Corp. have begun negotiations to amend the Revolver. The Company
believes that the Revolver will be amended prior to the end of calendar year
2000. In the event the Company is unable to obtain an amendment to the Revolver,
or obtain further waivers from Sunrock Capital Corp., the Company would be
required to look to alternative financial resources.
7
PRO FORMA RESULTS OF OPERATIONS
Presented below is a pro forma statement of operations for the fiscal
quarter and nine months' period ending October 31, 1999. The pro forma reflects
the combined operations of the Company and Meritus as if the merger of the
Company and Meritus occurred on February 1, 1999.
THREE MONTHS ENDED OCTOBER 31, 1999
----------------------------------------------------------
DSI MERITUS COMBINED
(UNAUDITED) (UNAUDITED) (UNAUDITED)
--------------- --------------- ---------------
Net sales .......................................................... $ 22,466,132 $ 6,206,585 $ 28,672,717
Net income ......................................................... $ 1,686,437 $ 18,342 $ 1,704,779
Basic earnings per share
Earnings per share ............................................... $ 0.20 $ 0.19
=============== ===============
Weighted average shares outstanding .............................. 8,533,157 9,086,365
=============== ===============
Diluted earnings per share
Earnings per share ............................................... $ 0.19 $ 0.19
=============== ===============
Weighted average shares outstanding .............................. 8,703,569 9,256,777
=============== ===============
THREE MONTHS ENDED OCTOBER 31, 1999
----------------------------------------------------------
DSI MERITUS COMBINED
(UNAUDITED) (UNAUDITED) (UNAUDITED)
--------------- --------------- ---------------
Net sales .......................................................... $ 41,040,770 $ 13,831,978 $ 54,872,748
Net income (loss) .................................................. $ 1,403,340 $ (616,535) $ 786,805
Basic earnings per share
Earnings per share ............................................... $ 0.19 $ 0.10
=============== ===============
Weighted average shares outstanding .............................. 7,500,335 8,033,543
=============== ===============
Diluted earnings per share
Earnings per share ............................................... $ 0.18 $ 0.10
=============== ===============
Weighted average shares outstanding .............................. 7,610,291 8,143,499
=============== ===============
8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT
OF 1995: STATEMENTS IN THIS REPORT THAT ARE NOT HISTORICAL FACTS, INCLUDING
STATEMENTS ABOUT PLANS AND EXPECTATIONS REGARDING PRODUCTS AND OPPORTUNITIES,
DEMAND AND ACCEPTANCE OF NEW AND EXISTING PRODUCTS, CAPITAL RESOURCES AND FUTURE
FINANCIAL CONDITION AND RESULTS ARE FORWARD-LOOKING. FORWARD-LOOKING STATEMENTS
INVOLVE RISKS AND UNCERTAINTIES, WHICH MAY CAUSE THE COMPANY'S ACTUAL RESULTS IN
FUTURE PERIODS TO DIFFER MATERIALLY AND ADVERSELY FROM THOSE EXPRESSED. THESE
UNCERTAINTIES AND RISKS INCLUDE, BUT ARE NOT LIMITED TO, CHANGING CONSUMER
PREFERENCES, LACK OF SUCCESS OF NEW PRODUCTS, LOSS OF THE COMPANY'S CUSTOMERS,
COMPETITION, AND OTHER FACTORS DISCUSSED IN THIS REPORT AND FROM TIME TO TIME IN
THE COMPANY'S FILINGS WITH THE SECURITIES AND EXCHANGE COMMISSION, INCLUDING THE
COMPANY'S ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDING DECEMBER 31,
1999.
EXCEPT AS OTHERWISE INDICATED, REFERENCES TO THE "COMPANY" REFER TO DSI
TOYS, INC. AND ITS WHOLLY OWNED SUBSIDIARIES, DSI (HK) LIMITED, MERITUS
INDUSTRIES LIMITED, RSP PRODUCTS LIMITED, AND ELITE DOLLS LIMITED (COLLECTIVELY,
"DSI (HK)"). THE TERMS "FISCAL YEAR" AND "FISCAL" REFER TO THE COMPANY'S FISCAL
YEAR, WHICH IS THE YEAR ENDING DECEMBER 31 OF THE CALENDAR YEAR MENTIONED. THE
COMPANY CHANGED ITS FISCAL YEAR FROM A JANUARY 31 YEAR-END TO A DECEMBER 31
YEAR-END DURING 1999; THEREFORE, REFERENCES TO FISCAL YEARS 1998 AND PRIOR REFER
TO THE COMPANY'S FISCAL YEAR ENDED JANUARY 31 OF THE FOLLOWING CALENDAR YEAR
MENTIONED. ACCORDINGLY, A REFERENCE TO FISCAL 1998 IS A REFERENCE TO THE PERIOD
ENDING JANUARY 31, 1999. A REFERENCE TO FISCAL 1999 IS A REFERENCE TO THE ELEVEN
MONTH PERIOD ENDING DECEMBER 31, 1999.
