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, 1998
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 9, 1998, 6,000,000 shares of common stock, par value $.01 per
share, of DSI Toys, Inc. were outstanding.
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TABLE OF CONTENTS
PAGE
PART I - FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
Consolidated Balance Sheet as of October 31, 1998 and January 31,
1998...............................................................1
Consolidated Statement of Operations for the Three Months and Nine
Months Ended October 31, 1998 and 1997.............................2
Consolidated Statement of Cash Flows for the Nine Months Ended
October 31, 1998 and 1997..........................................3
Notes to Consolidated Financial Statements..........................4
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS...............................................5
PART II - OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS..................................................10
Item 6. EXHIBITS AND REPORTS ON FORM 8-K...................................10
Signatures.................................................................11
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DSI Toys, Inc.
Consolidated Balance Sheet
<TABLE>
<CAPTION>
October 31, January 31,
1998 1998
------------ ------------
(Unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash ........................................................ $ 1,213,621 $ 383,690
Restricted cash ............................................. 150,000 150,000
Accounts receivable, net .................................... 6,893,518 8,008,288
Inventories ................................................. 6,797,276 6,437,418
Income tax receivable ....................................... 553,462 642,264
Prepaid expenses ............................................ 1,306,408 894,704
Deferred income taxes ....................................... 499,000 183,000
------------ ------------
Total current assets ................................... 17,413,285 16,699,364
Property and equipment, net ....................................... 1,470,210 1,252,572
Advances to shareholder (life insurance premiums) ................. 1,477,461 1,278,401
Deferred income taxes ............................................. 667,790 1,752,000
Other assets ...................................................... 273,957 224,783
------------ ------------
$ 21,302,703 $ 21,207,120
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities .................... $ 10,745,675 $ 9,740,201
Current portion of long-term debt ........................... 5,793,318 585,783
Income taxes payable ........................................ 441,933 108,630
------------ ------------
Total current liabilities .............................. 16,980,926 10,434,614
Long Term Debt .................................................... -- 7,495,000
Deferred income taxes ............................................. 119,000 119,000
------------ ------------
Total liabilities ...................................... 17,099,926 18,048,614
Shareholders' equity:
Preferred stock, $.01 par value, 5,000,000 shares authorized,
none issued or outstanding ............................. -- --
Common stock, $.01 par value, 20,000,000 shares authorized,
8,719,000 shares issued, 6,000,000 shares outstanding . 87,190 87,190
Additional paid-in capital .................................. 21,162,568 21,162,568
Common stock warrants ....................................... 102,500 102,500
Retained earnings ........................................... 5,494,057 4,437,653
Cumulative translation adjustment ........................... 17,054 29,187
------------ ------------
26,863,369 25,819,098
Less:treasury stock, 2,719,000 shares, at cost .............. (22,660,592) (22,660,592)
------------ ------------
Total shareholders' equity ............................. 4,202,777 3,158,506
------------ ------------
$ 21,302,703 $ 21,207,120
============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
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DSI Toys, Inc.
Consolidated Statement of Operations
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
October 31, October 31,
-------------------------- ---------------------------
1998 1997 1998 1997
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Net sales ............................................. $ 24,563,262 $ 30,018,242 $ 48,014,196 $ 61,828,627
Costs of goods sold ................................... 18,948,648 22,643,185 37,376,724 44,531,494
------------ ------------ ------------ ------------
Gross profit .......................................... 5,614,614 7,375,057 10,637,472 17,297,133
Selling, general and administrative expenses .......... 3,148,296 13,434,338 8,340,922 20,779,001
------------ ------------ ------------ ------------
Operating income (loss) ............................... 2,466,318 (6,059,281) 2,296,550 (3,481,868)
Interest expense ...................................... 276,916 286,124 710,103 1,158,138
Other income .......................................... (26,963) (49,771) (64,185) (215,778)
------------ ------------ ------------ ------------
Income (loss) before income taxes ..................... 2,216,365 (6,295,634) 1,650,632 (4,424,228)
Provision for (benefit from) income taxes ............. 786,577 (2,266,428) 594,228 (1,592,721)
------------ ------------ ------------ ------------
Income (loss) before extraordinary item ............... 1,429,788 (4,029,206) 1,056,404 (2,831,507)
Extraordinary item (net of tax) ....................... -- -- -- (480,754)
------------ ------------ ------------ ------------
Net income (loss) ..................................... $ 1,429,788 $ (4,029,206) $ 1,056,404 $ (3,312,261)
============ ============ ============ ============
Basic earnings per share
Earnings (loss) per share before extraordinary item $ 0.24 $ (0.67) $ 0.18 $ (0.56)
============ ============ ============ ============
Earnings (loss) per share ......................... $ 0.24 $ (0.67) $ 0.18 $ (0.66)
============ ============ ============ ============
Weighted average shares outstanding ............... 6,000,000 6,000,000 6,000,000 5,033,814
============ ============ ============ ============
Diluted earnings per share
Earnings (loss) per share before extraordinary item $ 0.24 $ (0.67) $ 0.18 $ (0.56)
============ ============ ============ ============
Earnings (loss) per share ......................... $ 0.24 $ (0.67) $ 0.18 $ (0.66)
============ ============ ============ ============
Weighted average shares outstanding ............... 6,000,000 6,000,000 6,000,000 5,033,814
============ ============ ============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
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DSI Toys, Inc.
