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 OCTOBER 31, 1999
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 December 13, 1999, 8,533,157 shares of common stock par value $.01
per share, of DSI Toys, Inc. were outstanding.
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
Consolidated Balance Sheet as of October 31, 1999 and
January 31, 1999...................................................1
Consolidated Statements of Operations for the Three Months and
Nine Months Ended October 31, 1999 and 1998........................2
Consolidated Statements of Cash Flows for the Nine Months Ended
October 31, 1999 and 1998..........................................3
Consolidated Statements of Shareholders' Equity.....................4
Notes to Consolidated Financial Statements..........................5
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS..............................................7
PART II - OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS..................................................13
Item 2. CHANGE IN SECURITIES AND USE OF PROCEEDS ..........................13
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ...............14
Item 6. EXHIBITS AND REPORTS ON FORM 8-K...................................15
Signatures................................................................ 16
i
DSI TOYS, INC.
CONSOLIDATED BALANCE SHEET
OCTOBER 31, JANUARY 31,
1999 1999
------------ ------------
(Unaudited) (Restated)
ASSETS
Current Assets:
Cash ........................................................ $ 258,123 $ 554,197
Restricted cash ............................................. 150,000 150,000
Accounts receivable, net .................................... 6,465,405 1,069,725
Inventories ................................................. 7,825,763 4,207,704
Prepaid expenses ............................................ 1,584,821 1,503,970
Deferred income taxes ....................................... 801,000 801,000
------------ ------------
Total current assets ................................... 17,085,112 8,286,596
Property and equipment, net ...................................... 1,841,937 1,642,672
Deferred income taxes ............................................ 760,060 1,117,000
Other assets ..................................................... 473,688 364,511
------------ ------------
$ 20,160,797 $ 11,410,779
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities .................... $ 7,760,795 $ 6,799,290
Current portion of long-term debt ........................... 2,363,518 824,675
Income taxes payable ........................................ 824,604 271,920
------------ ------------
Total current liabilities .............................. 10,948,917 7,895,885
Long-term Debt ................................................... 1,948,466 2,540,522
Deferred income taxes ............................................ 113,789 113,000
------------ ------------
Total liabilities ...................................... 13,011,172 10,549,407
Shareholders' equity:
Preferred stock, $.01 par value, 5,000,000 shares authorized,
none issued or outstanding
Common stock, $.01 par value, 35,000,000 and
20,000,000 shares authorized
8,719,000 shares issued, 8,533,157 and
6,000,000 shares outstanding ........................... 87,190 87,190
Additional paid-in capital .................................. 4,973,108 21,162,568
Common stock warrants ....................................... 102,500 102,500
Accumulated other comprehensive income/(loss) ............... (12,528) 14,296
Retained earnings ........................................... 3,558,750 2,155,410
------------ ------------
8,709,020 23,521,964
Less: treasury stock, 185,843 and 2,719,000 shares, at cost (1,559,395) (22,660,592)
------------ ------------
Total shareholders' equity ........................ 7,149,625 861,372
------------ ------------
$ 20,160,797 $ 11,410,779
============ ============
See accompanying notes to consolidated financial statements.
1
DSI TOYS, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED OCTOBER 31, NINE MONTHS ENDED OCTOBER 31,
----------------------------- -----------------------------
1999 1998 1999 1998
------------ ------------ ------------ ------------
(restated) (restated)
Net Sales .................................. $ 22,466,132 $ 24,563,262 $ 41,040,770 $ 48,014,196
Cost of goods sold ......................... 15,700,115 18,948,648 29,687,767 37,376,724
------------ ------------ ------------ ------------
Gross profit ............................... 6,766,017 5,614,614 11,353,003 10,637,472
Selling, general and administrative expenses 3,898,396 3,214,650 8,644,167 8,539,982
------------ ------------ ------------ ------------
Operating income ........................... 2,867,621 2,399,964 2,708,836 2,097,490
Interest expense ........................... 233,238 276,916 486,228 710,103
Other income ............................... (37,998) (26,963) (82,082) (64,185)
------------ ------------ ------------ ------------
Income before income taxes ................ 2,672,381 2,150,011 2,304,690 1,451,572
Provision for income taxes ................. 985,944 786,577 901,350 594,228
------------ ------------ ------------ ------------
Net income ................................. $ 1,686,437 $ 1,363,434 $ 1,403,340 $ 857,344
============ ============ ============ ============
BASIC EARNINGS PER SHARE
Earnings per share .................... $ 0.20 $ 0.23 $ 0.19 $ 0.14
============ ============ ============ ============
Weighted average shares outstanding ... 8,533,157 6,000,000 7,500,335 6,000,000
============ ============ ============ ============
DILUTED EARNINGS PER SHARE
Earnings per share .................... $ 0.19 $ 0.23 $ 0.18 $ 0.14
============ ============ ============ ============
Weighted average shares outstanding ... 8,703,569 6,000,000 7,610,291 6,000,000
============ ============ ============ ============
See accompanying notes to consolidated financial statements.