The impact of the Company's change in its fiscal year-end, which was
apparent in the net sales and net income numbers for the quarter ending June 30,
2000, is no longer evident in the net sales and net income numbers for the
quarter ending September 30, 2000, and the impact for the nine month period
ending September 30, 2000, is minimal.
GENERAL
The following discussion and analysis should be read in conjunction with
the financial statements and related notes contained elsewhere herein.
The Company designs, develops, markets and distributes toys and children's
consumer electronics. Core product categories are (i) juvenile audio products,
including walkie-talkies, pre-teen audio products and musical toys; (ii) girls'
toys, including dolls, play sets and accessories; and (iii) boys' toys,
including construction sets, radio control vehicles, and western and military
toys. Historically, the majority of the Company's sales have been made to
customers based in the United States. All of the Company's international sales
are denominated in United States dollars; therefore, the Company is not subject
to exchange rate risk with respect to international sales.
On January 7, 2000, the Company acquired Meritus Industries, Inc.
("Meritus"), a privately held toy manufacturer by way of merger. Pursuant to the
terms of the merger, the Company acquired all of the issued and outstanding
stock of Meritus in exchange for (i) 600,000 unregistered shares of the
Company's common stock, less 66,792 shares of the Company's common stock, which
shares were initially held by the Company and are payable to Walter and Susan
Reiling (the "Reilings"), upon satisfaction of certain post-closing conditions
as set forth in a Closing and Holdback Agreement between the parties; (ii)
$884,034 in cash; and (iii) the Company's Subordinated Secured Promissory Note
for $1,690,000 paid to the Reilings, who were the sole shareholders of Meritus.
Based upon the final accounting at the end of the holdback period (June 7, 2000)
the post-closing conditions were not satisfied and none of the held back
(66,792) shares will be paid to the Reilings. Contemporaneously with the merger,
the Company satisfied approximately $4.4 million of Meritus' debt.
Commensurate with the acquisition of Meritus, the Company borrowed
$5,000,000 from MVII, LLC, a California limited liability company controlled by
E. Thomas Martin ("MVII"), evidenced by a promissory note dated January 7, 2000.
The note bears interest at a rate of prime plus 2%, matures on July 1, 2004, and
is subordinated to senior debt of the Company. The proceeds from the note were
used in satisfaction of the Meritus debt discussed above.
9
As a result of its merger with Meritus, the Company acquired three wholly
owned Hong Kong subsidiaries, Meritus Industries Limited, RSP Products Limited,
and Elite Dolls Limited, which are engaged in the Company's doll manufacturing
operations. The Company is in the process of consolidating the three newly
acquired subsidiaries with DSI (HK) Limited.
As a result of the transactions consummated in connection with the merger
with Meritus, MVII's share ownership is approximately 61% of the Company's
outstanding shares of Common Stock.
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated certain income
and expense items expressed as a percentage of net sales:
PERCENT OF NET SALES
---------------------------------------------------------------------------
THREE MONTHS ENDED NINE MONTHS ENDED
----------------------------------- -----------------------------------
SEPTEMBER 30 OCTOBER 31 SEPTEMBER 30 OCTOBER 31
2000 1999 2000 1999
--------------- --------------- --------------- ---------------
Net sales ...................................... 100.0% 100.0% 100.0% 100.0%
Costs of goods sold ............................ 68.5 69.9 70.2 72.3
--------------- --------------- --------------- ---------------
Gross profit ................................... 31.5 30.1 29.8 27.7
Selling, general and administrative expenses ... 22.8 17.4 27.4 21.1
--------------- --------------- --------------- ---------------
Operating income ............................... 8.7 12.7 2.4 6.6
Interest expense ............................... (1.2) (1.0) (2.1) (1.2)
Other income ................................... .3 0.2 .3 0.2
--------------- --------------- --------------- ---------------
Income before income taxes ..................... 7.8 11.9 .6 5.6
Provision for income taxes ..................... (2.8) (4.4) (.2) (2.2)
--------------- --------------- --------------- ---------------
Net income ..................................... 5.0% 7.5% .4% 3.4%
=============== =============== =============== ===============
10
THREE MONTHS ENDED SEPTEMBER 30, 2000, COMPARED TO THE THREE MONTHS ENDED
OCTOBER 31, 1999
NET SALES.
