SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
FORM 10-Q
(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, 1997
------------------------
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 number 1-9599
GALOOB TOYS, INC
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(Exact name of registrant as specified in its charter)
Delaware 94-1716574
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(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
500 Forbes Boulevard, South San Francisco, California 94080
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (415) 952-1678
--------------
Indicate by check 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 [ ]
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13, or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court.
Yes [ ] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding
of each of the issuer's classes of common stock, as of the latest practicable
date.
Common stock, par value $.01, 18,100,864 as of September 30, 1997.
GALOOB TOYS, INC. AND SUBSIDIARIES
INDEX
PART I - FINANCIAL INFORMATION PAGE
- -------------------------------- ----
Item 1
- Condensed Consolidated Balance Sheets 1
- Condensed Consolidated Statements of Operations 2
- Condensed Consolidated Statements of Cash Flows 3
- Notes to Condensed Consolidated Financial Statements 4-6
Item 2
- Management's Discussion and Analysis of
Financial Condition and Results of Operations 7-11
PART II - OTHER INFORMATION
- -----------------------------
Item 1
- Legal Proceedings 12
Item 6
- Exhibits and Reports on Form 8-K 12
SIGNATURE 13
- ---------
GALOOB TOYS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except shares)
(Unaudited) (Unaudited) (Audited)
September 30 September 30 December 31
1997 1996 1996
------------ ----------- -------------
ASSETS
Current Assets
Cash and cash equivalents $21,766 $2,244 $27,920
Accounts receivable, net 75,161 99,018 102,322
Inventories 23,402 23,219 19,974
Tooling and related costs 13,423 15,247 15,436
Prepaid expenses and other assets 8,057 9,069 12,361
Deferred income taxes 10,009 --- 2,404
---------- ---------- ---------
Total Current Assets 151,818 148,797 180,417
Land, building and equipment, net 10,550 9,746 10,013
Indebtedness from related party 950 950 950
Other assets 12,001 5,462 5,525
Deferred income taxes 8,316 -- ---
---------- ---------- ---------
Total Assets $183,635 $164,955 $196,905
========== ========== =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Notes payable $ --- $44,043 $ ---
Accounts payable 24,056 25,137 19,655
Accrued expenses 30,329 17,159 24,680
Income taxes payable 449 1,742 1,671
Current portion of long-term debt --- 4,266 17
---------- ---------- ---------
Total Current Liabilities 54,834 92,347 46,023
Other liabilities 4,285 --- 20
Deferred income taxes --- --- 1,071
---------- ---------- ---------
Total Liabilities 59,119 92,347 47,114
---------- ---------- ---------
SHAREHOLDERS' EQUITY
Common stock, par value $.01 per share
authorized 50,000,000 shares
Issued and outstanding 18,100,864 shares,
15,149,651 shares, and 17,919,864 shares 181 152 179
Additional paid-in capital 171,707 106,030 170,291
Retained earnings (deficit) (46,808) (33,127) (20,232)
Cumulative translation adjustment (564) (447) (447)
---------- ---------- ---------
Total Shareholders' Equity 124,516 72,608 149,791
---------- ---------- ---------
Total Liabilities and Shareholders' Equity $183,635 $164,955 $196,905
========== ========== =========
The accompanying notes are an integral part of these
Consolidated Financial Statements.
1
GALOOB TOYS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(Unaudited)
Three Months Ended Nine Months Ended
September 30 September 30
------------ ------------
1997 1996 1997 1996
---- ---- ---- ----
Net revenues $83,248 $88,547 $176,202 $175,270
Costs of products sold 56,734 45,590 108,460 93,871
------ ------ ------- ------
Gross margin 26,514 42,957 67,742 81,399
Operating expenses:
Advertising and promotion 17,437 11,066 32,319 23,477
Other selling and administrative 9,493 10,164 24,432 22,916
Royalties, research and development 14,437 10,097 28,913 25,599
------ ------ ------ ------
Total operating expenses 41,367 31,327 85,664 71,992
------ ------ ------ ------
Earnings (loss) from operations (14,853) 11,630 (17,922) 9,407
Micro Machines license rights and
litigation settlement -- -- (22,949) --
Interest expense (134) (1,069) (252) (2,665)
Other income (expense), net (3,269) 94 (2,445) 185
------- ------- ------- -------
Earnings (loss) before income taxes (18,256) 10,655 (43,568) 6,927
Provision for income taxes (7,121) 1,386 (16,992) 1,386
------- ------ -------- ------
Net earnings (loss) (11,135) 9,269 (26,576) 5,541
Preferred stock dividends -- -- -- 21
Charge related to the exchange of
preferred stock for common -- -- -- 24,279
------ ------ ------- ------
Net earnings (loss) applicable
to common shares ($11,135) $9,269 ($26,576) ($18,759)
========= ====== ========= =========
Average common shares outstanding 18,073 16,387 18,019 13,565
Net earnings (loss) per common share ($0.62) $0.57 ($1.47) ($1.38)
The accompanying notes are an integral part of these
Consolidated Financial Statements.