2
DSI TOYS, INC
CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
NINE MONTHS ENDED OCTOBER 31,
1999 1998
----------- ------------
(restated)
Cash flows from operating activities:
Net income ................................................ $ 1,403,340 $ 857,344
Adjustments to reconcile net loss to net cash
provided (used) by operating activitites:
Depreciation and amortization ......................... 474,096 469,038
Amortization and write-off of
debt discount and issuance costs ................... 30,108 --
Provision for doubtful accounts ....................... 45,358 36,541
Loss on sale of equipment ............................. 628 --
Deferred income taxes ................................. 357,729 768,210
Changes in assets and liabilities:
Accounts receivable ................................ (5,441,038) 1,078,229
Inventories ........................................ (3,618,059) (359,858)
Income taxes receivable/payable .................... 552,684 422,105
Prepaid expenses ................................... (80,851) (411,704)
Accounts payable and accrued liabilities ........... 961,505 1,005,474
----------- -----------
Net cash provided (used) by operating activities (5,314,500) 3,865,379
Cash flows from investing activities:
Capital expenditures ..................................... (677,776) (686,676)
Proceeds from sale of equipment .......................... 3,787 --
Increase in other assets ................................. (53,852) (49,174)
----------- -----------
Net cash used in investing activities ........... (727,841) (735,850)
Cash flows from financing activities:
Net borrowing (repayments) under revolving lines of credit 931,473 (2,287,465)
Net borrowings on long-term debt ......................... 15,314 --
Net proceeds from issuance of common stock ............... 4,911,737 --
Debt and stock issue costs ............................... (85,433) --
----------- -----------
Net cash provided (used) by financing activities 5,773,091 (2,287,465)
Effect of exchange rate changes on cash ........................ (26,824) (12,133)
----------- -----------
Net increase/(decrease) in cash ................................ (296,074) 829,931
Cash and cash equivalents, beginning of period ................. 554,197 383,690
----------- -----------
Cash and cash equivalents, end of period ....................... $ 258,123 $ 1,213,621
=========== ===========
See accompanying notes to consolidated financial statements.
3
DSI TOYS, INC.
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(Unaudited)
COMMON STOCK ADDITIONAL
-------------------------- PAID-IN
SHARES AMOUNT CAPITAL WARRANTS
--------- ------------ ------------ ------------
Balance, Jan. 31, 1998 ..... 8,719,000 $ 87,190 $ 21,162,568 $ 102,500
(As restated)
Comprehensive loss:
Net loss ............
Foreign currency
translation adj
net of tax .......
Comprehensive
loss.....
--------- ------------ ------------ ------------
Balance, Jan. 31, 1999 ..... 8,719,000 87,190 21,162,568 102,500
Issuance 566,038
Common
shares ........... (3,515,096)
Comprehensive
loss:
Net loss .........
Foreign currency
translation adj .
net of tax ........
Comprehensive
loss ....
--------- ------------ ------------ ------------
Balance, Apr. 30, 1999 ..... 8,719,000 87,190 17,647,472 102,500
Issuance 1,892,453
Common shares ...... (11,964,133)
Options exercised .... (518,189)
Stock issuance costs . (185,449)
Comprehensive
income:
Net income ...........
Foreign currency
translation adj
net of tax .......
Comprehensive
income ..
--------- ------------ ------------ ------------
Balance, July 31, 1999 .... 8,719,000 87,190 4,979,701 102,500
Stock issuance costs . (6,593)
Comprehensive
income:
Net income ...........
Foreign currency
translation adj
net of tax .......
Comprehensive
income ..
--------- ------------ ------------ ------------
Balance, Oct. 31, 1999 .... 8,719,000 $ 87,190 $ 4,973,108 $ 102,500
========= ============ ============ ============
ACCUMULATED
OTHER
COMPREHENSIVE RETAINED TREASURY
INCOME EARNINGS STOCK TOTALS
------------ ------------ ------------ ------------
Balance, Jan. 31, 1998 ..... $ 29,187 $ 3,159,252 $(22,660,592) $ 1,880,105
(As restated)
Comprehensive loss:
Net loss ............ (1,003,842) (1,003,842)
Foreign currency
translation adj
net of tax ....... (14,891) (14,891)
------------
Comprehensive (1,018,733)
loss ....
------------ ------------ ------------ ------------
Balance, Jan. 31, 1999 ..... 14,296 2,155,410 (22,660,592) 861,372
Issuance 566,038
Common
shares .............. 4,715,096 1,200,000
Comprehensive
loss:
Net loss ......... (498,285) (498,285)
Foreign currency
translation adj .
net of tax ........ (2,276) (2,276)
------------
Comprehensive (500,561)
loss ....
------------ ------------ ------------ ------------
Balance, Apr. 30, 1999 ..... 12,020 1,657,125 (17,945,496) 1,560,811
Issuance 1,892,453
Common shares ...... 15,764,133 3,800,000
Options exercised .... 621,968 103,779
Stock issuance costs . (185,449)
Comprehensive
income:
Net income ........... 215,188 215,188
Foreign currency
translation adj.
net of tax ....... (8,126) (8,126)
------------
Comprehensive 207,062
income ..
