<PAGE>
DYNATEC INTERNATIONAL, INC.
3820 WEST GREAT LAKES DRIVE
SALT LAKE CITY, UTAH 84120
November 11, 1998
VIA ELECTRONIC SUBMISSION
- -------------------------
Securities and Exchange Commission
450 Fifth Street N.W.
Washington, DC 20549
Re: Dynatec International, Inc.
Form 10-QSB
Ladies and Gentlemen:
On Behalf of Dynatec International, Inc., a Utah corporation, pursuant to
the Securities Act of 1934, as amended, and the rules and regulations
promulgated thereunder, we hereby submit for filing, via electronic
transmission, the attached Form 10-QSB.
Please do not hesitate to call the undersigned at (801) 973-9500 with any
comments.
Very Truly Yours,
/s/Paul A. Boyer
- ----------------
Paul A. Boyer
Chief Financial Officer
<PAGE>
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
----------------
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Quarterly Period Ended: SEPTEMBER 30, 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 NUMBER: 0-12806
DYNATEC INTERNATIONAL, INC.
-----------------------------------
(EXACT NAME OF SMALL BUSINESS ISSUER AS SPECIFIED IN
ITS CHARTER)
UTAH 87-0367267
- --------------------------------------- ---------------------------------
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
3820 GREAT LAKES DRIVE
SALT LAKE CITY, UTAH 84120
- --------------------------------------- ---------------------------------
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(801) 973-9500
--------------
(ISSUER'S TELEPHONE NUMBER, INCLUDING AREA CODE)
----------------------------------------------------
(FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR,
IF CHANGED SINCE LAST REPORT)
CHECK WHETHER THE ISSUER (1) FILED ALL REPORTS REQUIRED TO BE FILED BY SECTION
13 OR 15(D) OF THE SECURITIES EXCHANGE ACT DURING THE PAST 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.
X YES NO
- --- ---
THE COMPANY HAD 2,800,112 SHARES OF COMMON STOCK OUTSTANDING AT NOVEMBER 01,
1998.
THE AGGREGATE MARKET VALUE OF VOTING STOCK HELD BY NON-AFFILIATES OF THE COMPANY
AT NOVEMBER 01, 1998 WAS $11,121,383
TRANSITIONAL SMALL BUSINESS DISCLOSURE FORMAT. YES NO X
----- -----
<PAGE>
DYNATEC INTERNATIONAL, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
- -------------------------------
<TABLE>
<CAPTION>
<S> <C>
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)
Condensed Consolidated Balance Sheets as of September 30, 1998 and December 31, 1997.................... 3
Condensed Consolidated Statements of Operations for the three months ended
September 30, 1998 and 1997, respectively............................................................ 5
Condensed Consolidated Statements of Operations for the nine months ended
September 30, 1998 and 1997, respectively............................................................ 6
Condensed Consolidated Statements of Cash Flows for the nine months ended
September 30, 1998 and 1997, respectively............................................................ 7
Notes to Condensed Consolidated Financial Statements.................................................... 9
ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations...........................................................................................13
PART II. OTHER INFORMATION
- ---------------------------
ITEM 1. Legal Proceedings.......................................................................................20
ITEM 5. Other Information.......................................................................................21
ITEM 6. Exhibits and Reports on Form 8-K........................................................................21
</TABLE>
2
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
DYNATEC INTERNATIONAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
-------------------- --------------------
(Unaudited)
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 163,918 $ 332,894
Accounts receivable, net of allowance for doubtful accounts of $31,257 and
$29,684 respectively 2,258,198 1,549,888
Accounts receivable - other - 426,131
Inventories (see Note 2) 4,790,135 2,522,149
Prepaid expenses and other 269,042 261,312
----------- ----------
Total current assets 7,481,293 5,092,374
----------- ----------
PROPERTY AND EQUIPMENT, at cost:
Building and improvements 2,214,144 2,214,144
Furniture, fixtures and equipment 3,559,306 3,289,886
Land 365,860 365,860
----------- ----------
6,139,310 5,869,890
Less accumulated depreciation and amortization 2,226,812 1,928,303
----------- ----------
Net property and equipment 3,912,498 3,941,587
----------- ----------
TRADEMARKS AND OTHER INTANGIBLES, net of accumulated amortization of $366,952
and $324,446, respectively 220,320 267,825
----------- ----------
DEFERRED LOAN COSTS, net of accumulated amortization of $53,071 and
$-0-, respectively 424,569 -
----------- ----------
OTHER ASSETS 69,367 107,631
----------- ----------
$12,108,047 $9,409,417
=========== ==========
</TABLE>
The accompanying notes to condensed consolidated financial statements
are an integral part of these condensed consolidated balance sheets.