Net sales for the three months ended September 30, 2000, increased $7.4
million, or 33.2%, to $29.9 million from $22.5 million in the comparable period
of 1999. This increase included $4.7 million in sales of Meritus items.
Excluding these Meritus items, net sales increased $2.7 million, or 12.2%, from
the third quarter of 1999. The total increase was due to increased sales of
girls' toys, offset by decreases in other categories. ("See Item 2 -
Introduction and Note 1 to Consolidated Financial Statements.")
Net sales of juvenile audio products during the third quarter ended
September 30, 2000, decreased $400,000, or 3.0%, to $13.8 million from $14.2
million compared to the similar period of 1999. This decrease was due primarily
to a reduction in sales of walkie-talkies, partially offset by increased sales
of musical toys.
Net sales of girls' toys increased $8.1 million, or 266.0% to $11.1
million during the third quarter ended September 30, 2000, from $3.0 million in
the third quarter in 1999. Meritus items contributed $4.7 million of this
increase. Excluding these Meritus items, net sales of girls' toys in the third
quarter of 2000 were $6.4 million, a 211.0% increase from the third quarter of
1999. Increased sales for 2000 were also driven by sales of the PRIDE & JOY
(SWEET FAITH)(TM) and HUSH LI'L BABY(R) dolls.
Net sales of boys' toys was $4.1 million in the third quarter ended
September 30, 2000, equal to the $4.1 million in the third quarter of 1999. A
sales increase due to the introduction of the INSECTOR(TM) remote control car in
2000 was offset by reduced sales of military building items from the comparable
1999 period.
Net sales of products in other categories during the third quarter ended
September 30, 2000, decreased $200,000, or 17.9%, to $900,000 during the third
quarter ended September 30, 2000, from $1.1 million in the third quarter of
1999. The decrease was due primarily to reduced sales of game and listening
detection products.
International net sales for the three months ended September 30, 2000,
increased $1.1 million, or 20.1%, to $7.0 million from $5.9 million in the
comparable period of 1999. The increase was due primarily to increased sales to
the United Kingdom.
GROSS PROFIT. Gross profit increased $2.6 million, or 39.4%, to $9.4
million for the third quarter ended September 30, 2000, from $6.8 million in the
first nine months of 1999. Gross profit as a percentage of net sales increased
to 31.5% in the third quarter ended September 30, 2000, from 30.1% in the third
quarter of fiscal 1999. The gross profit dollar increase reflects the increased
sales volume for the quarter. The increase in gross profit as a percentage of
sales reflects the predominance of proprietary products in the sales mix.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased to $6.8 million in the third quarter ended
September 30, 2000, compared with $3.9 million for the third quarter of 1999, an
increase of $2.9 million. The increase was primarily due to additional expenses,
including those associated with the Meritus merger, such as salaries,
professional fees and goodwill amortization, as well as television advertising
expense related to INSECTOR(TM) and HUSH LI'L BABY(R).
INTEREST EXPENSE. Interest expense during the third quarter ended
September 30, 2000, increased to $373,000 from $233,000 in the second quarter of
1999 due to borrowings associated with the Meritus merger.
NINE MONTHS ENDED SEPTEMBER 30, 2000, COMPARED TO THE NINE MONTHS ENDED OCTOBER
31, 1999 NET SALES.
Net sales for the nine months ended September 30, 2000, increased $9.4
million, or 22.8%, to $50.4 million from $41.0 million in the comparable period
of 1999. This increase included $8.9 million in sales of Meritus items.
Excluding these Meritus items, net sales increased $500,000, or 1.0%, from the
first nine months of 1999. The total increase was due to increased sales of
girls' toys, offset by decreases in other categories. ("See Item 2 -
Introduction and Note 1 to Consolidated Financial Statements.")
Net sales of juvenile audio products during the nine months ended
September 30, 2000, decreased $4.1 million, or 15.9%, to $21.5 million, from
$25.6 million compared to the similar period of 1999. This decrease was due
primarily to a reduction in sales of walkie-talkies, due to a product line
transition.