------------ ------------ ------------ ------------
Balance, July 31, 1999 .... 3,894 1,872,313 (1,559,395) 5,486,203
Stock issuance costs (6,593)
Comprehensive
income:
Net income ........... 1,686,437 1,686,437
Foreign currency
translation adj.
net of tax ....... (16,422) (16,422)
------------
Comprehensive 1,670,015
income ..
------------ ------------ ------------ ------------
Balance, Oct. 31, 1999 .... $ (12,528) $ 3,558,750 $ (1,559,395) $ 7,149,625
============ ============ ============ ============
See accompanying notes to consolidated financial statements.
4
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 subsidiary (the "Company") have been prepared in
accordance with generally accepted accounting principles 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 generally accepted
accounting principles 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 / A for the year ended January 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.
The results of operations for the three months ended October 31, 1999 are
not necessarily indicative of the results expected for the full year ending
January 31, 2000 (effective December 31, 1999, the Company will change its
fiscal year end from January 31 to a calendar year end).
2. ACCOUNTS RECEIVABLE
Accounts receivable consist of the following:
OCTOBER 31, 1999 JANUARY 31, 1999
---------------- ----------------
Trade receivables ........................................ $ 9,197,085 $ 2,984,619
Provisions for:
Discounts, markdowns and
return of defective goods ......................... (2,564,229) (1,791,436)
Doubtful accounts ...................................... (167,451) (123,458)
----------- -----------
Accounts receivable, net ................................. $ 6,465,405 $ 1,069,725
=========== ===========
3. SEGMENT INFORMATION
Financial information for the nine months ended October 31, 1999 and 1998
is as follows:
United States Hong Kong Consolidated
Nine months ended October 31, 1999:
Net sales .................................. $13,859,098 $27,181,672 $41,040,770
Operating gain ............................. 758,375 1,950,461 2,708,836
Total assets at October 31, 1999 ........... 15,597,177 4,563,620 20,160,797
Nine months ended October 31, 1998:
Net sales .................................. $14,025,323 $33,988,873 $48,014,196
Operating gain ............................. 237,777 1,859,713 2,097,490
Total assets at October 31, 1998 ........... 13,928,684 5,896,558 19,825,242
5
4. RESTATEMENT OF FINANCIALS
The Company has restated previously reported financial results for the
periods presented herein, except for the period ending October 31, 1999, to give
effect to expensing of previously capitalized split-dollar life insurance
premium costs. All disclosures related to the periods presented have been
amended, as appropriate, to reflect the restatement and are summarized as
follows:
THREE MONTHS ENDED NINE MONTHS ENDED
OCTOBER 31, OCTOBER 31,
1998 1998
------------------ -----------------
Selling, general and
administrative expenses
As reported ................... $ 3,148,296 $ 8,340,922
As restated ................... $ 3,214,650 $ 8,539,982
Net income
As reported ................... $ 1,429,788 $ 1,056,404
As restated ................... $ 1,363,434 $ 857,344
Basic earnings per share
As reported ................... $ 0.24 $ 0.18
As restated ................... $ 0.23 $ 0.14
Diluted earnings per share
As reported ................... $ 0.24 $ 0.18
As restated ................... $ 0.23 $ 0.14
The cumulative effect at January 31, 1998 was to reduce retained earnings
by $1,278,400.
As a result of the restatement of its financial statements as of April 30,
1999, the Company was not in compliance with a certain covenant under the
Revolver. However, as of July 31, 1999 and the date of the restated financial
statements herein, the Company was again in compliance with such covenant under
the Revolver. Sunrock Capital Corp. has executed and delivered a written waiver
of this covenant violation to the Company.
6
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 /A FOR THE FISCAL YEAR ENDING JANUARY 31,
1999. .
EXCEPT AS OTHERWISE INDICATED, REFERENCES TO THE "COMPANY" REFER TO DSI
TOYS, INC. AND ITS WHOLLY OWNED SUBSIDIARY, DSI (HK) LTD. ("DSI (HK)"). THE
TERMS "FISCAL YEAR" AND "FISCAL" REFER TO THE COMPANY'S FISCAL YEAR WHICH IS THE
YEAR ENDING JANUARY 31 OF THE FOLLOWING CALENDAR YEAR MENTIONED (E.G., A
REFERENCE TO FISCAL 1999 IS A REFERENCE TO THE PERIOD ENDING JANUARY 31, 2000
[EFFECTIVE DECEMBER 31, 1999, THE COMPANY WILL CHANGE ITS FISCAL YEAR END FROM
JANUARY 31 TO A CALENDAR YEAR END]).