3
<PAGE>
DYNATEC INTERNATIONAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (CONTINUED)
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
--------------------- ---------------------
(Unaudited)
<S> <C> <C>
CURRENT LIABILITIES:
Short-term note payable $ 1,947,430 $ 1,331,169
Current portion of long-term debt 167,838 1,003,477
Current portion of capital lease obligations 16,228 15,699
Accounts payable 909,634 1,077,632
Accounts payable other (see Note 3) 1,003,625 -
Accrued expenses 192,005 238,121
Accrued advertising 179,806 350,000
Accrued royalties payable 68,933 17,882
----------- -----------
Total current liabilities 4,485,499 4,033,980
LONG-TERM DEBT, net of current portion 2,080,050 1,994,355
CONVERTIBLE DEBENTURES (see Note 4) 1,565,671 -
DEFERRED INCOME TAXES 5,036 5,036
CAPITAL LEASE OBLIGATIONS, net of current portion 33,080 46,086
----------- -----------
Total liabilities 8,169,336 6,079,457
----------- -----------
STOCKHOLDERS' EQUITY (see Note 3):
Common stock, $.01 par value; 100,000,000 shares authorized and
2,891,627 and 2,859,940 shares outstanding, respectively 28,916 28,599
Treasury stock, at cost, 91,515 shares (915,150) (915,150)
Additional paid-in capital 6,461,690 5,596,840
Accumulated deficit (1,636,745) (1,380,329)
----------- -----------
Total stockholders' equity 3,938,711 3,329,960
----------- -----------
$12,108,047 $ 9,409,417
=========== ===========
</TABLE>
The accompanying notes to condensed consolidated financial statements
are an integral part of these condensed consolidated balance sheets.
4
<PAGE>
DYNATEC INTERNATIONAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
-----------------------------------------------
<TABLE>
<CAPTION>
Three Months Ended Three Months Ended
September 30, 1998 September 30, 1997
------------------------- ------------------------
(Unaudited)
<S> <C> <C>
PRODUCT SALES AND OTHER REVENUE (see Note 5) $4,382,334 $5,041,055
COST OF SALES 2,977,658 3,592,528
---------- ----------
Gross Margin 1,404,676 1,448,527
---------- ----------
OPERATING COSTS AND EXPENSES:
Selling expenses 772,748 696,863
Research and development 27,546 59,864
General and administrative 618,758 433,439
---------- ----------
Total operating costs and expenses 1,419,052 1,190,166
---------- ----------
Income (loss) from operations (14,376) 258,361
---------- ----------
OTHER INCOME (EXPENSE), net:
Interest expense (see Note 4) (243,989) (109,089)
Interest income - 2,635
---------- ----------
Other expense (1,284) (19,000)
---------- ----------
Other income - 516,019
---------- ----------
Total other income (expense), net (245,273) 390,565
---------- ----------
Income (loss) before income tax provision (259,649) 648,926
INCOME TAX PROVISION (see Note 2) - -
---------- ----------
Net income (loss) $ (259,649) $ 648,926
========== ==========
BASIC NET INCOME (LOSS) PER SHARE $(.09) $.29
========== ==========
DILUTED NET INCOME (LOSS) PER SHARE (see Note 2) $(.09) $.23
========== ==========
WEIGHTED AVERAGE SHARES - BASIC 2,790,252 2,219,096
========== ==========
WEIGHTED AVERAGE SHARES - DILUTED 2,790,252 2,821,243
========== ==========
</TABLE>
The accompanying notes to condensed consolidated financial statements
are an integral part of these condensed consolidated statements.