Consolidated Statement of Cash Flows
<TABLE>
<CAPTION>
Nine Months Ended October 31,
1998 1997
------------ ------------
(Unaudited)
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) ......................................... $ 1,056,404 $ (3,312,261)
Adjustments to reconcile net income (loss) to net cash
provided (used) by operating activities:
Extraordinary item ...................................... -- 480,754
Depreciation and amortization ........................... 469,038 585,854
Amortization and write-off of
debt discount and issuance costs ..................... -- 199,152
Provision for doubtful accounts ......................... 36,541 74,487
Gain on sale of equipment ............................... -- (3,355)
Deferred income taxes ................................... 768,210 (1,638,802)
Changes in assets and liabilities:
Accounts receivable .................................. 1,078,229 (8,206,246)
Due from shareholder ................................. -- 151,667
Inventories .......................................... (359,858) (8,668,928)
Income taxes receivable/payable ...................... 422,105 (193,211)
Prepaid expenses ..................................... (411,704) 567,903
Accounts payable and accrued liabilities ............. 1,005,474 11,294,499
------------ ------------
Net cash provided (used) by operating activities .. 4,064,439 (8,668,487)
Cash flows from investing activities:
Capital expenditures ...................................... (686,676) (665,595)
Proceeds from sale of equipment ........................... -- 6,140
Life insurance premiums paid for shareholder .............. (199,060) --
Decrease in insurance receivable from shareholder ......... -- 220,704
(Increase)/decrease in other assets ....................... (49,174) 368,213
------------ ------------
Net cash used in investing activities ............. (934,910) (70,538)
Cash flows from financing activities:
Net borrowings (repayments) under revolving lines of credit (2,287,465) 3,861,560
Payments on long-term debt ................................ -- (13,427,225)
Net proceeds from issuance of common stock ................ -- 17,753,184
Proceeds from sale of warrants to underwriters ............ -- 2,500
------------ ------------
Net cash provided (used) by financing activities .. (2,287,465) 8,190,019
Effect of exchange rate changes on cash ....................... (12,133) 35,893
------------ ------------
Net increase (decrease) in cash ............................... 829,931 (513,113)
Cash and cash equivalents, beginning of period ................ 383,690 1,501,992
------------ ------------
Cash and cash equivalents, end of period ...................... $ 1,213,621 $ 988,879
============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
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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 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 for the year ended January 31, 1998.
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 and nine months ended
October 31, 1998 are not necessarily indicative of the results expected for the
full year ending January 31, 1999.
Certain prior year amounts have been reclassified to conform to the current
year presentation.
2. ACCOUNTS RECEIVABLE
Accounts receivable consist of the following:
OCTOBER 31, 1998 JANUARY 31, 1998
---------------- ----------------
Trade receivables .............. $ 9,016,221 $ 10,999,014
Provisions for:
Discounts, markdowns and
return of defective goods (1,948,673) (2,786,396)
Doubtful accounts ............ (174,030) (204,330)
--------------- ---------------
Accounts receivable, net ....... $ 6,893,518 $ 8,008,288
=============== ===============
3. COMPREHENSIVE INCOME
Effective February 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130")
which establishes standards for reporting and display of comprehensive income
and its components. Adoption of SFAS 130 did not have a material impact on the
Company's financial statements.
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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 CHANGING CONSUMER PREFERENCES, LACK OF SUCCESS
OF NEW PRODUCTS, LOSS OF THE COMPANY'S CUSTOMERS, LIQUIDITY OF THE COMPANY,
COMPETITION, AND OTHER FACTORS DISCUSSED IN THIS REPORT AND FROM TIME TO TIME IN
THE COMPANY'S FILINGS WITH THE SECURITIES AND EXCHANGE COMMISSION.
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 1998 IS A REFERENCE TO THE FISCAL YEAR ENDING JANUARY 31,
1999).
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(Trademark) and Digi-Tech(Trademark) walkie-talkies, pre-teen
audio products and Kawasaki(Registered Trademark) musical toys; (ii) girls'
toys, including dolls, play sets and accessories; and (iii) boys' toys,
including Kawasaki(Registered Trademark) and Burnin' Thunder (Trademark) radio
control vehicles, BlockMen (Trademark) construction sets and western and
military action 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.
1998 net sales are expected to be less than 1997 net sales because the
Company's conservative 1998 strategy does not include any TV-promoted products.