GENERAL
The Company designs, develops, markets and distributes toys and children's
consumer electronics. Core product categories are (i) juvenile audio products,
including Tech-Link(TM) and Digi-Tech(TM) walkie-talkies, pre-teen audio
products and Kawasaki(R) musical toys; (ii) girls' toys, including dolls, play
sets and accessories; and (iii) boys' toys, including BLOCKMEN(R) construction
sets, Kawasaki(R) and Burnin' Thunder(TM) 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 April 15, 1999, the Company entered into a Stock Purchase and Sale
Agreement (the "Stock Purchase Agreement") with MVII, LLC, a California limited
liability company controlled by E. Thomas Martin ("MVII"). Pursuant to the Stock
Purchase Agreement, MVII purchased 566,038 shares of Common Stock, par value
$.01 per share (the "Common Stock"), of the Company from the Company for $1.2
million on April 15, 1999, and purchased an additional 1,792,453 shares of
Common Stock from the Company for $3.8 million on June 1, 1999. Also, pursuant
to the Stock Purchase Agreement, on April 21, 1999, MVII commenced a tender
offer for 1.6 million shares of the outstanding Common Stock at $4.38 per share
net to the seller in cash (the "Offer"). On May 26, 1999, MVII accepted for
payment 1.6 million shares that were validly tendered and not withdrawn in the
Offer by the Company's shareholders. The Stock Purchase and Sale Agreement and
the transactions contemplated thereby were approved by the Company's
shareholders at the annual meeting of shareholders held on May 24, 1999.
As a result of the transactions consummated pursuant to the Stock Purchase
Agreement, MVII has made a total investment in the Company's Common Stock of $12
million. Of that $12 million, $5 million was paid by MVII directly to the
Company for Common Stock. MVII currently is the record owner of approximately
47% of the Company's outstanding shares of Common Stock. When MVII's record
ownership is combined with MVII's rights under the Shareholders' and Voting
Agreement dated April 15, 1999, by and among the Company, MVII, Messrs. Davis,
Conrad, Matlock and Smith and a limited partnership controlled by Mr. Crosby
(the "Voting Agreement"), executed in connection with the Stock Purchase
Agreement, MVII is the beneficial owner of approximately 61% of the Company's
outstanding shares of Common Stock. Furthermore, the Voting Agreement entitles
MVII to nominate all but two of the members of the Company's board of directors.
On June 1, 1999, DSI accepted the resignations of Messrs. Crosby, Smith, Conrad
and Neitz from its Board. Such vacancies have been filled by MVII's nominees,
namely Messrs. E. Thomas Martin, Robert L. Burke, Joseph S. Whitaker, and John
McSorley. At the Company's annual meeting of shareholders on May 24, 1999, the
Company's shareholders approved such appointments. On June 1, 1999, E. Thomas
Martin was appointed by the Company to serve as Chairman of the Board.
The Company, entered into a non-binding letter of intent with Meritus
Industries, Inc., ("Meritus") effective June 24, 1999, which contemplated the
Company acquiring Meritus by means of a merger. A definitive Agreement
7
and Plan of Merger was signed on October 7, 1999. Under this agreement, Meritus
will merge into the Company, with the shareholders of Meritus receiving merger
consideration consisting of shares of the Company's common stock equal to $1.86
million, $1.1 million in cash and a promissory note for $1.69 million. The
Company has provided Meritus a deposit of $300,000, which sum was used by
Meritus to reduce its existing debt. The transaction also entitles Meritus to
one board seat, which will be added to the current six-member board of the
Company. Meritus will appoint Walter S. Reiling to the board of the Company.
Subject to the satisfaction of various covenants and conditions, the merger is
anticipated to close in January 2000. Meritus is a privately held toy
manufacturer headquartered in Fairfield, NJ, with offices and distribution
facilities in Hong Kong. Meritus is involved in the manufacture and marketing of
dolls, doll accessories, and girls' toys such as the Little Darlings(R), Baby
Beans(R), and Forever Girlfriends(R) brands. Meritus products are currently sold
in more than 40 countries worldwide.
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
------------------ -----------------
OCTOBER 31, OCTOBER 31,
----------------- -----------------
1999 1998 1999 1998
------ ------ ------ ------
Net sales .................................. 100.0% 100.0% 100.0% 100.0%
Costs of goods sold ........................ 69.9 77.1 72.3 77.8
------ ------ ------ ------
Gross profit ............................... 30.1 22.9 27.7 22.2
Selling, general and administrative expenses 17.4 13.1 21.1 17.8
------ ------ ------ ------
Operating income ........................... 12.7 9.8 6.6 4.4
Interest expense ........................... 1.0 1.1 1.2 1.5
Other income ............................... (0.2) (0.1) (0.2) (0.1)
------ ------ ------ ------
Income before income taxes ................. 11.9 8.8 5.6 3.0
Provision for income taxes ................. 4.4 3.2 2.2 1.2
------ ------ ------ ------
Net income ................................. 7.5% 5.6% 3.4% 1.8%
====== ====== ====== ======
THREE MONTHS ENDED OCTOBER 31, 1999 COMPARED TO THE THREE MONTHS ENDED OCTOBER
31, 1998
NET SALES. Net sales for the three months ended October 31, 1999 decreased
$ 2.1 million, or 8.5%, to $22.5 million, from $24.6 million in the comparable
period in 1998. The decrease was due primarily to decreased sales of juvenile
audio products, partially offset by increased sales of boys' and girls' toys.