5
<PAGE>
DYNATEC INTERNATIONAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
-----------------------------------------------
<TABLE>
<CAPTION>
Nine Months Ended Nine Months Ended
September 30, 1998 September 30, 1997
----------------------- -----------------------
(Unaudited)
<S> <C> <C>
PRODUCT SALES AND OTHER REVENUE (see Note 5) $12,746,092 $11,086,616
COST OF SALES 8,005,006 7,716,962
----------- -----------
Gross Margin 4,741,086 3,369,654
----------- -----------
OPERATING COSTS AND EXPENSES:
Selling expenses 2,154,713 1,816,441
Research and development 112,741 227,742
General and administrative 1,572,395 1,359,033
----------- -----------
Total operating costs and expenses 3,839,849 3,403,216
----------- -----------
Income (loss) from operations 901,237 (33,562)
----------- -----------
OTHER INCOME (EXPENSE), net:
Interest expense (see Note 4) (1,138,378) (332,861)
Interest income 3,340 8,650
----------- -----------
Other expense (22,616) (32,500)
----------- -----------
Other income - 606,555
----------- -----------
Total other income (expense), net (1,157,654) 249,844
----------- -----------
Income (loss) before income tax provision (256,417) 216,282
INCOME TAX PROVISION (see Note 2) - (500)
----------- -----------
Net income (loss) $ (256,417) $ 215,782
=========== ===========
BASIC NET INCOME (LOSS) PER SHARE $(.09) $.10
=========== ===========
DILUTED NET INCOME (LOSS) PER SHARE (see Note 2) $(.09) $.08
=========== ===========
WEIGHTED AVERAGE SHARES - BASIC 2,790,252 2,219,096
=========== ===========
WEIGHTED AVERAGE SHARES - DILUTED 2,790,252 2,821,243
=========== ===========
</TABLE>
The accompanying notes to condensed consolidated financial statements
are an integral part of these condensed consolidated statements.
6
<PAGE>
DYNATEC INTERNATIONAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Nine Months Ended Nine Months Ended
September 30, 1998 September 30, 1997
----------------------- ------------------------
(Unaudited)
Increase (Decrease) in Cash and Cash Equivalents
- ------------------------------------------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (256,417) $ 215,782
Adjustments to reconcile net income (loss) to net cash used in
operating activities:
Depreciation and amortization 359,723 366,177
Amortization of deferred loan costs 53,071 3,906
Non-cash interest expense on convertible debentures (see Note 4) 685,611 -
Loss (Gain) on sale of assets 22,616 (402,361)
Changes in assets and liabilities:
Accounts receivable trade (708,311) (970,364)
Accounts receivable - other 426,131 (532)
Inventories (2,267,986) (591,727)
Prepaid expenses and other 30,534 (274,848)
Accounts payable (82,998) (32,433)
Accounts payable other (21,375) -
Accrued expenses 19,555 567,901
Accrued advertising (170,194) (23,130)
Accrued royalties 51,052 40,196
Income tax payable - (100)
----------- -----------
Net cash used in operating activities (1,858,988) (1,101,533)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from the sale of assets 48,006 1,196,687
Receivable from related parties - 295,419
Purchase of property and equipment (376,195) (423,384)
----------- -----------
Advance to third parties - (60,000)
----------- -----------
Net cash provided by (used in) investing activities (328,189) 1,008,722
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings on line of credit 616,261 29,260
Debt issuance costs (275,640) -
Net borrowings (payments) on long-term debt (749,944) 66,103
Principal payments on capital lease obligations (12,476) (33,800)
Proceeds from the convertible debenture offering (see Note 4) 1,500,000 -
Receipt of Treasury stock - (923,150)
Proceeds from future Regulation S offering (see Note 3) 940,000 -
Proceeds from stock sold pursuant to Regulation S offering - 1,000,000
----------- -----------
Net cash provided by financing activities 2,018,201 138,413
----------- -----------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (168,976) 45,602
CASH AND CASH EQUIVALENTS AT BEGINNING OF THE PERIOD 332,894 240,145
----------- -----------
CASH AND CASH EQUIVALENTS AT END OF THE PERIOD $ 163,918 $ 285,747
=========== ===========
</TABLE>
The accompanying notes to condensed consolidated financial statements
are an integral part of these condensed consolidated statements.