For the future, the Company intends to (a) focus on strengthening and growing
core business; (b) continue to seek proprietary product from independent
inventors and designers; (c) look for strategic brand and product licensing
opportunities; and (d) strengthen product development and marketing to support
effective planning, risk assessment, product development, marketing and sales.
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,
----------- -----------
1998 1997 1998 1997
-------- -------- -------- --------
Net sales........................ 100.0% 100.0% 100.0% 100.0%
Costs of goods sold.............. 77.1 75.4 77.8 72.0
-------- -------- -------- --------
Gross profit..................... 22.9 24.6 22.2 28.0
Selling, general and administrative
expenses......................... 12.8 44.8 17.4 33.6
-------- -------- -------- --------
Operating income (loss).......... 10.1 (20.2) 4.8 (5.6)
Interest expense................. 1.1 1.0 1.5 1.9
Other income..................... (0.1) (0.2) (0.1) (0.3)
-------- -------- -------- --------
Income (loss) before income taxes 9.1 (21.0) 3.4 (7.2)
Provision for (benefit from) income
taxes............................ 3.2 (7.6) 1.2 (2.6)
-------- -------- -------- --------
Income (loss) before extraordinary
item............................. 5.9 (13.4) 2.2 (4.6)
Extraordinary item (net of tax).. 0.0 0.0 0.0 (0.8)
-------- -------- -------- --------
Net income (loss)................ 5.9% (13.4)% 2.2% (5.4)%
======== ======== ======== ========
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THREE MONTHS ENDED OCTOBER 31, 1998 COMPARED TO THE THREE MONTHS ENDED
OCTOBER 31, 1997
NET SALES. Net sales for the three months ended October 31, 1998 decreased
$5.4 million, or 18.2%, to $24.6 million, from $30.0 million in the comparable
period in 1997.
Net sales of juvenile audio products increased $1.4 million, or 8.2%, to
$18.0 million during third quarter ended October 31, 1998, from $16.7 million in
the comparable period in 1997. This increase was due primarily to continued
strength in walkie talkies and musical keyboards, partially offset by a decline
in pre-school audio products.
Net sales of girls' toys decreased $6.8 million, or 83.2%, to $1.4 million
during the third quarter ended October 31, 1998, from $8.2 million in the
comparable period in 1997. Sales for the third quarter 1997 were driven
principally by the TV-promotion of three dolls (Baby Pick Me Up(Registered
Trademark), Dreamie Sweets(Registered Trademark) and Rosie(Registered
Trademark)). Sales for the third quarter 1998 were comprised principally of one
new non-promoted doll (Baby Learns To Walk(Trademark)).
Net sales of boys' toys increased $1.6 million, or 72.3%, to $3.8 million
in the third quarter ended October 31, 1998, from $2.2 million in the comparable
period in 1997. The increase was due primarily to the introduction of the
BlockMen(Trademark) construction sets and the new radio-controlled "Burnin'
Thunder"(Trademark) car, partially offset by a decrease in sales of the
radio-controlled Kawasaki(Registered Trademark) Ninja(Registered Trademark)
motorcycle.
Net sales of products in other categories decreased $1.6 million, or 54.3%,
to $1.4 million during the third quarter ended October 31, 1998, from $3.0
million in the comparable period in 1997. The decrease was due primarily to
decreased sales of handheld electronics games and Hoppin' Poppin'
Spaceballs(Registered Trademark), an action game that was TV promoted in 1997.
International net sales for the three months ended October 31, 1998
decreased $2.0 million, or 29.2%, to $4.8 million, from $6.8 million in the
comparable period in 1997. The decline was due primarily to decreased sales to
United Kingdom, Canada, Greece, Italy and Mexico.
Gross profit. Gross profit decreased 23.9% to $5.6 million for the third
quarter ended October 31, 1998, from $7.4 million in the comparable period in
1997. Gross profit as a percentage of net sales decreased to 22.9% in the third
quarter ended October 31, 1998, from 24.6% in the third quarter of fiscal 1997.
Such decrease was primarily due to decreased sales of TV-promoted toys,
principally dolls, which generally have higher gross margins to cover the
related costs of TV advertising.
Selling, general and administrative expenses. Selling, general and
administrative expenses decreased 76.6% to $3.1 million in the third quarter
ended October 31, 1998, from $13.4 million in the third quarter of fiscal 1997.
The decrease resulted primarily from absence of the TV advertising expense in
1998.
Interest expense. Interest expense during the third quarter ended October
31, 1998 remained relatively flat at $277,000 compared to $286,000 in the
similar period in 1997.
Other income. Other income decreased $23,000 to $27,000 in the third
quarter ended October 31, 1998, from $50,000 in the comparable period in 1997,
reflecting the effect of changes in levels of short-term investments and foreign
exchange translation.