2
GALOOB TOYS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands, except shares)
(Unaudited)
Nine Months Ended September 30
------------------------------
1997 1996
---- ----
CASH FLOW FROM OPERATING ACTIVITIES:
Net earnings (loss) $(26,576) $5,541
Adjustments to reconcile net earnings
(loss) to net cash provided by (used in)
operating activities:
Depreciation and amortization 654 540
Changes in assets and liabilities:
Accounts receivable 27,161 (30,616)
Inventories (3,428) (5,728)
Tooling and related costs 2,013 (6,936)
Prepaid expenses and other assets (2,172) (1,244)
Deferred income taxes (16,992) ---
Accounts payable 4,401 7,996
Accrued expenses and other liabilities 9,914 2,939
Income taxes payable (1,222) 1,011
------- --------
Net cash (used in) provided by operating
activities (6,247) (26,497)
------- --------
CASH FLOW FROM INVESTING ACTIVITIES:
Investment in land, building and
equipment, net (1,191) (1,505)
------- -------
Net cash (used in) provided by investing activities (1,191) (1,505)
------- -------
CASH FLOW FROM FINANCING ACTIVITIES:
Net borrowings under notes payable --- 28,972
Repayments under long-term debt agreements (17) (156)
Proceeds from issuance of common stock 1,418 1,144
Redemption of preferred stock --- (462)
Costs associated with the conversion
of debentures and the preferred shares exchange --- (1,282)
Other, net (117) ---
------- -------
Net cash (used in) provided by financing activities 1,284 28,216
------- -------
INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS (6,154) 214
CASH AND CASH EQUIVALENTS AT
BEGINNING OF PERIOD 27,920 2,030
------- -------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $21,766 $2,244
======= ======
SUPPLEMENTAL DISCLOSURE OF NON-CASH ACTIVITY:
During the nine months ended September 30, 1996, $14 million of the Company's 8%
convertible subordinated debentures were converted into 1,511,872 shares of its
common stock. Deferred loan costs and accrued interest amounting to
approximately $0.5 million, net, were charged against additional paid-in
capital. See Note F.
During the nine months ended September 30, 1996, 1,822,899 depositary shares of
the Company's preferred stock were exchanged for 3,359,432 shares of its common
stock. See Note G.
The accompanying notes are an integral part of these
Consolidated Financial Statements.
3
GALOOB TOYS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1997
(Unaudited)
NOTE A - CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
- -----------------------------------------------------
The condensed consolidated balance sheets as of September 30, 1997 and 1996 and
the condensed consolidated statements of operations for the three- and
nine-month periods ended September 30, 1997 and 1996 and the condensed
consolidated statements of cash flows for the nine-month periods ended September
30, 1997 and 1996 have been prepared by the Company without audit. In the
opinion of management, all adjustments (which include only normal recurring
adjustments) necessary to present fairly the financial position, results of
operations and cash flows at September 30, 1997 and 1996 have been made.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been omitted. It is suggested that these condensed consolidated financial
statements be read in conjunction with the financial statements and notes
thereto included in the Company's Form 10-K for the year ended December 31,
1996. Certain amounts in the financial statements of prior years have been
reclassified to conform with the current year's presentation.
The results of operations for the three- and nine-month periods ended September
30, 1997 and 1996 are not necessarily indicative of the operating results for
the full year.
NOTE B - LEGAL
- --------------
The current status of litigation is described in Part II, Item 1, herein.
NOTE C - LOAN AGREEMENT
- -----------------------
In 1995, the Company entered into an amended and restated loan and security
agreement (the "Loan Agreement") with Congress Financial Corporation (Central)
(the "Lender"). The Loan Agreement provided an original line of credit of $40
million which has been increased to $50 million, with a provision to increase
the line to $60 million at the option of the Company. Borrowing availability is
determined by a formula based on both accounts receivable and inventories. The
interest rate was generally prime rate plus 1% until March 31, 1997. In
consideration for entering into the Loan Agreement, the Company paid a $100,000
fee; additional fees of $100,000 were paid as the Company exercised its option
to increase the line. The Company has also agreed to pay an unused line fee of
0.25% and certain management fees. The Loan Agreement has been amended to extend
until December 31, 1997. The interest rate was prime plus 2% for the period
April 1, 1997 through September 30, 1997 and will be prime plus 1% for the
period October 1, 1997 through December 31, 1997. A fee of $25,000 was paid for
these extensions. On October 10, 1997, the Company signed a letter agreement
with the Lender increasing the credit limit to $75 million, extending the Loan
Agreement until December 31, 2000 with the interest rate equal to prime. The
letter agreement is subject to certain conditions and final documentation.