7
<PAGE>
DYNATEC INTERNATIONAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
<TABLE>
<CAPTION>
Nine Months Ended Nine Months Ended
September 30, 1998 September 30, 1997
----------------------- ------------------------
<S> <C> <C>
Cash paid for interest $422,140 $332,861
======== ========
Cash paid for income taxes $ - $ 500
======== ========
Debt issuance costs attributable to warrants to placement agent $ 22,444 $ -
======== ========
</TABLE>
The accompanying notes to condensed consolidated financial statements
are an integral part of these condensed consolidated statements.
8
<PAGE>
DYNATEC INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(1) DESCRIPTION OF BUSINESS AND NATURE OF OPERATIONS
------------------------------------------------
Dynatec International, Inc. (the "Company"), a Utah corporation, has four
wholly owned subsidiaries; namely, Softalk, Inc., Arnco Marketing, Inc., Nordic
Technologies, Inc. and SofTalk Communications, Inc.. During the nine months
ended September 30, 1998, the Company conducted most of its operations through
certain of its subsidiaries.
The Company primarily is engaged in the manufacture and distribution of
consumer products in the following areas; Telephone Accessories,
Hardware/Housewares, Mass Market, Flashlights, Telecommunication Headsets and
other miscellaneous products sold to mass market merchandisers.
The Company's business follows seasonal trends. As a result the Company
experiences its highest revenues in the fourth quarter. Because the Company
sells its products primarily to major retailers, the Company's sales performance
is significantly dependent on the performance of those retailers.
BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have
been prepared by the Company in accordance with the rules and regulations of the
Securities and Exchange Commission for Form 10-QSB, and accordingly, do not
include all of the information and footnotes required by generally accepted
accounting principles. In the opinion of management, these consolidated
financial statements reflect all adjustments, which consist only of normal
recurring adjustments, which are necessary to present fairly the Company's
financial position, results of operations and cash flows as of September 30,
1998 and for the periods presented herein. These unaudited condensed
consolidated financial statements should be read in conjunction with the
consolidated financial statements and notes thereto included in the Company's
annual report on form 10-KSB for the year ended December 31, 1997.
The results of operations for the nine months ended September 30, 1998 are
not necessarily indicative of the results that may be expected for the remainder
of the year ending December 31, 1998.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
------------------------------------------
Inventories
Effective January 1, 1998, the Company changed its method of determining
the cost of inventory from last-in, first-out (LIFO) to first-in, first-out
(FIFO). Historically, the difference between the LIFO and current costs of
inventories has been immaterial.
Inventories, consisting principally of telephone accessory,
hardware/housewares, flashlights, telecommunication headsets, and other
miscellaneous products sold to mass market merchandisers as of September 30,
1998 and December 31, 1997, respectively, are summarized as follows:
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
------------------- --------------------
<S> <C> <C>
Raw materials............................................... $1,115,915 $ 831,483
Finished Goods.............................................. 3,674,220 1,690,666
------------------- --------------------
$4,790,135 $2,522,149
=================== ====================
</TABLE>
9
<PAGE>
DYNATEC INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(UNAUDITED)
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
-------------------------------------------------------
Income Taxes
The Company has net operating loss carry-forwards from prior years which
will exceed income generated during 1998. The deferred tax asset related to
these carry-forwards was fully reserved for as of December 31, 1997.
BASIC AND DILUTED NET INCOME (LOSS) PER COMMON SHARE
Basic net income (loss) per common share is calculated based upon the
weighted average number of common shares outstanding during the periods
presented. Diluted net income (loss) per common share is calculated based upon
the weighted average number of common shares outstanding plus the assumed
exercise of all dilutive securities using the treasury stock method and the "if
converted" method for convertible securities.
A reconciliation between the basic and diluted weighted-average number of
shares outstanding as of September 30, 1998 and 1997 is summarized as follows:
<TABLE>
<CAPTION>
September 30,
-------------------------------------
1998 1997
----------------- ---------------
<S> <C> <C>
Basic weighted average number of common shares................... 2,790,252 2,219,096
Weighted average number of common stock options.................. - 602,147
Diluted weighted average number of shares.................. 2,790,252 2,821,243
================= ===============
</TABLE>
In calculating net loss per share for the three and nine months ended
September 30, 1998, respectively, there were warrants and options to purchase
3,508,375 potential common shares that were not included in the computation of
diluted net loss per common shares as their effect would have been anti-
dilutive, thereby decreasing the net loss per common share.