NINE MONTHS ENDED OCTOBER 31, 1998 COMPARED TO THE NINE MONTHS ENDED OCTOBER
31, 1997
NET SALES. Net sales for the nine months ended October 31, 1998 decreased
$13.8 million, or 22.3%, to $48.0 million, from $61.8 million in the comparable
period in 1997.
Net sales of juvenile audio products increased $2.0 million, or 6.0%, to
$34.7 million during the nine months ended October 31, 1998, from $32.8 million
in the comparable period in 1997. The increase was primarily attributable to
continued strength in walkie-talkies and musical keyboards, partially offset by
a decline in pre-school audio products.
Net sales of girls' toys decreased $14.7 million, or 82.4%, to $3.1 million
during the nine months ended October 31, 1998, from $17.8 million in the
comparable period in 1997. Sales for the nine months ended October 31, 1997 were
driven principally by the TV promotion of three dolls (Baby Pick Me
Up(Registered Trademark), Dreamie Sweets(Registered Trademark) and
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Rosie(Registered Trademark)). Sales for the nine months ended October 31, 1998
were comprised principally of sales of one new non-promoted doll (Baby Learns To
Walk(Trademark)) and final closeouts of 1997 doll inventory.
Net sales of boys' toys increased $285,000, or 4.3%, to $6.9 million in the
nine months ended October 31, 1998, from $6.6 million in the comparable period
in 1997. This increase was attributable to the introduction of the
BlockMen(Trademark) construction sets and the new radio-controlled "Burnin'
Thunder"(Trademark) car, partially offset by a decrease in sales of the
radio-controlled Kawasaki(Registered Trademark) Ninja(Registered Trademark)
motorcycle.
Net sales of products in other categories decreased $1.4 million, or 30.0%,
to $3.3 million during the nine months ended October 31, 1998, from $4.7 in the
comparable period in 1997. The decrease was due primarily to decreased sales of
handheld electronic games and Hoppin' Poppin' Spaceballs(Registered Trademark),
an action game that was TV promoted in 1997.
International net sales for the nine months ended October 31, 1998
decreased $2.9 million, or 22.2%, to $10.2 million, from $13.2 million in the
comparable period in 1997. The decline was due primarily to decreased sales to
Canada, Italy, Greece, United Kingdom and Mexico, partially offset by an
increase in sales to Denmark and France.
GROSS PROFIT. Gross profit decreased 38.5% to $10.6 million for the nine
months ended October 31, 1998, from $17.3 million in the comparable period in
1997. Gross profit as a percentage of net sales decreased to 22.2% in the nine
months ended October 31, 1998, from 28.0% in the first nine months of fiscal
1997. Such decrease was primarily due to decreased sales of TV-promoted toys,
principally dolls, which generally have higher gross margins to cover the
related costs of TV advertising.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses decreased 59.9% to $8.3 million in the nine months ended
October 31, 1998, from $20.8 million in the first nine months of fiscal 1997.
The decrease resulted primarily from the absence of TV advertising expense for
the first three quarters of fiscal 1998.
INTEREST EXPENSE. As a result of debt repayment using the proceeds from the
Company's initial public offering in June 1997, interest expense decreased
$448,000 to $710,000 in the nine months ended October 31, 1998, from $1.2
million in the comparable period in 1997.
OTHER INCOME. Other income decreased $152,000 to $64,000 in the nine months
ended October 31, 1998, from $216,000 in the comparable period in 1997. In 1997,
the Company received interest income related to certain insurance proceeds. The
effects of foreign currency translation also contributed to the decrease.
LIQUIDITY AND CAPITAL RESOURCES
The Company historically 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.
For the nine months ended October 31, 1998, the Company's operating
activities provided net cash of $4.1 million, consisting primarily of decreases
in accounts receivable and income taxes receivable and increases in accounts
payable and accrued liabilities, partially offset by the increases in
inventories and prepaid expenses. Net cash used in investing activities was
$935,000 and was primarily the result of capital expenditures. Net cash used in
financing activities was $2.3 million and represented net payments under
revolving lines of credit. The Company's working capital at October 31, 1998 was
$432,000 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 Bank One, Texas, N.A. (the "Revolver").
The Company's operating cash requirements for the remainder of fiscal 1998
and 1999 include payments totaling approximately $3.3 million related to
television advertisements run in November and December 1997. Such
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<PAGE>
amount is due to two media companies and is currently being paid in monthly
installments through November 1999. The Company has projected approximately $1
million for capital expenditures, consisting primarily of purchases of tools and
molds for fiscal 1999.
In addition, the Company is obligated to make future minimum royalty
payments under certain of its license agreements. As of October 31, 1998, the
Company was required to pay guaranteed royalties under these licenses of $15,000
in fiscal 1998 and $150,000 per year from 1999 through year 2002.
At December 9, 1998, the Company had additional borrowing capacity of an
aggregate of $1.3 million under the Revolver and the Hong Kong Credit Facility.