NOTE D - INVENTORIES
- --------------------
(in thousands) September 30 December 31
------------ -----------
1997 1996 1996
---- ---- ----
Finished goods $23,089 $23,165 $19,667
Raw materials and parts 313 54 307
---------- --------- ----------
$23,402 $23,219 $19,974
========== ========= ==========
4
NOTE E - RESEARCH AND DEVELOPMENT
- ---------------------------------
Research and development expenses amounted to $2.1 million and $2.3 million for
the three months ended September 30, 1997 and 1996, respectively, and $7.8
million and $7.4 million for the nine months ended September 30, 1997 and 1996,
respectively.
NOTE F - LONG-TERM DEBT
- -----------------------
In February 1996, the Company issued a call for the redemption of its 8%
Convertible Subordinated Debentures originally due November 30, 2000 (the
"Debentures"). This call resulted in the conversion on March 15, 1996, of all
$14,000,000 Debentures at $9.26 per share and the issuance of 1,511,872 new
shares of common stock. Unamortized debt issuance costs of $833,000 were charged
against additional paid-in capital on conversion of the Debentures.
NOTE G - SHAREHOLDERS' EQUITY
- -----------------------------
In February 1996, the Company offered to exchange 1.85 shares of its common
stock for each Depositary Exchangeable Preferred Share (the "Depositary Shares")
outstanding. Each Depositary Share represents 1/10th of a share of $17.00
Convertible Exchangeable Preferred Stock. This inducement offer was accepted by
the owners of 98% of the Depositary Shares resulting in the issuance of
3,336,433 shares of common stock on March 29, 1996. Generally accepted
accounting principles require a non-cash charge to reduce Net Earnings
Applicable to Common Shares in the calculation of Earnings Per Share for the
fair value of the securities issued in excess of the existing conversion rate of
approximately 1.185 common shares per Depositary Share. This non-cash charge
amounted to $24,279,000 or $1.76 per common share in the nine months ended
September 30, 1996. Excluding this charge, net earnings for the nine months
ended September 30, 1996 would have been $0.38 per common share as compared to
$1.38 net loss per common share.
The balance of the Depositary Shares were converted at the specified 1.185
exchange rate or redeemed by the Company in June 1996.
NOTE H - MICRO MACHINES LICENSE RIGHTS AND LITIGATION SETTLEMENT
- ----------------------------------------------------------------
During June 1997, the Company finalized an agreement under which it acquired all
outstanding rights to its line of miniature vehicles, playsets and accessories
marketed under the Micro Machines(R) brand. The agreement also ended litigation
between the Company and Clemens V. Hedeen, Patti Jo Hedeen, and various
affiliated entities (the "Licensor") over past royalties claimed by the Licensor
and the extent of the Licensor's rights in Micro Machines. Under the agreement,
the Company paid the Licensor an initial payment of $22,500,000. Additional
amounts with a present value of $4,911,000, as of the agreement date, are due
periodically through June 1, 2012. The agreement eliminates all future royalty
payments to the Licensor, effective after March 31, 1997.
The Company accounted for this agreement by taking a pre-tax charge of
$22,949,000 in the quarter ended June 30, 1997. The present value of the
remaining balance amounting to $4,462,000 was classified as other assets and is
being amortized.
5
NOTE I - RECENT ACCOUNTING PRONOUNCEMENTS
- -----------------------------------------
The FASB issued three new standards, SFAS No. 128, Earnings per Share, SFAS No.
130, Reporting Comprehensive Income, and SFAS No. 131, Disclosures about
Segments of an Enterprise and Related Information. SFAS 128 simplifies the
standards for computing earnings per share ("EPS") previously found in APB
Opinion No. 15 "Earnings per Share". This new standard replaces the presentation
of primary EPS with a presentation of basic EPS. It also requires dual
presentation of basic and diluted EPS on the face of the income statement for
all entities with complex capital structures and requires a reconciliation of
the numerator and denominator of the basic EPS computation to the numerator and
denominator of the diluted EPS computation. Basic EPS excludes dilution and is
computed by dividing income available to common stockholders by the
weighted-average number of common shares outstanding for the period. Diluted EPS
reflects the potential dilution that could occur if securities or other
contracts to issue common stock were exercised or converted into common stock or
resulted in the issuance of common stock that then shared in the earnings of the
entity. For the three and nine months ended September 30, 1997, SFAS 128 would
have had no impact on the reported EPS as primary and basic are equal since the
potentially dilutive securities were anti-dilutive. SFAS No. 130 establishes
standards for reporting comprehensive income and its components in a financial
statement and display of the accumulated balance of other comprehensive income
separately from retained earnings and additional paid-in capital. The Company
does not expect the implementation of SFAS No. 130 to have a significant impact
on the financial statements. SFAS No. 131 establishes standards for the
reporting of selected information about operating segments in annual financial
statements and interim financial reports issued to shareholders and the related
disclosures about products and services, geographic areas and major customers.