Accounting Standards
During the nine months ended September 30, 1998, the Company adopted
Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting
Comprehensive Income.". SFAS No. 130 requires an "all-inclusive" income
statement approach which specifies that all revenues, expenses, gains and losses
recognized during the period be reported in income, regardless of whether they
are considered to be results of operations of the period. The adoption of SFAS
No. 130 had no material impact on the Company's financial statement
presentation.
The Company is required to adopt SFAS No. 131, "Disclosures about Segments
of an Enterprise and Related Information," in 1998, however, this Statement need
not be applied to interim financial statements in the initial year of its
application. SFAS No. 131 will supersede the business segment disclosure
requirements currently in effect under SFAS No. 14. SFAS No. 131, among other
things, establishes standards regarding the information a company is required to
disclose about its operating segments and provides guidance regarding what
constitutes a reportable operating segment. The Company is currently evaluating
disclosures under SFAS No. 131 compared to current disclosures.
RECLASSIFICATIONS
Certain reclassifications have been made in the prior period's consolidated
financial statements to conform with the current year presentation.
10
<PAGE>
DYNATEC INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(UNAUDITED)
(3) STOCKHOLDERS' EQUITY
--------------------
As of September 30, 1998, $940,000 in funds, which is included in accounts
payable-other in the accompanying condensed balance sheet, has been received in
anticipation of future Regulation S common stock offerings as approved by the
Board of Directors in March 1997. The terms and agreements for these stock
offerings are still under negotiation. Regulation S stock is typically sold at
a significant discount from market value because of its restricted nature.
On June 16, 1998, Canaccord Capital Corporation ("Canaccord"), a Canadian
broker/dealer, filed an action against the Company in the U.S. District Court in
Salt Lake City, Utah. The action seeks an order compelling the issuance of
125,000 shares of Dynatec stock. Canaccord and the Company agree that the
Company, or its transfer agent, had erroneously over-issued shares of stock to
Canaccord in early 1997. In September 1997, Canaccord tendered certificates for
other shares in acknowledgment of a separate over-issuance. Management of the
Company believed that an additional 125,000 shares had been over issued. The
disputed certificate was subsequently returned to the transfer agent and
canceled under the direction of the Board of Directors of the Company. This
action was taken by the Company based upon the understanding of management that
the entity believed by the Company to be holding the beneficial interest in the
certificate had not paid for the shares, and was not a holder in due course or a
"protected person" under applicable Uniform Commercial Code provisions. On
August 3, 1998, the Court entered an order granting the preliminary injunction
in favor of Canaccord and compelling the issuance of a stock certificate to
Canaccord's designee for the disputed 125,000 shares of stock. If one of the
other entities now named in the litigation should subsequently establish a right
to the issuance of 125,000 shares of the stock of the Company, Dynatec may be
required to issue additional shares. Related to the forgoing litigation, a claim
for an additional 125,000 shares of the stock of the Company had been made by
Katori Consultants, Ltd., a Philippines corporation. The answer and third party
complaint of Dynatec named Katori Consultants, Ltd. As a third party defendant
so that such additional claim could be addressed as part of the single legal
action. On October 21, 1998, Katori Consultants, Ltd. Gave written notice to
Dynatec that it relinquished any claim to additional shares of common stock of
the Company. Dynatec intends to continue to pursue its claim for damages and
declaratory relief in this litigation (see Part II Other Information; Item 1.
"Legal Proceedings")..
(4) CONVERTIBLE DEBENTURES/EQUITY LINE-OF-CREDIT
--------------------------------------------
On May 22, 1998, the Company closed a transaction that has provided net
capital proceeds of $1,335,000. These funds have been raised pursuant to the
sale by the Company of a Convertible Debenture (the "Convertible Debenture") in
the face amount of $1,500,000. The debentures are convertible into common stock
of the Company at the lessor of: (i) seventy five percent of the average of the
three lowest closing bid prices of the Common Stock during the ten day trading
period immediately preceding the conversion date or (ii) one hundred percent of
the closing bid price on the trading day immediately preceding the closing date
of the agreement. The transaction has been accomplished pursuant to a
Convertible Debenture and Private Equity Line of Credit Agreement (the "Equity
Line-of-Credit", collectively referred to herein as the "Credit Agreement")
between the Company and a group of five investors which have not previously been
shareholders of the Company. In addition, under the Equity Line-of-Credit, the
Company can use a "put" mechanism to periodically draw down up to $10,000,000.