Net sales of juvenile audio products during the third quarter ended
October 31, 1999 decreased $3.9 million or 21.4%, to $14.2 million, from $18.0
million compared to the similar period in 1998. This decrease was due primarily
to slower than expected transition between our previous walkie-talkies and the
new Tech-Link(TM) line in the retail segment of the marketplace and also due to
competition within the category.
Net sales of girls' toys increased $1.7 million, or 121.4%, to $3.0
million during the third quarter ended October 31, 1999 from $1.4 million in the
comparable period in 1998. The sales for the third quarter 1999 were driven by
the sales of the Sweet Faith(TM) and the Hush Li'l Baby(TM) dolls. In the third
quarter 1998, there were no major dolls introduced to the marketplace.
Net sales of boys' toys increased $343,000 or 9.1%,to $4.1 million in the
third quarter ended October 31, 1999, from $3.8 million in the comparable period
in 1998. The increase was due primarily to the continued strong sales of the
BLOCKMEN(R) construction sets.
Net sales of products in other categories during the third quarter ended
October 31, 1999 decreased $245,000 or 17.9% to $1.1 million during the third
quarter ended October 31, 1999 from $1.4 million in the comparable period in
1998. The decrease was due primarily to decreased sales of preschool toys in the
third quarter of 1999 as compared to the same period in 1998.
8
International net sales for the three months ended October 31, 1999
increased $1.1 million or 22.7%, to $5.9 million, from $4.8 million in the
comparable period in 1998. The increase was due primarily to increased sales to
France, Switzerland, Poland and Canada.
GROSS PROFIT. Gross profit increased $1.2 million, or 20.5%, to $6.8
million for the third quarter ended October 31, 1999, from $5.6 million in the
comparable period in 1998. The gross profit as a percentage of net sales
increased to 30.1% in the third quarter ended October 31, 1999 from 22.9% in the
third quarter of fiscal 1998. Such increase in gross profit and gross profit as
a percentage of net sales was primarily due to increased emphasis on proprietary
products, which command higher margins.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased to $3.9 million in the third quarter ended
October 31, 1999 compared to $3.2 million for the third quarter 1998, an
increase of $684,000. The increase was due to additional expense in connection
with increased television advertising in the domestic market.
INTEREST EXPENSE. Interest expense during the third quarter ended October
31, 1999, decreased to $233,000 compared to $277,000 in the similar period in
1998 due to lower average loan balances.
OTHER INCOME. Other income increased $11,000 to $38,000 in the third
quarter ended October 31, 1999 from $27,000 in the comparable period in 1998,
reflecting the effect of changes in levels of short-term investments and foreign
exchange translation.
NINE MONTHS ENDED OCTOBER 31, 1999 COMPARED TO THE NINE MONTHS ENDED OCTOBER 31,
1998
NET SALES. Net sales for the nine months ended October 31, 1999 decreased
$7.0 million, or 14.5% to $41.0 million, from $48.0 million in the comparable
period in 1998. The decrease was due primarily to decreased sales of juvenile
audio products, partially offset by increased sales of boys' and girls' toys.
Net sales of juvenile audio products decreased $9.1 million, or 26.3 %, to
$25.6 million during the nine months ended October 31, 1999, from $34.7 million
in the comparable period in 1998. This decrease was due primarily to slower than
expected transition between our previous walkie-talkies and the new
Tech-Link(TM) line in the retail segment of the marketplace and also due to
competition within the category.
Net sales of girls' toys increased $1.6 million or 51.1% to $4.7 million
during the nine months October 31, 1999, from $3.1 million in the comparable
period in 1998. Sales for the third quarter 1999 were driven by the sales of the
Sweet Faith(TM) and Hush Li'l Baby(TM) dolls.
Net sales of boys' toys increased $1.3 million, or 18.4%, to $8.2 million
in the nine months ended October 31, 1999, from $6.9 million in the comparable
period in 1998. The increase was due primarily to the expansion of the
BLOCKMEN(R) construction sets reflecting the continued strength of BLOCKMEN(R)
in the marketplace, offset partially by lower sales of the remote control
vehicles.
Net sales of products in other categories decreased $725,000, or 22.1%, to
$2.6 million, during the nine months ended October 31, 1999, from $3.3 million
in the comparable period in 1998. The decrease was due primarily to decreased
sales of preschool toys and Hoppin' Poppin' Spaceballs(R).
International net sales for the nine months ended October 31, 1999
decreased $762,000, or 2.4 %, to $10.6 million, from $10.2 million in the
comparable period in 1998. The decline was due primarily to decreased sales to
France, Spain and Hong Kong.