The Company has not determined the impact of SFAS No. 131 on the financial
statements. The Company will be required to adopt the SFAS 128 for the year
ending December 31, 1997, and SFAS 130 and SFAS 131 for the year ending December
31, 1998.
6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
---------------------------------------------------------------
Overview
- --------
On October 14, 1997, the Company entered into an exclusive, worldwide license
with Lucas Licensing Ltd. to make small-scale figures, vehicles, playsets and
accessories for the next three Star Wars movies. In addition, the Company's
current rights to market toys based on the original Star Wars trilogy was
included in the new license. In a separate agreement, the Company also acquired
long-term preferential negotiating rights from Lucasfilm Ltd. for the same
categories of toys based on new Lucasfilm movies.
In consideration of these agreements, the Company has granted the Lucas
companies warrants for slightly less than 20% of the Company's issued and
outstanding common stock, equal to approximately 3.6 million shares as of the
closing date, at an exercise price of $15.00 per share. The new Star Wars
agreement also calls for advance payments against future royalties of $140
million payable as the three new films are released.
In connection with the acquisition of the Star Wars license, the Company has
restructured its product portfolio and changed its product selection strategy.
These adjustments are intended to maximize the future value of the rights
acquired to market small-scale toys for the next three Star Wars films and the
classic Star Wars Trilogy. Therefore, for the three months ended September 30,
1997, the Company incurred special charges amounting to $17.6 million after tax.
These special charges principally relate to the costs of discontinuing all of
the Company's male action lines introduced in 1996 and 1997, and all future male
action properties under development. These charges also include provisions for
unrecovered costs associated with the Company's Sky Dancers(R) line,
miscellaneous expenses, and expenses incurred for arranging financing the
Company ultimately did not need to use in connection with the acquisition of the
Star Wars license.
Results of Operations
- ---------------------
The following table sets forth for the periods indicated the percentage
relationships between revenues and certain expense and earnings items:
Percentage of Net Revenues
Three Months Ended Nine Months Ended
September 30 September 30
------------ ------------
1997 1996 1997 1996
---- ---- ---- ----
Net revenues 100.0% 100.0% 100% 100%
Costs of products sold 68.1 51.5 61.6 53.6
---- ---- ---- ----
Gross margin 31.9 48.5 38.4 46.4
Advertising and promotion 21.0 12.5 18.3 13.4
Other selling and administrative 11.4 11.5 13.9 13.0
Royalties, research and development 17.3 11.4 16.4 14.6
---- ---- ---- ----
Earnings (loss) from operations (17.8) 13.1 (10.2) 5.4
Micro Machines license rights and litigation settlement --- --- (13.0) ---
Interest expense (0.2) (1.2) (0.1) (1.5)
Other income (expense), net (3.9) 0.1 (1.4) 0.1
Provision for income taxes 8.5 (1.6) 9.6 (0.8)
----- ----- --- -----
Net earnings (loss) (13.4)% 10.4% (15.1)% 3.2%
======= ===== ======= ====
Net earnings (loss) have been affected by certain unusual non-recurring items. A
comparison of the net earnings (loss) per common share and the net earnings
(loss) per common share adjusted to exclude unusual items is set forth below:
7
Three Months Ended Nine Months Ended
September 30 September 30
------------ ------------
1997 1996 1997 1996
---- ---- ---- ----
Net earnings (loss) per common share
on a primary basis, as reported $ (0.62) $ 0.57 $(1.47) $(1.38)
Net earnings (loss) per common share on a
primary basis, adjusted to exclude the unusual items $ (0.62) $ 0.57 $(0.70) $ 0.38
The unusual items excluded are as follows: Acquisition of Micro Machines license
rights and litigation settlement of $14.0 million (after tax) in the nine months
ended September 30, 1997 and a one-time charge related to the exchange of
preferred stock for common stock of $24.3 million in the nine months ended
September 30, 1996.