Under the terms of the Credit Agreement, a minimum of $1,000,000 must be drawn
in increments of not less than $50,000 in exchange for common stock of the
Company issued at 80 percent of the average of the three lowest bid prices
during the six day valuation period consisting of three days prior to the put
and ending two days after the put date. The put mechanism cannot be utilized
until after the effective date of the registration statement for the underlying
stock of the Credit Agreement. Additionally, upon registration of the
underlying shares, the Company will issue an additional $500,000 of Convertible
Debenture.
11
<PAGE>
DYNATEC INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(UNAUDITED)
(4) CONVERTIBLE DEBENTURES/EQUITY LINE-OF CREDIT (CONTINUED)
--------------------------------------------------------
In connection with the Credit Agreement, the investors and placement agent
were issued warrants. These warrants have been issued as Series A and Series B
as follows:
<TABLE>
<CAPTION>
Placement Exercise
Investors Agent Price
------------------- ------------------ ------------------
<S> <C> <C> <C>
Series A Warrants...................... 150,000 150,000 $6.50
Series B Warrants...................... 150,000 300,000 $7.15
</TABLE>
The Company is to issue an additional 50,000 Series A warrants each to both
the placement agent and the investors upon the issuance of an additional
$500,000 Convertible Debenture. One-sixth of the market value of the Series A
and B warrants was allocated to the Convertible Debenture and five-sixths was
allocated to the Equity Line-of-Credit. This allocation was based on the
relative notional amounts of the two elements of the Credit Agreement. The value
of the warrants issued to the investors has been written off as a one-time, non-
cash debt issuance cost, as the warrants are immediately exercisable. The value
of the warrants issued to the placement agent and allocated to the debentures is
being amortized over the 36 month life of the debentures. In addition, because
the debentures are convertible at a 25 percent discount from the market value,
an additional $500,000 representing the intrinsic value of the beneficial
conversion premium was written off as a non-cash expense for the second quarter
of 1998. These non-cash charges for the market value of the warrants are
included with interest expense in the condensed consolidated statements of
operations for the three and nine month periods ended September 30, 1998,
respectively. The market value of the warrants issued to the investors in
connection with the $500,000 of convertible debentures will charged to
operations at the time of issuance.
The Company is also directly issuing, as part of this registration,
consideration of up to 80,000 of its common shares as a fee or consideration to
the placement agent. Of these shares, 20,000 were issued at the time of the
closing of the transaction. The remaining 60,000 shares are retained in escrow
and are to be released in 6,000 share increments as each $1,000,000 is drawn
down under the Equity Line-of-Credit. If all of the Equity Line-of-Credit is not
utilized, the remaining shares held in escrow will be returned to the Company
and cancelled.
In the event that the registration statement for the shares underlying the
Credit Agreement is not effective with the SEC within 90 days of the closing
date, liquidated damages are assessed against the Company at the rate of two
percent of the purchase price of the outstanding securities (debentures) for the
first thirty-day period beyond the original 90 days and three percent of the
purchase price of the then outstanding securities (pro rated on a daily basis)
for each thirty-day period thereafter. As of November 11, 1998 (the date of
this filing), the registration statement had not yet become effective. As a
result the Company has paid $30,000 and accrued $30,000 in liquidated damages.
(5) OTHER
-----
In the period ended March 31, 1998, the Company recognized revenue related
to an agreement with an overseas supplier whereby non-exclusive rights to market
Company products internationally were sold for $580,000. According to the terms
of the agreement, the purchase price was funded by the sale of Company common
stock held by the supplier.
On May 27, 1998, the Company obtained a new, secured revolving credit
facility from a financing institution to provide for up to $5,000,000, bearing
interest at a rate of prime plus one percent, with interest payable monthly. The
credit facility is secured by both accounts receivable and inventories. The Note
is due May 26, 2001. Under the terms of the agreement, the Company is required
to maintain financial covenants and ratios, including book net worth, net income
and debt service coverage. At September 30, 1998, the Company was in default of
certain of these covenants, however, the Company has obtained a waiver. The
Company and its lender are currently negotiating an amendment to the agreement
which will amend the terms of certain of the financial covenants and ratios.