As of October 31, 1998, the Company was out of compliance with certain of the
covenants of the Revolver, and on December 7, 1998, Bank One notified the
Company that such noncompliance constituted events of default. However, by
agreement dated December 11, 1998, Bank One agreed not to exercise its rights
and remedies with respect to such default, and the Company agreed to accelerate
the maturity of the Revolver to January 22, 1999 from March 31, 1999. The
Company believes that it can obtain acceptable credit from other sources to
replace the Revolver by January 22, 1999. The Company has received non-binding
proposals from two lenders to replace the Revolver. However, there can be no
assurance that the Company can replace the Revolver, and in the event it is not
fully replaced, the Company's ability to fund its operations would be adversely
affected. The Company is considering financing alternatives, including issuing
additional debt and equity securities.
Effective August 17, 1998, listing of the Company's Common Stock was moved
to the Nasdaq SmallCap Market from the Nasdaq National Market because the
Company's net tangible assets are below the Maintenance Standards for continued
listing on the Nasdaq National Market. Management does not believe that the move
to the SmallCap Market has had or will have any material adverse effect on
trading of the Company's common stock or on the Company's ability to issue
additional equity if required.
As part of the Company's strategy, the Company will evaluate potential
acquisitions of other toy businesses or product lines that the Company believes
would complement its existing business. The Company has no present understanding
or agreement with respect to any acquisition.
SEASONALITY
The 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 1997, 73.9% 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; (iii) local area network and personal computer operating systems.
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The MIS systems at the Company's Hong Kong subsidiary have been upgraded
and successfully tested to be Y2K compliant. The MIS systems at the Company's
U.S. headquarters are in the process of being upgraded, replaced and tested.
The Company is currently reprogramming, or replacing, and testing the EDI
software. The Company is communicating with its customers to evaluate their EDI
Y2K compliance. The Company believes that over the upcoming months its major
customers plan to test their EDI systems for internal, intermediary and supplier
Y2K compliance. 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 Company's local area network operating system will require upgrades
according to vendors, but such upgrades are available at minimal cost. The
Company also intends to replace personal computers and software found not to
be Y2K compliant.
The Company has incurred approximately $7,000 in expenses in connection
with making its computer systems and programs Y2K compliant. The Company expects
to incur additional Y2K costs of approximately $25,000 throughout the balance of
1998 and 1999. The Company is utilizing both internal and external sources to
address Y2K Issues, and the Company anticipates Y2K compliance by June 30, 1999.
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 currently has not developed a detailed contingency plan. The
Company assesses its Y2K status regularly and will begin to develop
comprehensive contingency plans if the Company believes it will not complete the
Y2K project in a timely manner. If the Company's Y2K project is not completed on
a timely basis, or if its 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 and the referenced completion dates are 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 Item 2 of this
report, which addresses forward-looking statements made by the Company.
-9-
<PAGE>
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Effective August 28, 1998 the Company entered into a confidential agreement
which settled all claims in the lawsuit brought by a former independent sales
representative for the Company (Anderson-Crawford Associates, Inc., et al vs.
DSI Toys, Inc., et al., CA. No. 286,815-401, Probate Court No. 3 of Harris
County, Texas). The settlement did not have a material adverse effect on either
the Company's financial position or results of operations.
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 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: None.
-10-
<PAGE>
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, 1998 /s/ M. D. DAVIS
-------------------------------------------------
M. D. Davis
Chairman and Chief Executive Officer
Dated: December 15, 1998 By: /s/ J. RUSSELL DENSON
-------------------------------------------------
J. Russell Denson
Executive Vice President and Chief Financial
Officer
(Principal Financial and Accounting Officer)
-11-
<PAGE>
INDEX TO EXHIBITS
EXHIBIT
NUMBER EXHIBIT
------ -------
10.22 Second Amendment to Amended and Restated Letter Loan Agreement.
27 Financial Data Schedule.
-12-
EXHIBIT 10.22
SECOND AMENDMENT TO AMENDED AND
RESTATED LETTER LOAN AGREEMENT
THIS SECOND AMENDMENT TO AMENDED AND RESTATED LETTER LOAN AGREEMENT
("AMENDMENT") is made and entered into effective the 30th day of September,
1998, by and between DSI TOYS, INC., a Texas corporation (herein called
"BORROWER"), BANK ONE, TEXAS, N.A., with offices in Houston, Texas (herein
called "LENDER").
R E C I T A L S:
WHEREAS, Borrower and Lender entered into an Amended and Restated Letter
Loan Agreement dated October ___, 1997, and a First Amendment to Amended and
Restated Letter Loan Agreement dated effective January 31, 1998 (collectively,
the "LOAN AGREEMENT"; the terms defined therein being used herein as therein
defined unless otherwise defined herein); and
WHEREAS, Borrower and Lender desire to amend certain terms and provisions
of the Loan Agreement, which include (i) modifying some existing financial
covenants, and (ii) amending certain other terms and provisions of the Loan
Agreement.