1997 Compared to 1996
- ---------------------
Net sales decreased 6% to $83.2 million in the third quarter of 1997 as compared
to $88.5 million in the third quarter of 1996. Domestic sales increased 6%, to
$57.7 million while international sales decreased 25% to $25.5 million, due to a
generally weak European retail environment.
The Company's worldwide sales of boys' toys decreased 17% in the third quarter
of 1997 as compared to the third quarter of 1996. This decrease was attributable
to reduced sales of the Company's Dragon Flyz(TM) and Jonny Quest(TM) lines of
toys which accounted for 37% of worldwide boys' toys sales in the third quarter
of 1996. This decrease was partially offset by an increase in the worldwide
sales of Micro Machines (including Star Wars(TM) Action Fleet(R)), which
increased by 16% in the third quarter of 1997 as compared to the third quarter
of 1996. United States retail sales success of Micro Machines continued,
reaching its nineteenth consecutive quarter of growth.
The Company's worldwide sales of girls' toys increased by 27% in the third
quarter of 1997 as compared to the third quarter of 1996. This increase was
attributable to the introduction of the Company's Anastasia(TM) line and growth
in the Company's Pound Puppies(R) line, offset by a decrease in worldwide sales
of the Company's Sky Dancers line.
Net sales increased 1% to $176.2 million in the nine months ended September 30,
1997 as compared to $175.3 million in the nine months ended September 30, 1996.
Domestic sales increased 12%, rising to $124.5 million. International sales
decreased 20%, to $51.7 million. This decrease was due to the same factors noted
for the third quarter.
As discussed above, the Company has discontinued several product lines. These
discontinued lines include Dragon Flyz, Jonny Quest and Men in Black(TM), its
male action lines introduced in 1996 and 1997. In addition, the Company has
discontinued Sky Dancers from the Company's girls' toys line.
Gross margins decreased $16.5 million to $26.5 million in the third quarter of
1997 from $43.0 million in the third quarter of 1996. The lower sales volume
decreased gross margin by $2.6 million and a decrease in the gross margin rate
accounted for $13.9 million. The gross margin rate decreased to 31.9% in the
third quarter of 1997 as compared to 48.5% in the third quarter of 1996. The
change in the gross margin rate was primarily attributable to provisions for
unrecovered costs associated with the Company's discontinued lines including
tooling, packaging development, inventory valuation allowances and price
concessions offset by a favorable mix of sales between domestic and
international markets. The Company's gross margin rate on domestic sales is
significantly greater than foreign sales because the Company's prices on foreign
sales are lower than on domestic sales as the foreign customer is responsible
for the cost of importing and promoting the products.
Gross margins decreased $13.7 million to $67.7 million in the nine months ended
September 30, 1997 from $81.4 million in the nine months ended September 30,
1996. The gross margin rate decreased to 38.4% in the nine months ended
September 30, 1997 as compared to 46.4% in the nine months ended September 30,
1996. This decrease was primarily attributable to the same factors as noted for
the third quarter.
8
Advertising and promotion expenses were $17.4 million, or 21.0% of net revenues
in the third quarter of 1997, as compared to $11.1 million, or 12.5% of net
revenues in the third quarter of 1996. For the nine months ended September 30,
1997, these expenses were $32.3 million, or 18.3% of net revenues as compared to
$23.5 million, or 13.4% in the nine months ended September 30, 1996. The
increase in the advertising and promotion expenses in both periods reflected
higher television advertising expense, trade show and product promotion expenses
and sample costs which included the impact of the Company's discontinued lines.
Other selling and administrative expenses were $9.5 million in the third quarter
of 1997 as compared to $10.2 million in the third quarter of 1996. This decrease
was primarily attributable to lower personnel and legal costs partially offset
by provisions for expenses associated with the Company's future discontinued
lines. For the nine months ended September 30, 1997, these expenses were $24.4
million as compared to $22.9 million in the nine months ended September 30,
1996. Other selling and administrative expenses in the nine months ended
September 30, 1996 include a recovery received by the Company in settlement of a
claim for damages partially offset by unusual legal expenses related to this
claim and a lawsuit. Exclusive of this net recovery in the nine months ended
September 30, 1996, other selling and administrative expenses remained
relatively unchanged in the nine month comparable periods.
Royalties, research and development expenses were $14.4 million in the third
quarter of 1997 as compared to $10.1 million in the third quarter of 1996. For
the nine months ended September 30, 1997, these expenses were $28.9 million as
compared to $25.6 million in the nine months ended September 30, 1996. The
increase in royalties, research and development for the three- and nine-month
periods was primarily related to the write-off of royalty advances and
commitments associated with discontinued products.