12
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain information
relating to the operations of the Company expressed in dollars (rounded) and
percentage changes from period to period. Data in the table reflects the
consolidated results of the Company for the three and nine month periods ended
September 30, 1998 and 1997, respectively. As supplemental information, the
table also segregates the Company's revenues by product line type.
<TABLE>
<CAPTION>
For the Three Months Ended For the Nine Months Ended
----------------------------------------------- ----------------------------------------
% OF % OF
CHG CHG
FROM FROM
SEPTEMBER SEPTEMBER 1997 TO SEPTEMBER SEPTEMBER 1997 TO
30,1998 30,1997 1998 30,1998 30, 1997 1998
----------------------------------------------- ----------------------------------------
<S> <C> <C> <C> <C> <C> <C>
UNAUDITED STATEMENT OF OPERATIONS DATA:
Product sales and other revenue........ $4,382,000 $5,041,000 (13.1)% $12,746,000 $11,087,000 15.0 %
Cost of sales.......................... 2,978,000 3,593,000 (17.1) 8,005,000 7,717,000 3.7
---------- ---------- ----------- -----------
Gross margin.......................... 1,404,000 1,448,000 (3.0) 4,741,000 3,370,000 40.7
---------- ---------- ----------- -----------
OPERATING COSTS AND EXPENSES:
Selling expenses....................... 773,000 697,000 10.9 2,155,000 1,816,000 18.7
Research and development............... 28,000 60,000 (53.3) 113,000 228,000 (50.4)
General and administrative............. 618,000 433,000 42.8 1,572,000 1,359,000 15.7
---------- ---------- ----------- -----------
Total operating costs and
Expenses............................. 1,419,000 1,190,000 19.2 3,840,000 3,403,000 12.8
OTHER INCOME (EXPENSE), NET:
Interest expense....................... (244,000) (109,000) 123.8 (1,138,000) (333,000) 241.7
---------- ---------- ----------- -----------
Interest income........................ - 3,000 - 3,000 9,000 (61.4)
---------- ---------- ----------- -----------
Other (expense)........................ (1,000) (19,000) (94.7) (23,000) (33,000) (30.3)
---------- ---------- ----------- -----------
Other income........................... - 516,000 - - 607,000 -
---------- ---------- ----------- -----------
Net (loss) income...................... $ (260,000) $ 649,000 (140.0)% $ (257,000) $ 217,000 (218.8)%
========== ========== =========== ===========
Unaudited Supplemental Information:
- ------------------------------------------
Revenue by product line type:
Telephone accessories.................... $1,547,000 $1,760,000 (12.1)% $ 4,773,000 $ 4,607,000 3.6 %
Hardware/housewares..................... 1,276,000 811,000 57.4 3,311,000 2,528,000 31.0
Mass market............................. 1,023,000 2,217,000 (53.8) 1,854,000 3,050,000 (39.2)
Flashlights............................ 202,000 203,000 (0.5) 838,000 608,000 37.8
Telecommunication headsets............. 308,000 5,000 642.2 1,204,000 5,000 23,890.0
Other revenue........................... 26,000 45,000 (42.2) 766,000 289,000 165.2
---------- ---------- ----------- -----------
Total product sales and other....... $4,382,000 $5,041,000 (13.1)% $12,746,000 $11,087,000 15.0 %
========== ========== =========== ===========
</TABLE>
THE FOLLOWING ARE EXPLANATIONS OF SIGNIFICANT PERIOD TO PERIOD CHANGES FOR THE
THREE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997:
REVENUES
TOTAL PRODUCT SALES AND OTHER REVENUES. Total product sales and other
revenues decreased by $659,000, or 13.1%, from $5,041,000 to $4,382,000 for the
three months ended September 30, 1998 compared to the three months ended
September 30, 1997.
TELEPHONE ACCESSORIES. Telephone accessories sales decreased $213,000,
or 12.1%, from $1,760,000 to $1,547,000 for the three months ended September 30,
1998 compared to the three months ended September 30, 1997. The decrease in
telephone accessories was primarily attributable to a Radio Shack order for the
"Softalk II" product which was received during the three months ended September
30, 1997 that did not occur in 1998. Overall gross margins for telephone
accessories increased to 48.2% for the three months ended September 30, 1998
from 45.9% for the three months ended September 30, 1997, as a result of the
sales mix.