GROSS PROFIT. Gross profit increased $716,000, or 6.7%, to $11.4 million
for the nine months ended October 31, 1999, from $10.6 million in the comparable
period in 1998. Gross profit as a percentage of net sales increased to 27.7% in
the nine months ended October 31, 1999 from 22.2% in the first nine months of
fiscal 1998. Such increase in gross profit and gross profit as a percentage of
net sales was primarily due to increased emphasis on proprietary products, which
command higher margins.
9
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased $104,000, or 1.2% to $8.6 million in the nine
months ended October 31, 1999 from $8.5 million in the first nine months of
fiscal 1998. The increase resulted primarily from additional expense in
connection with increased television advertising in the domestic market.
INTEREST EXPENSE. As a result of debt repayment using the proceeds from
the stock sales to MVII, LLC on April 15 and June 1, 1999, interest expense
decreased $224,000, or 31.5%, to $486,000 in the nine months ended October 31,
1999 from $710,000 in the comparable period in 1998 due to lower average loan
balances.
OTHER INCOME. Other income increased $18,000, or 27.9%, to $82,000 in the
nine months ended October 31, 1999 from $64,000 in the comparable period in
1998, reflecting the effect of changes in levels of short-term investments and
foreign exchange translation.
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 of inventory, financing
accounts receivable and capital expenditures for product development.
The Company's operating activities used net cash of $5.3 million during
the first nine months of fiscal year 1999, consisting primarily of increases in
accounts receivable and increases in inventories, partially offset by the
increase in accounts payable. Net cash used in investing activities was $728,000
and was primarily the result of capital expenditures. Net cash provided in
financing activities was $5.8 million representing net borrowing under revolving
lines of credit and net proceeds of $4.9 million from the sale of Common Stock.
The Company's working capital at October 31, 1999 was $6.1 million and
unrestricted cash was $258,000, and the Company's working capital at October
31, 1998, was $433,000 and unrestricted cash was $1.2 million. 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 fiscal quarters. To manage
these working capital requirements, the Company maintains credit facilities
secured 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 December 13, 1999 the Company
had additional borrowing capacity of $2.4 million in the aggregate under the
Revolver and the Hong Kong Credit Facility.
The Company's operating cash requirements for the remainder of fiscal 1999
include payments totaling approximately $1.0 million related to television
advertisements run in November and December 1997. The Company has projected
approximately $900,000 for capital expenditures, consisting primarily of
purchases of tools and molds for fiscal 1999.
On October 7, 1999, the Company entered into an Agreement and Plan of
Merger with Meritus Industries, Inc. "Meritus", a New Jersey corporation, its
wholly owned subsidiary, Meritus Industries Ltd., a Hong Kong corporation; and
its sole shareholders Walter S. Reiling and Susan Reiling, which contemplates
the merger of Meritus with and into the Company, with the Company being the
surviving corporation in the merger. Under the Agreement and Plan of Merger, the
shareholders of Meritus will receive merger consideration consisting of shares
of the Company's common stock equal to $1.86 million, $1.1 million in cash, and
a promissory note for $1.69 million. The Company has provided Meritus a deposit
of $300,000, which sum was used by Meritus to reduce its existing debt. The
transaction also entitles Meritus to one board seat, which will be added to the
current six member board of the Company. Meritus will appoint Walter S. Reiling
to the board of the Company after the closing of the merger. Subject to the
satisfaction of various convenants and conditions, the merger is anticipated to
close in January of 2000. (See Exhibit 10.45)
In addition, the Company is obligated to make future minimum royalty
payments under certain of its license agreements. As of October 31, 1999, the
Company was required to pay guaranteed royalties under these licenses of
$42,500, $297,000, $258,000, and $150,000 per year from 1999 through year 2002.
10
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 generally 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 1998, 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.
YEAR 2000 COMPLIANCE
Many existing computer systems and programs process transactions using two
digits rather than four digits for the year of a transaction. Unless the
hardware and/or the software has been modified, a significant number of those
computer systems and programs may process a transaction with a date of the year
"2000" as the year "1900", which could cause the system or the program to fail
or create erroneous results before, on or after January 1, 2000 (the "Y2K
Issue").
The Company's principal computer systems consist of: (i) management
information software ("MIS") for accounts receivable, general ledger, payables,
order entry, sales reporting, inventory tracking, product distribution, and
production scheduling; (ii) electronic data interchange ("EDI") for
order-taking, invoicing and the like between the Company and its major
customers; and (iii) local area network and personal computer operating systems.
The Company has completed its reprogramming, or replacing, and testing of
its EDI software, and such software has been determined by the Company to be Y2K
compliant. The Company has communicated with its customers to evaluate their EDI
Y2K compliance. Based on these communications, the Company understands that its
major customers have tested their EDI systems for internal, intermediary and
supplier Y2K compliance, and found them to be Y2K compliant. The Company would
be unable to receive and invoice orders from a customer though EDI if the
customer or its EDI intermediaries were not Y2K compliant. Although the Company
does not transmit electronic orders to its independent manufacturers, delays or
non-delivery of goods to the Company could arise from Y2K issues affecting their
businesses and presently the Company is communicating with its independent
manufacturers to evaluate their Y2K compliance. The effect of non-compliance by
independent manufacturers and other third parties is not determinable.