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Net sales of girls' toys increased $14.8 million, or 322.0%, to $19.5
million during the nine months ended September 30, 2000, from $4.7 million in
the first nine months in 1999. Meritus items contributed $8.9 million of this
increase. Excluding these Meritus items, net sales of girls' toys in the first
nine months of 2000 were $10.6 million, a 228.0% increase from the first nine
months of 1999. Increased sales for 2000 were also driven by sales of the PRIDE
& JOY (SWEET FAITH)(TM) and HUSH LI'L BABY(R) dolls.
Net sales of boys' toys decreased $1.0 million, or 12.1%, to $7.2 million
in the nine months ended September 30, 2000, from $8.2 million in the first nine
months of 1999. The decrease was primarily due to a decrease in sales of
military items, western guns, and the remote control gyrocycle from the first
nine months of 1999, offset by the 2000 introduction of the INSECTOR(TM) remote
control car.
Net sales of products in other categories during the nine months ended
September 30, 2000, decreased $400,000, or 17.7%, to $2.2 million from $2.6
million in the first nine months of 1999. The decrease was due primarily to
decreased sales of games, listening detection devices, and preschool products.
International net sales for the nine months ended September 30, 2000,
decreased $100,000, or 1.3%, to $10.5 million from $10.6 million in the first
nine months ended October 31, 1999. The decrease was due primarily to decreased
sales to European Continent countries, partially offset by increased sales to
the United Kingdom.
GROSS PROFIT. Gross profit increased $3.6 million, or 32.3%, to $15.0
million for the nine months ended September 30, 2000, from $11.4 million in the
first nine months of 1999. Gross profit as a percentage of net sales increased
to 29.8% in the nine months ended September 30, 2000, from 27.7% in the first
nine months of fiscal 1999. The gross profit dollar increase reflects the
increased sales volume for the quarter. The increase in gross profit as a
percentage of sales reflects the predominance of proprietary products in the
sales mix.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased to $13.8 million in the nine months ended
September 30, 2000, compared with $8.6 million for the first nine months of
fiscal 1999, an increase of $5.2 million. The increase was primarily due to
additional expenses, including those associated with the Meritus merger, such as
salaries, professional fees and goodwill amortization, as well as television
advertising expense related to INSECTOR(TM) and HUSH LI'L BABY(R) .
INTEREST EXPENSE. Interest expense during the nine months ended September
30, 2000, increased to $1.0 million from $486,000 in the first nine months of
1999 due to borrowings associated with the Meritus merger.
LIQUIDITY AND CAPITAL RESOURCES
Historically, the Company has funded its operations and capital
requirements with cash generated from operations and borrowings. The Company's
primary capital needs have consisted of acquisitions to inventory, financing
accounts receivable and capital expenditures for product development.
The seasonal nature of the toy business results in complex working capital
needs. The Company's working capital needs, which the Company generally
satisfies through short-term borrowings, are greatest in the first two quarters.
To manage these working capital requirements, the Company maintains credit
facilities collateralized principally by accounts receivable and inventory. The
Company currently has a line of credit facility with State Street Bank and Trust
Company - Hong Kong Branch (the "Hong Kong Credit Facility") and a revolving
credit facility with Sunrock Capital Corp. (the "Revolver"). At October 31,
2000, the Company had additional eligible borrowing capacity of $2.2 million in
the aggregate under the Revolver and the Hong Kong Credit Facility.
The Company's operating activities used net cash of $5.9 million during
the first nine months of fiscal year 2000, consisting primarily of increases in
accounts receivable and inventory partially offset by accounts payable. Net cash
used in investing activities was $2.0 million and was primarily the result of
capital expenditures and the acquisition of Meritus. Net cash provided by
financing activities was $7.8 million including $5.1 million in net borrowings
under revolving lines of credit and net borrowings of long-term debt of $7.1
million, offset by the payment of $4.4 million in debt assumed in the Meritus
acquisition. The Company's working capital at September
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30, 2000, was $7.2 million and unrestricted cash was $407,000, and the Company's
working capital at October 31, 1999, was $6.1 million and unrestricted cash was
$258,000.
The Company believes that available borrowings under the Revolver and the
Hong Kong Credit Facility, which was $3.0 million at September 30, 2000,
together with cash from operations will be sufficient to meet the Company's
operating cash requirements, fund the Company's anticipated capital expenditures
and fund scheduled debt service for the foreseeable future. In the event the
Company's operations do not generate sufficient cash flow and borrowing capacity
to meet the Company's requirements, the Company would be required to look to
alternative financial resources, such as issuing additional debt and equity
securities. ("See Item 2 - Seasonality.")