During the nine months ended September 30, 1997, the Company acquired all
outstanding rights to its line of miniature vehicles, playsets and accessories
marketed under the Micro Machines brand and settled related litigation. In 1986,
the Licensor (as previously defined) licensed a concept to the Company that
contributed to the origination of Micro Machines. The Company had paid royalties
to the Licensor on the majority of Micro Machines sales. The agreement
eliminates all future royalty payments to the Licensor, effective after March
31, 1997. The agreement also ends litigation between the Company and the
Licensor over past royalties claimed by the Licensor and the extent of the
Licensor's rights in Micro Machines. The Company recorded a pre-tax charge to
earnings of $22.9 million in the nine months ended September 30, 1997, relating
to this transaction. Additionally, the Company capitalized $4.5 million which is
being amortized.
Interest expense was $0.1 million in the third quarter of 1997, as compared to
$1.1 million in the second quarter of 1996. For the nine months ended September
30, 1997, this expense was $0.3 million as compared to $2.7 million in the nine
months ended September 30, 1996. The decrease in interest expense was due to the
paydown of the Company's borrowings under its loan agreement with Congress
Financial Corporation in the fourth quarter of 1996 and the conversion of the
$14 million convertible debentures to common stock in the first quarter of 1996.
Other expense was $3.3 million in the third quarter of 1997 as compared to other
income of $0.1 million in the third quarter of 1996. For the nine months ended
September 30, 1997, other expense was $2.4 million as compared to other income
of $0.2 million in the nine months ended September 30, 1996. Other expenses in
the three- and nine-month periods ended September 30, 1997 include expenses
incurred for arranging financing the Company ultimately did not use in
connection with the acquisition of the Star Wars license.
The income tax benefit in the third quarter and nine months ended September 30,
1997 reflects the quarterly application of the estimated annual rate based on
projected full year earnings. The income tax provision for the three- and
nine-month periods ended September 30, 1996 reflects the quarterly application
of the estimated annual rate based on projected full-year earnings and includes
the effect of the utilization of net operating loss carryforwards and federal
tax credits.
All of the Company's products are manufactured to its specifications by
nonaffiliated parties located in China and, to a lesser extent, other foreign
locations. Therefore, the Company could be adversely affected by political or
economic unrest or disruptions affecting business in such countries. The Company
does not carry insurance for political or economic unrest or disruptions for
several reasons, including, but not limited to, costs of such insurance and the
limited insurance coverage available. The political unrest in 1989 in China had
9
an insignificant impact on the manufacturing and shipping of the Company's
products. There can be no assurance that in the future the Company will not be
adversely affected by political or economic disruptions in China or other
foreign locations.
Further, changes in tariffs could have an adverse effect on the cost of goods
imported from China. While China is currently accorded Most Favored Nation
("MFN") status by the United States, this status (which was last renewed in May
1997) is subject to annual review and could be revoked prospectively for any
given year. Current MFN tariffs on toys imported into the United States are
zero, and the loss of MFN status for China would result in a substantial
increase in tariffs applicable to toys imported from China. This increase in
duty could be large enough that it could have a material adverse effect on the
Company's business, financial condition and results of operations. Products
shipped from China to other countries would not be affected by China's loss of
MFN status with the United States without similar actions being taken by the
other importing countries. Moreover, many other toy companies also source
products from China and could be affected to similar degrees.
The Company can also be subject to the imposition of retaliatory tariffs or
other import restrictions as a result of trade disputes between China and the
United States. Generally, trade negotiations over matters in dispute between the
two countries have been difficult but have been resolved without the imposition
of trade retaliation. In the past, proposed retaliation by the United States has
not included increased tariffs or other trade restrictions applicable to toys
imported from China. It is possible, however, that some future trade dispute
could result in substantial increases in tariffs or other restrictions on
imports, such as quotas, of toys from China. These increased tariffs or other
restrictions could be imposed under Section 301 of the Trade Act of 1974, as
amended, whether or not the trade dispute itself involved toys. Such increased
tariffs or other trade restrictions could have a material adverse effect on the
Company's business, financial condition and results of operations.
The impact on the Company of any political or economic unrest or disruptions in
China, the loss of China's MFN status or the imposition of retaliatory trade
restrictions on products manufactured in China would depend on several factors,
including, but not limited to, the Company's ability to (i) procure alternative
manufacturing sources satisfactory to the Company, (ii) retrieve its tooling
located in China, (iii) relocate its production in sufficient time to meet
demand, and (iv) pass cost increases likely to be incurred as a result of such
factors to the Company's customers through product price increases. As a result,
any political or economic unrest or disruptions in China, the loss of China's
MFN status or the imposition of retaliatory trade restrictions on products
manufactured in China could have a material adverse effect on the Company's
business, financial condition and results of operations.