A G R E E M E N T:
NOW, THEREFORE, in consideration of the mutual promises herein contained
and other good and valuable consideration, the receipt of which is hereby
acknowledged, Borrower and Lender hereby agree to amend the Loan Agreement as
hereinafter set forth.
1. AMENDMENT TO LOAN AGREEMENT. The Loan Agreement is, effective the date
hereof, and subject to the satisfaction of the conditions precedent set forth in
Section 2 hereof, hereby amended as follows:
(a) Section 5(o), AFFIRMATIVE COVENANTS, of the Loan Agreement is amended
by deleting the same in its entirety and substituting the following therefor:
"(o) Borrower shall timely make the payments to advertisers, as set
forth in the schedule below (without prepayment):
=============----------------------------------------===============
Nickelodeon
Month/Year Turner Broadcasting Network Totals
=============----------------------------------------===============
09/98 $63,803.04 $131,808.70 $195,611.74
=============----------------------------------------===============
10/98 $64,281.53 $120,000.00 $184,281.53
=============----------------------------------------===============
11/98 $64,763.64 $120,000.00 $184,763.64
=============----------------------------------------===============
12/98 $65,249.37 $120,000.00 $185,249.37
<PAGE>
=============----------------------------------------===============
01/99 $65,738.74 $120,000.00 $185,738.74
=============----------------------------------------===============
02/99 $66,231.78 $120,000.00 $186,231.78
=============----------------------------------------===============
03/99 $66,728.52 $250,000.00 $316,728.52
=============----------------------------------------===============
04/99 $67,228.98 $250,000.00 $317,228.98
=============----------------------------------------===============
05/99 $67,733.20 $250,000.00 $317,733.20
=============----------------------------------------===============
06/99 $68,241.20 $250,000.00 $318,241.20
=============----------------------------------------===============
07/99 $250,000.00 $250,000.00
=============----------------------------------------===============
08/99 $250,000.00 $250,000.00
=============----------------------------------------===============
09/99 $250,000.00 $250,000.00
=============----------------------------------------===============
10/99 $250,000.00 $250,000.00
=============----------------------------------------===============
11/99 $250,000.00 $250,000.00
=============----------------------------------------===============
12/99 $250,000.00 $250,000.00
====================================================================
TOTALS: $660,000.00 $3,231,808.70 $3,891,808.70
====================================================================
Borrower will promptly notify Lender if it cannot adhere to its
payment obligations relating to this advertising payment schedule."
(b) Section 5, AFFIRMATIVE COVENANTS, is hereby modified by including the
following additional subparagraph (p), Year 2000 Compliance:
"(p) YEAR 2000 COMPLIANCE. Borrower shall perform all acts
reasonably necessary to ensure that (i) Borrower and any business in
which Borrower holds a substantial interest, and (ii) all customers,
suppliers and vendors that are material to Borrower's business,
become Year 2000 Compliant in a timely manner. Such acts shall
include, without limitation, performing a comprehensive review and
assessment of all of Borrower's systems and adopting a detailed
plan, with itemized budget, for the remediation, monitoring and
testing of such systems. As used in this paragraph, "Year 2000
Compliant" shall mean, in regard to any entity, that all software,
hardware, firmware, equipment, goods or systems utilized by or
material to the business operations or financial condition of such
entity, will properly perform date sensitive functions before,
during and after the year 2000. Borrower shall, immediately upon
request, provide to Bank such certifications or other evidence of
Borrower's compliance with the terms of this paragraph as Bank may
from time to time require."
-2-
<PAGE>
(c) Section 11, MISCELLANEOUS, is hereby modified by including the
following additional subparagraph (m), Jury Waiver:
"(m) JURY WAIVER. THE UNDERSIGNED AND BANK (BY ITS ACCEPTANCE
HEREOF) HEREBY VOLUNTARILY, KNOWINGLY, IRREVOCABLY AND
UNCONDITIONALLY WAIVE ANY RIGHT TO HAVE A JURY PARTICIPATE IN
RESOLVING ANY DISPUTE (WHETHER BASED UPON CONTRACT, TORT OR
OTHERWISE) BETWEEN OR AMONG THE UNDERSIGNED AND BANK ARISING OUT OF
OR IN ANY WAY RELATED TO THIS DOCUMENT ANY OTHER LOAN DOCUMENT, OR
ANY RELATIONSHIP BETWEEN BANK AND THE UNDERSIGNED. THIS PROVISION IS
A MATERIAL INDUCEMENT TO BANK TO PROVIDE THE FINANCING DESCRIBED
HEREIN OR IN THE OTHER LOAN DOCUMENT."