The Company has projected approximately $1.2 million for capital
expenditures, consisting primarily of purchases of tools and molds for fiscal
2000.
On January 7, 2000, the Company acquired all of the issued and outstanding
stock of Meritus in exchange for (i) 600,000 unregistered shares of the
Company's common stock, less 66,792 shares of the Company's common stock, which
shares are currently held by the Company and are payable to the Reilings upon
satisfaction of certain post closing conditions as set forth in a Closing and
Holdback Agreement between the parties; (ii) $884,034 in cash; and (iii) the
Company's Subordinated Secured Promissory Note for $1,690,000 paid to the
Reilings, who were the sole shareholders of Meritus. The note, bearing interest
at 10.0375% per annum, requires quarterly principal and interest payments
beginning April 1, 2000. Contemporaneously with the merger, the Company
satisfied approximately $4.4 million of Meritus' debt.
In connection with the acquisition of Meritus, the Company borrowed $5
million from MVII. The debt is evidenced by a promissory note dated January 7,
2000. The note bears interest at a rate of prime plus 2%, matures on July 1,
2004, and is subordinate to the Revolver. The proceeds from the note were used
primarily to facilitate the merger, including the payment of Meritus' debt
described above.
In addition, the Company is obligated to make future minimum royalty
payments under certain of its license agreements. As of September 30, 2000, the
Company was required to pay guaranteed royalties under these licenses of
$112,000, $206,000 and $43,000 per year from 2000 through 2002, respectively.
As of September 30, 2000, the Company was not in compliance with certain
of the financial covenants under the Revolver and does not anticipate being in
compliance with the quarterly bank measurement of these covenants in the
foreseeable future. Sunrock Capital Corp. has executed a written waiver of these
covenant violations for the period ending September 30, 2000. Further, the
Company and Sunrock Capital Corp. have begun negotiations to amend the Revolver.
The Company believes that the Revolver will be amended prior to the end of
calendar year 2000. In the event the Company is unable to obtain an amendment to
the Revolver, or obtain further waivers from Sunrock Capital Corp., the Company
would be required to look to alternative financial resources.
As part of the Company's strategy, the Company will continue to evaluate
potential acquisitions of other toy businesses or product lines that the Company
believes would complement its existing business.
SEASONALITY
The retail toy industry is very seasonal, with the Christmas holiday
season representing over two-thirds of total annual retail toy sales. The
Company has experienced this seasonal pattern in its net sales. To accommodate
this peak selling season, holiday toy lines are introduced early in the first
calendar quarter. Retailers normally commit to their holiday season purchases
during the first two calendar quarters, and those orders are generally shipped
to the retailers' distribution centers on a scheduled basis from May through
October. During fiscal 1999, 80% of the Company's net sales were made during the
Company's second and third fiscal quarters (May through October), generally in
connection with retail sales for the Christmas holiday season. As a result of
the seasonality of the Company's business, the Company expects that it will
incur a loss in the first quarter and fourth quarter of each fiscal year, even
in years in which the Company is profitable for the entire year.
13
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is involved in various legal proceedings and claims incident
to the normal conduct of its business. The Company believes that such legal
proceedings and claims, individually and in the aggregate, are not likely to
have a material adverse effect on its financial position or results of
operations. The Company maintains product liability and general liability
insurance in amounts it believes to be reasonable.
ITEM 5. OTHER INFORMATION
On September 12, 2000, by action of the Board of Directors of the Company,
pursuant to Article III, Section I of the Company's Bylaws, the number of
directors of the Company was increased from seven (7) to eight (8), and (ii)
Michael J. Lyden was appointed to fill the created director position until the
annual meeting of the Company in 2001.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
The information required by this Item 6(a) is set forth in the Index to
Exhibits accompanying this quarterly report and is incorporated herein by
reference.
(b) Reports Submitted on Form 8-K
The Company filed a Form 8-K dated January 7, 2000, and filed on January
21, 2000, for the purpose of reporting the acquisition of all of the issued and
outstanding shares of common stock of Meritus Industries, Inc.
The Company filed a Form 8-K/A dated January 7, 2000, and filed on
February 15, 2000, for the purpose of reporting certain financial statements and
financial information in connection with the acquisition of all of the issued
and outstanding shares of common stock of Meritus Industries, Inc., which
financial statements and financial information was unavailable at the time of
the original filing of the Form 8-K referenced hereinabove.