The MIS systems at the Company's U.S. headquarters and Hong Kong
subsidiary have been upgraded and successfully tested to be Y2K compliant. The
Company's local area network operating system has been upgraded and is Y2K
compliant. The Company has replaced all critical computers and software found
not to be Y2K compliant.
The Company has incurred approximately $30,000 through October 31, 1999 in
expenses in connection with making its computer systems and programs Y2K
compliant. The Company expects to incur additional Y2K costs of approximately
$60,000 during the remainder of fiscal 1999 for work which has been completed
but has not yet been billed to the Company. The Company has utilized both
internal and external sources to address Y2K Issues, and is currently in
compliance. All historical and future costs have been and will continue to be
funded out of existing cash and cash flow from operations.
The failure to successfully address a material Y2K Issue could result in
an interruption in, or failure of, certain normal business activities or
operations. Such failures could materially and adversely affect the Company's
results of operations, liquidity and financial condition. Particularly because
of the uncertainty of the Y2K readiness of customers, suppliers and contractors,
the Company is unable to assess at this time whether the consequences of the Y2K
Issue will have a material impact on the Company's results of operations,
liquidity or financial condition. The Company has been in direct communication
with its customers, contractors, and suppliers to evaluate their Y2K compliance.
Based upon the responses received to date from our key customers, contractors,
and suppliers, the
11
Company has no reason to believe that they will not be Y2K compliant prior to
December 31, 1999. Notwithstanding the above, the most likely impact would be a
reduced level of activity in the latter part of the last quarter of fiscal 1999
and the early part of the first quarter of fiscal 2000. The Company has
addressed its non-IT systems at its various facilities and there has been no
indication that the systems are not Y2K compliant. The Company believes that in
the event of a failure of its non-IT systems, there will not be a material
adverse impact on the Company's operation.
The Company currently has not developed a detailed contingency plan to
address situations in which its major customers or suppliers are not Y2K
compliant. If the Company's major customers or suppliers fail to address all of
the Y2K Issues, the Company believes it could have a material adverse impact on
the Company's operations.
The cost of Y2K compliance is based on management's best estimates and may
be updated as additional information becomes available. Reference is made to the
first paragraph of Part I of this report, which addresses forward-looking
statements made by the Company.
12
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 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(a) On May 24, 1999, at the Company's annual meeting of shareholders,
the shareholders approved an amendment to the Company's Amended and
Restated Articles of Incorporation to increase the number of authorized
shares of Common Stock from 20,000,000 shares to 35,000,000 shares. Such
amendment was filed with the Texas Secretary of State on May 28, 1999. The
rights of the holders of Common Stock were not modified by the amendment.
However, the Company now has additional authorized shares for issuance
which, if it elects to issue in the future, could result in a decrease in
the percentage ownership of the Company by the current holders of the
Company's Common Stock.
(b) Pursuant to the Stock Purchase and Sale Agreement by and between the
Company and MVII, LLC ("MVII") dated as of April 15, 1999 (the "Stock
Purchase Agreement"), the Company issued to MVII 100,000 shares of Common
Stock on July 1, 1999. Consideration for these shares of Common Stock is
included in the $5 million paid by MVII to the Company under the terms of
the Stock Purchase Agreement, pursuant to which MVII purchased an
aggregate of 2,458,491 shares of Common Stock (including the 100,000
shares of Common Stock issued on July 1, 1999). The $5 million total
proceeds received by the Company from the stock purchases made by MVII
under the Stock Purchase Agreement have been used by the Company for the
repayment of a $3.6 million indebtedness, and general operating expenses
of $1.4 million.
The Stock Purchase Agreement, including the stock sales by the
Company to MVII thereunder, constituted a privately negotiated transaction
between the Company and MVII. MVII was organized in connection with the
transactions contemplated by the Stock Purchase Agreement. The sales of
Common Stock to MVII pursuant to the Stock Purchase Agreement were made by
the Company in reliance on the exemption from registration set forth in
Section 4(2) of the Securities Act of 1933, as amended. The Company
believes the Section 4(2) exemption from registration was available based
upon the established criteria for effecting a private offering by virtue
of the following facts, among others: (i) MVII had access to the type of
information that would be included in a registration statement and
conducted a comprehensive due diligence review in connection with the
Stock Purchase Agreement and the transactions thereunder, (ii) MVII's
principals have adequate financial means to bear the risk of MVII's
investment in the Company and can be described as sophisticated, (iii)
MVII was the only offeree in the transaction, (iv) MVII made
representations that it acquired the Common Stock for investment and not
with a view toward distribution, (v) the Stock Purchase Agreement contains
restrictions on resale of the Common Stock sold by the Company to MVII,
and (vi) no underwriters were involved nor were any underwriters'
commissions paid in connection with the transactions.