(d) Section 11, MISCELLANEOUS, is hereby modified by including the
following additional subparagraph (n), Arbitration:
"(n) ARBITRATION. Bank and Borrower agree that upon the written
demand of either party, whether made before or after the institution
of any legal proceedings, but prior to the rendering of any judgment
in that proceeding, all disputes, claims and controversies between
them, whether individual, joint or class in nature, arising from the
Revolving Note or the Term Note, any Loan Document or otherwise,
including without limitation contract disputes and tort claims.,
shall be resolved by binding arbitration pursuant to the Commercial
Rules of the American Arbitration Association ("AAA"). Any
arbitration proceeding held pursuant to this arbitration provision
shall be conducted in the city nearest the Borrower's address having
an AAA regional office, or at any other place selected by mutual
agreement of the parties. No act to take or dispose of any
Collateral shall constitute a waiver of this arbitration agreement
or be prohibited by this arbitration agreement. This arbitration
provision shall not limit the right of either party during any
dispute, claim or controversy to seek, use, and employ ancillary, or
preliminary rights and/or remedies, judicial or otherwise, for the
purposes of realizing upon, preserving, protecting, foreclosing upon
or proceeding under forcible entry and detainer for possession of,
any real or personal property, and any such action shall not be
deemed an election of remedies. Such remedies include, without
limitation, obtaining injunctive relief or a temporary restraining
order, invoking a power of sale under any deed of trust or mortgage,
obtaining a writ of attachment or imposition of a receivership, or
exercising any rights relating to personal property, including
exercising the right of set-off, or taking
-3-
<PAGE>
or disposing of such property with or without judicial process
pursuant to the Uniform Commercial Code. Any disputes, claims or
controversies concerning the lawfulness or reasonableness of an act,
or exercise of any right or remedy concerning any Collateral,
including any claim to rescind, reform or otherwise modify any
agreement relating to the Collateral, shall also be arbitrated;
provided, however that no arbitrator shall have the right or the
power to enjoin or restrain any act of either party. Judgment upon
any award rendered by any arbitrator may be entered in any court
having jurisdiction. The statute of limitations, estoppel, waiver,
laches and similar doctrines which would otherwise be applicable in
an action brought by a party shall be applicable in any arbitration
proceeding, and the commencement of an arbitration proceeding shall
be deemed the commencement of any action for these purposes. The
Federal Arbitration Act (Title 9 of the United States Code) shall
apply to the construction, interpretation, and enforcement of this
arbitration provision."
2. CONDITIONS OF EFFECTIVENESS. This Amendment shall become effective when,
and only when, Lender shall have received counterparts of this Amendment
executed by Borrower, and Section 1 hereof shall become effective when, and only
when, Lender shall have additionally received all of the following:
(a) Certificate of the Boards of Directors of Borrower authorizing
the execution, delivery and performance of this Amendment, and the matters
contemplated hereby; and
(b) Any and all other documentation as Lender may reasonably
require.
3. REPRESENTATIONS AND WARRANTIES OF BORROWER. Borrower represents and
warrants as follows:
(a) That Borrower is duly authorized and empowered to execute,
deliver and perform this Amendment and all other instruments referred to or
mentioned herein to which it is a party, and all action on its part
requisite for the due execution, delivery and the performance of this
Amendment has been duly and effectively taken. This Amendment, when
executed and delivered, will constitute valid and binding obligations of
Borrower enforceable in accordance with its terms. This Amendment does not
violate any provisions of Borrower's Articles of Incorporation, By-Laws, or
any contract, agreement, law or regulation to which Borrower is subject,
and does not require the consent or approval of any regulatory authority or
governmental body of the United States or any state.
(b) That the representations and warranties made by Borrower in the
Loan Agreement are true and correct as of the date of this Amendment.
(c) No event has occurred and is continuing which constitutes an
Event of Default or would constitute an Event of Default but for the
requirement that notice be given or time elapse or both.
<PAGE>
4. REFERENCE TO AND EFFECT ON THE SECURITY INSTRUMENTS.
(a) Upon the effectiveness of Section 1 hereof, on and after the
date hereof each reference in the Loan Agreement to "this Agreement",
"hereunder", "hereof", "herein" or words of like import, and each reference
in the other Security Instruments (hereinafter defined) to the Loan
Agreement, shall mean and be a reference to the Loan Agreement as amended
hereby.
(b) Except as specifically amended above, the Loan Agreement and all
other instruments securing or guaranteeing Borrower's obligations to Lender
(the "SECURITY INSTRUMENTS") shall remain in full force and effect and are
hereby ratified and confirmed. Without limiting the generality of the
foregoing, the Security Instruments and all collateral described therein do
and shall continue to secure the payment of all obligations of Borrower
under the Loan Agreement, as amended hereby, and under the other Security
Instruments.
(c) The execution, delivery and effectiveness of this Amendment
shall not, except as expressly provided herein, operate as a waiver of any
right, power or remedy of Lender under any of the Security Instruments, nor
constitute a waiver of any provision of any of the Security Instruments.