In 1994, certain quotas on toy products made in China were introduced in the
European Economic Community. The quotas did not have a material impact on the
Company's business in 1995 and, although no assurance can be given, are not
expected to have a material impact on the Company's business in the foreseeable
future.
In addition, the Company's subsidiary, Galco International Toys, N.V. ("Galco")
is located in Hong Kong. On July 1, 1997, ownership of Hong Kong reverted back
to China. At the present time, the Company is unable to predict the effect, if
any, that such change will have on the Company's or Galco's business, financial
condition or results of operations. In addition, changes in the relationship
between the United States dollar and the Hong Kong dollar may have an impact on
the cost of goods purchased from manufacturers.
Disclosure Regarding Forward-Looking Statements
- -----------------------------------------------
All statements other than statements of historical fact included in this Form
10-Q Report, including, without limitation the statements under "Management's
Discussion and Analysis of Financial Condition and Results of Operations" are,
or may be deemed to be, forward-looking statements within the meaning of Section
27A of the Securities Act and Section 21E of the Exchange Act. Important factors
that could cause actual results to differ materially from those discussed in
such forward-looking statements ("Cautionary Statements") include: the demand
for the Company's products (including those products developed under the new
Star Wars license); the Company's dependence on timely development, introduction
and customer acceptance of new products (including those products developed
under the new Star Wars license); possible weakness of the Company's markets;
the impact of competition on revenues, margins and pricing; the effect of
currency fluctuations; other risks and uncertainties as may be disclosed from
time to time in the Company's public announcements; the gross national product
10
in the United States and other countries, which also influences demand for the
Company's products; customer inventory levels; the cost and availability of raw
materials; and changes in trade conditions regarding China. All subsequent
written and oral forward-looking statements attributable to the Company or
persons acting on behalf of one or both of them are expressly qualified in their
entirety by such Cautionary Statements.
Liquidity, Financial Resources and Capital Expenditures
- -------------------------------------------------------
Demand for the Company's products is greatest in the third and fourth quarters
of the year. As a result, collections of accounts typically peak in the fourth
quarter and early first quarter of the following year. Due to the seasonality of
its revenues and collections, the Company's working capital requirements
fluctuate significantly during the year. The Company's seasonal financing
requirements are usually highest during the fourth quarter of each calendar
year.
In 1995, the Company entered into an amended and restated loan and security
agreement (the "Loan Agreement") with Congress Financial Corporation (Central)
(the "Lender"). The Loan Agreement provided an original line of credit of $40
million which has been increased to $50 million, with a provision to increase
the line to $60 million at the option of the Company. Borrowing availability is
determined by a formula based on both accounts receivable and inventories. The
interest rate was generally prime rate plus 1% until March 31, 1997. In
consideration for entering into the Loan Agreement, the Company paid a $100,000
fee; additional fees of $100,000 were paid as the Company exercised its option
to increase the line. The Company has also agreed to pay an unused line fee of
0.25% and certain management fees. The Loan Agreement has been amended to extend
until December 31, 1997. The interest rate was prime plus 2% for the period
April 1, 1997 through September 30, 1997 and will be prime plus 1% for the
period October 1, 1997 through December 31, 1997. A fee of $25,000 was paid for
these extensions. On October 10, 1997, the Company signed a letter agreement
with the Lender increasing the credit limit to $75 million, extending the Loan
Agreement until December 31, 2000 with the interest rate equal to prime. The
letter agreement is subject to certain conditions and final documentation.
During the nine months ended September 30, 1997, the Company used $6.2 million
of cash in its operating activities. The net cash used by operating activities
resulted primarily from the net loss which included the acquisition of the Micro
Machines rights and litigation settlement. Also contributing to the use of cash
were increases in inventories and deferred taxes, offset by a decrease in
accounts receivable and increases in accounts payable and accrued expenses.
Working capital was $97.0 million at September 30, 1997 compared to $134.4
million at December 31, 1996 and $56.5 million at September 30, 1996. The ratio
of current assets to current liabilities was 2.8 to 1.0 at September 30, 1997
compared to 3.9 to 1.0 at December 31, 1996 and 1.6 to 1.0 at September 30,
1996.
The Company had no material commitments for capital expenditures at September
30, 1997.
On October 14, 1997, the Company entered into an exclusive, worldwide license
with Lucas Licensing Ltd. to make small-scale figures, vehicles, playsets and
accessories for the next three Star Wars movies as well as the Company's current
rights to market toys based on the original Star Wars trilogy. This licensing
agreement calls for advance payment against future royalties of $140 million
payable as the three new films are released. The first payment is anticipated to
be due in the Spring of 1999.