13
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company held its annual meeting of shareholders on May 24, 1999. At
that meeting, the Shareholders were presented with proposals with respect to (i)
the election of directors whose three-year terms expire in 2002, (ii) the
approval and ratification of the Stock Purchase Agreement and the transactions
contemplated thereunder, (iii) the approval of the amendment to the Company's
Amended and Restated Articles of Incorporation authorizing an increase in the
number of authorized shares of Common Stock, (iv) the approval and ratification
of the appointment of four (4) directors nominated by MVII to fill vacancies on
the board as a result of the consummation of the transactions contemplated by
the Stock Purchase Agreement, and (v) the adoption and approval of a proposal to
amend the Company's Stock Option Plan to increase from 600,000 to 900,000 the
aggregate number of shares of the Company Stock reserved for issuance under the
Plan and related conforming changes. The results of the vote of the shareholders
at its annual meeting are set forth below with respect to each of the proposals
presented.
(i) Messrs. Jack R. Crosby and Barry B. Conrad were the nominees for the class
of directors whose three-year terms will expire in 2002. Shares of the
Company's Common Stock with respect to the election of such directors were
voted as follows: with respect to Mr. Crosby, the number of votes that
were cast for his election were 3,936,747 and the number of votes withheld
were 5,100; with respect to Mr. Conrad, the number of votes that were cast
for his election were 3,936,747 and the number of votes withheld were
5,100.
Messrs. Crosby and Conrad were elected for terms expiring on the date of
the annual meeting of shareholders in 2002. Messrs. Crosby and Conrad
subsequently resigned from their board positions on June 1, 1999. Messrs.
Matlock and Davis, current members of the Board, have terms expiring on
the date of the annual meeting of shareholders in 2000. As of the annual
meeting of shareholders held on May 24, 1999, Messrs. Neitz and Smith had
terms expiring in 2001. However, they resigned from their board positions
on June 1, 1999. See discussion in Item 5 regarding the Company's current
Board composition.
(ii) With respect to the proposal to approve and ratify the Stock Purchase
Agreement and the transactions contemplated thereunder, shares of the
Company's Common Stock were voted as follows: the number of votes cast for
such proposal was 3,887,747, the number of votes cast against such
proposal was 42,100, and the number of votes abstaining was 12,000.
(iii) With respect to the proposal to approve an amendment to the Company's
Amended and Restated Articles of Incorporation that would increase the
number of authorized shares of Common Stock of the Company from 20,000,000
shares to 35,000,000 shares, shares of the Company's Common Stock were
voted as follows: the number of votes cast for such proposal was
3,770,358, the number of votes cast against such proposal was 156,400, and
the number of votes abstaining was 15,089.
(iv) With respect to the proposal to approve and ratify the appointment of
Messrs. E. Thomas Martin, Robert L. Burke, Joseph S. Whitaker and John
McSorley as directors by the remaining directors to fill certain vacancies
on the Board in connection with the Stock Purchase Agreement, shares of
the Company's Common Stock were voted as follows: the number of votes cast
for such proposal was 3,880,031, the number of votes cast against such
proposal was 41,900, and the number of votes abstaining was 19,916.
(v) With respect to the proposal to adopt and approve a proposal to amend the
Company's Stock Option Plan (a) to increase from 600,000 to 900,000 the
aggregate number of shares of Common Stock of the Company reserved for
issuance under the Plan and (b) to make certain conforming changes, shares
of the Company's Common Stock were voted as follows: the number of votes
cast for such proposal was 3,754,131, the number of votes cast against was
168,600, and the number of votes abstaining was 19,116.
14
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 on November
23, 1999, for the purpose of reporting the restatement of certain of its
financial statements.
15
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: December 15, 1999 /s/ MICHAEL J. LYDEN
Michael J. Lyden
President and Chief Executive Officer
Dated: December 15, 1999 By: /s/ ROBERT L. WEISGARBER
Robert L. Weisgarber
Chief Financial Officer
(Principal Financial and
Accounting Officer)
16
INDEX TO EXHIBITS
EXHIBIT
NUMBER EXHIBIT
------- -------
3.1 Amended and Restated Articles of Incorporation of the Company (filed
as Exhibit 3.1 to the Registration Statement on Form S-1, File No.
333-23961), incorporated herein by reference.
3.1.1 Amendment to Amended and Restated Articles of Incorporation of the
Company (filed as Exhibit 3.1.1 to the Quarterly Report on Form 10-Q
for the quarter ended April 30, 1999), incorporated herein by
reference.
3.2 Amended and Restated Bylaws of the Company (filed as Exhibit 3.2 to
the Registration Statement on Form S-1, File No. 333-23961),
incorporated herein by reference.
3.3 Amendment to Amended and Restated Bylaws of the Company (filed as
Exhibit 3.3 to the Registration Statement on Form S-1, File No.
333-23961), incorporated herein by reference.
10.45 Agreement and Plan of Merger between Meritus Industries, Inc. et al,
and the Company, dated October 7, 1999.
27 Financial Data Schedule
17