5. WAIVER. As additional consideration for the execution, delivery and
performance of this Amendment by the parties hereto and to induce Lender to
enter into this Amendment, Borrower warrants and represents to Lender that no
facts, events, statuses or conditions exist or have existed which, either now or
with the passage of time or giving of notice, or both, constitute or will
constitute a basis for any claim or cause of action against Lender or any
defense to (i) the payment of any obligations and indebtedness under the Note
and/or the Security Instruments or (ii) the performance of any of its
obligations with respect to the Note and/or the Security Instruments, and in the
event any such facts, events, statuses or conditions exist or have existed,
Borrower unconditionally and irrevocably waives any and all claims and causes of
action against Lender and any defenses to its payment and performance
obligations in respect to the Note and the Security Instruments.
6. COSTS AND EXPENSES. Borrower agrees to pay on demand all costs and
expenses of Lender in connection with the preparation, reproduction, execution
and delivery of this Amendment and the other instruments and documents to be
delivered hereunder, including the reasonable fees and out-of-pocket expenses of
counsel for Lender. In addition, Borrower shall pay any and all fees payable or
determined to be payable in connection with the execution and delivery, filing
or recording of this Amendment and the other instruments and documents to be
delivered hereunder, and agrees to save Lender harmless from and against any and
all liabilities with respect to or resulting from any delay in paying or
omission to pay such fees.
7. EXECUTION IN COUNTERPARTS. This Amendment may be executed in any number
of counterparts and by different parties hereto in separate counterparts, each
of which when so executed and delivered shall be deemed to be an original and
all of which taken together shall constitute but one and the same instrument.
-5-
<PAGE>
8. GOVERNING LAW. This Amendment shall be governed by and construed in
accordance with the laws of the State of Texas.
9. DUE ON MATURITY. THIS LOAN IS PAYABLE IN FULL AT MATURITY. BORROWER MUST
REPAY THE ENTIRE OUTSTANDING PRINCIPAL BALANCE OF THE LOAN AND ANY UNPAID
INTEREST THEN DUE. LENDER IS UNDER NO OBLIGATION TO REFINANCE THE LOAN AT THAT
TIME, AND DOES NOT PLAN TO REFINANCE THE LOAN AT THAT TIME. BORROWER WILL,
THEREFORE, BE REQUIRED TO MAKE PAYMENT OUT OF OTHER ASSETS THAT BORROWER MAY
OWN, OR BORROWER WILL HAVE TO FIND A LENDER, WHICH IS WILLING TO LEND BORROWER
THE MONEY TO MAKE SUCH PAYMENT.
10. FINAL AGREEMENT. THIS WRITTEN SECOND AMENDMENT TO AMENDED AND RESTATED
LETTER LOAN AGREEMENT REPRESENTS THE FINAL AGREEMENT BETWEEN THE PARTIES AND MAY
NOT BE CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS, OR SUBSEQUENT ORAL
AGREEMENTS OF THE PARTIES. THERE ARE NO UNWRITTEN ORAL
AGREEMENTS BETWEEN THE PARTIES.
IN WITNESS WHEREOF, the parties hereto have caused this instrument to be
duly executed in multiple counterparts, each of which is an original instrument
for all purposes, all as of the day and year first above written.
BORROWER:
DSI TOYS, INC.
By: /s/ M. D. DAVIS
Name: M. D. DAVIS
Title: CHIEF EXECUTIVE OFFICER
LENDER:
BANK ONE, TEXAS, N.A.
By: /s/ GAIL WAGGONER
Name: GAIL WAGGONER
Title: VICE PRESIDENT
-6-
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE DSI TOYS,
INC. FINANCIAL STATEMENTS AS OF AND FOR THE NINE MONTHS ENDED OCTOBER 31, 1998
AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> OCT-31-1998
<CASH> 1,363,621
<SECURITIES> 0
<RECEIVABLES> 9,016,221
<ALLOWANCES> (2,122,703)
<INVENTORY> 6,797,276
<CURRENT-ASSETS> 17,413,285
<PP&E> 5,436,406
<DEPRECIATION> (3,966,196)
<TOTAL-ASSETS> 21,302,703
<CURRENT-LIABILITIES> 16,980,926
<BONDS> 0
0
0
<COMMON> 87,190
<OTHER-SE> 4,115,587
<TOTAL-LIABILITY-AND-EQUITY> 21,302,703
<SALES> 48,014,196
<TOTAL-REVENUES> 48,014,196
<CGS> 37,376,724
<TOTAL-COSTS> 8,340,922
<OTHER-EXPENSES> 64,185
<LOSS-PROVISION> 36,541
<INTEREST-EXPENSE> 710,103
<INCOME-PRETAX> 1,650,632
<INCOME-TAX> 594,228
<INCOME-CONTINUING> 1,056,404
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,056,404
<EPS-PRIMARY> .18
<EPS-DILUTED> .18
</TABLE>