The Company believes that its cash flow from operations, cash on hand and
borrowings under the extended credit arrangement will be sufficient to meet its
working capital and capital expenditure requirements and provide the Company
with adequate liquidity to meet its anticipated operating needs for the
foreseeable future.
11
Part II - OTHER INFORMATION
Item 1. Legal Proceedings
-----------------
Licensing Litigation
- --------------------
In June 1995, the Company filed a declaratory judgment action in the United
States District Court for the Northern District of California. The suit named
Clemens V. Hedeen, Jr., Patti Jo Hedeen, and various affiliated entities, as
defendants, and sought a determination that the Company is not obligated to pay
royalties to the defendants under their license agreement on certain specific
products sold under the Company's "Micro Machines" name and trademark. The
defendants filed a cross-complaint for breach of this license agreement
claiming, among other things, damages for past royalties allegedly due but not
paid under the license agreement, and claiming entitlement to additional
royalties on future sales of such product. On June 2, 1997, the Company entered
into a Settlement & Release Agreement (the "Agreement") with all of the
defendants in this pending litigation. Under the Agreement, the litigation was
terminated and the various claims and counterclaims were dismissed with
prejudice, and the Company acquired all of the outstanding rights to its "Micro
Machines" brand. Acquisition of these rights by the Company has eliminated all
future royalty payments by it to the defendants in connection with the Micro
Machines brand, effective after March 31, 1997.
In October 1995, the Company filed a breach of contract action in the United
States District Court for the Northern District of California. The suit named
Abrams Gentile Entertainment Inc. and Up, Up and Away as defendants, and alleged
damages for the licensing, marketing and sale of products that are in violation
of the Company's rights as licensee under its Sky Dancers and Dragon Flyz
license agreements with Abrams Gentile Entertainment, Inc. The defendants filed
a number of counterclaims, including breach of contract, interference with
contractual relationships, misappropriation of copyright, unfair competition and
trade libel. The Company has settled all of the open matters in this litigation,
and the various claims and counterclaims have been dismissed with prejudice. The
settlement will not result in additional liabilities to the Company, and the
Company's rights under the license agreements have been preserved.
Manufacturer Litigation
- -----------------------
In January 1991, the Company, through its wholly owned subsidiary, Galco, filed
a lawsuit in Hong Kong against Kader Industrial Co., Ltd. ("Kader") alleging
damages suffered by both Galco and the Company as a result of Kader's defective
manufacturing of two lead doll items for the Company's Bouncin' Babies toy line
in 1990. Kader filed counterclaims alleging breach of 17 individual contracts.
In August 1996, the trial court rendered a decision in favor of Kader on the
general issue of liability in this matter, including an award of damages based
on Kader's counterclaims which was approximately $250,000, plus prejudgment
interest. In addition, the court awarded certain litigation costs to Kader, the
amount of which will be determined in future proceedings and could substantially
exceed the amount of the damages awarded. However, in the opinion of management
of the Company, such amount is not likely to have a material adverse effect on
the business, financial condition and results of operations of the Company.
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
(a) Exhibits
4.1 Warrant, dated as of October 14, 1997, between Lucasfilm
Ltd. and Galoob Toys, Inc.
4.2 Warrant, dated as of October 14, 1997, between Lucas
Licensing Ltd. and Galoob Toys, Inc.
4.3 Agreement of Strategic Relationship, dated as of October 14,
1997, between Lucasfilm Ltd., a California corporation, and
Galoob Toys, Inc.
10 Toy License Agreement, dated as of October 14, 1997, between
Lucas Licensing Ltd. and Galoob Toys, Inc.
27 Financial Data Schedule
(b) Reports on Form 8-K
The Company filed a current report on Form 8K dated October 14, 1997,
which sets forth information under Item 5, Other Events and Exhibits.
12
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.
GALOOB TOYS, INC.
(Registrant)
Date: November 13, 1997 By: /s/ Roger J. Kowalsky
----------------------------------
Roger J. Kowalsky
Executive Vice President, Finance
and Chief Financial Officer
13
EXHIBIT INDEX
-------------
Exhibit Description
4.1 Warrant, dated as of October 14, 1997, between Lucasfilm Ltd. and
Galoob Toys, Inc.
4.2 Warrant, dated as of October 14, 1997, between Lucas Licensing Ltd.
and Galoob Toys, Inc.
4.3 Agreement of Strategic Relationship, dated as of October 14, 1997,
between Lucasfilm Ltd., a California corporation, and Galoob Toys,
Inc.
10 Toy License Agreement, dated as of October 14, 1997, between Lucas
Licensing Ltd. and Galoob Toys, Inc.
27 Financial Data Schedule