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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.
DSI Toys, Inc.
Dated: November 14, 2000 /s/ MICHAEL J. LYDEN
-------------------------------------------------
Michael J. Lyden
President and Chief Executive Officer
Dated: November 14, 2000 By: /s/ ROBERT L. WEISGARBER
-------------------------------------------------
Robert L. Weisgarber
Chief Financial Officer
(Principal Financial and Accounting Officer)
15
INDEX TO EXHIBITS
2.1 Articles/Certificate of Merger of Meritus Industries, Inc. into the
Company, dated January 7, 2000 (filed as Exhibit 2.2 to the Company's Form
8-K dated January 7, 2000), incorporated herein by reference.
3.1 Amended and Restated Articles of Incorporation of the Company. (1)
3.1.1 Amendment to Amended and Restated Articles of Incorporation of the Company
(filed as Exhibit 3.1.1 to the Company's Form 10-Q for the quarterly
period ended April 30, 1999), incorporated herein by reference.
3.2 Amended and Restated Bylaws of the Company. (1)
3.3 Amendment to Amended and Restated Bylaws of the Company. (1)
10.1 Agreement and Plan of Merger between Meritus Industries, Inc. et al. and
the Company, dated October 7, 1999 (filed as Exhibit 10.45 to the
Company's Form 10-Q for the quarterly period ended October 31, 1999),
incorporated herein by reference.
10.2 Closing and Holdback Agreement dated January 7, 2000, by and between the
Company and Meritus Industries, Inc. et al. (filed as Exhibit 2.3 to the
Company's Form 8-K dated January 7, 2000), incorporated herein by
reference.
10.3 Shareholders' and Voting Agreement dated January 7, 2000, by and among the
Company, MVII, LLC and Walter S. and Susan Reiling (filed as Exhibit 10.1
to the Company's Form 8-K dated January 7, 2000), incorporated herein by
reference.
10.4 Limited Irrevocable Proxy dated January 7, 2000, between MVII, LLC and
Walter S. and Susan Reiling (filed as Exhibit 10.2 to the Company's Form
8-K dated January 7, 2000), incorporated herein by reference.
10.5 Registration Rights Agreement dated January 7, 2000, by and between the
Company and Walter S. and Susan Reiling (filed as Exhibit 10.3 to the
Company's Form 8-K dated January 7, 2000), incorporated herein by
reference.
10.6 Subordinated Secured Promissory Note dated January 7, 2000, from the
Company to Walter S. and Susan Reiling (filed as Exhibit 10.4 to the
Company's Form 8-K dated January 7, 2000), incorporated herein by
reference.
10.7 Promissory Note dated January 7, 2000, from the Company to MVII, LLC
(filed as Exhibit 10.5 to the Company's Form 8-K dated January 7, 2000),
incorporated herein by reference.
10.8 Amendment No. 2 dated January 7, 2000, to Loan and Security Agreement, by
and between Sunrock Capital Corp. and the Company (filed as Exhibit 10.6
to the Company's Form 8-K dated January 7, 2000), incorporated herein by
reference.
10.9 Employment Agreement dated January 7, 2000, by and between the Company and
Beth Reiling (filed as Exhibit 10.7 to the Company's Form 8-K dated
January 7, 2000), incorporated herein by reference.
10.10 Employment Agreement dated January 7, 2000, by and between the Company and
Joseph Reiling (filed as Exhibit 10.8 to the Company's Form 8-K dated
January 7, 2000), incorporated herein by reference.
10.11 Amendment No. 2 to DSI Toys, Inc. 1997 Stock Option Plan (filed as Exhibit
10.11 to the Company's Form 10-Q for the quarterly period ended June 30,
2000), incorporated herein by reference.
10.12 Amendment No. 3 dated July 14, 2000, to Loan and Security Agreement, by
and between Sunrock Capital Corp. and the Company (filed as Exhibit 10.12
to the Company's Form 10-Q for the quarterly period ended June 30, 2000),
incorporated herein by reference.
27 Financial Data Schedule. *
16
99.1 DSI Toys, Inc. Audit Committee of the Board of Directors, Charter, adopted
by the Board of Directors on May 23, 2000 (filed as Exhibit 99.1 to the
Company's Form 10-Q for the quarterly period ended June 30, 2000),
incorporated herein by reference.
(1) Filed as a part of the Registrant's Registration Statement on Form S-1
(No. 333-23961) and incorporated herein by reference.
* Filed herewith
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