13
<PAGE>
HARDWARE/HOUSEWARES. Hardware/houseware revenues increased $465,000, or 57.4%,
from $811,000 to $1,276,000 for the three months ended September 30, 1998
compared to the three months ended September 30, 1997. The increase in
hardware/houseware revenues was primarily attributable to the introduction of
several new drawer organization products, namely "Expand-A-Drawer", which
accounted for $339,000 of this increase. Overall gross margins for products in
this category increased from 26.6% to 30.2% for the three months ended September
30, 1998.
MASS MARKET. Mass market revenues decreased $1,194,000, or 53.8%, from
$2,217,000 to $1,023,000 for the three months ended September 30, 1998 compared
to the three months ended September 30, 1997. This decrease was primarily the
result of the Company receiving certain orders for crayons which were
subsequently deferred to the fourth quarter of 1998 and the first quarter of
1999. Gross margins on products sold generally range between ten and twenty
percent, depending on the sales mix. Substantially all sales in this area were
to Dolgencorp, Inc.
FLASHLIGHTS. Flashlight revenues decreased $1,000, or 0.5%, from $203,000 to
$202,000 for the three months ended September 30, 1998 compared to the three
months ended September 30, 1997. Although sales were relatively flat for the
period, gross margins on these product lines increased from 24.4% to 38.1% for
the three months ended September 30, 1998, as a result of management's effort to
effectively source these products from more reliable overseas vendors to ensure
timely delivery of reliable, high-quality flashlight products.
TELECOMMUNICATION HEADSETS. Telecommunication headset revenues increased
$303,000, or 642.2%, from $5,000 to $308,000 for the three months ended
September 30, 1998 compared to the three months ended September 30, 1997. The
increase was primarily attributable to the Company introducing a new line of
telecommunications products to include wired and wireless telephone headsets,
telephones, conference speakers, and other related products. In the first
quarter of 1998, initial orders for telephonic amplifiers and headsets were
filed with Lucent technologies. Overall gross margins for this product line for
the three months ended September 30, 1998 were approximately 29.6%. In
addition, the Company has been able to secure pages in several catalogues of
major providers for various office products which began circulating during the
second and third quarters of 1998.
OTHER REVENUE. Other revenue decreased $19,000, or 42.2%, from $45,000 to
$26,000 for the three months ended September 30, 1998 compared to the three
months ended September 30, 1997. The decrease in other revenue was primarily
attributable to a decline in other miscellaneous products sold by the Company,
namely, "Softalk Erasable Boards" and product packaging for AT&T and Fuji Novel
Battery lines.
OPERATING COSTS AND EXPENSES
SELLING EXPENSES. Selling expenses increased $76,000, or 10.9%, from $697,000
to $773,000 for the three months ended September 30, 1998 compared to the three
months ended September 30, 1997. The increase in selling expenses was primarily
attributable to increased advertising expense related to the Company securing
pages in several office products providers catalogues. In addition, the Company
experienced an increase in the cost of shipping products to its customers and is
addressing this issue by sourcing competative bids from other carriers. These
increases were partially offset by a decrease of approximately $28,000 in travel
and entertainment expense.
RESEARCH AND DEVELOPMENT. Research and development decreased by $32,000, or
53.3%, from $60,000 to $28,000 for the three months ended September 30, 1998
compared to the three months ended September 30, 1997. This decrease was
primarily attributable to the completion of the Research and Development related
to the introduction of the Company's new line of telecommunication headset
products.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased $185,000, or 42.8%, from $433,000 to $618,000 for the three months
ended September 30, 1998 compared to the three months ended September 30, 1997.
The increase in general and administrative expenses was due in part to increased
legal and accounting fees related to the Company's registration of securities on
Form SB-2 in connection with its Convertible Debenture and Equity Line-of-Credit
financing agreement which was put into place in May 1998.
TOTAL OPERATING COSTS AND EXPENSES. Total operating costs and expenses
increased by $229,000, or 19.2%, from $1,190,000 to $1,419,000 for the three
months ended September 30, 1998 compared to the three months ended September 30,
1997, for the reasons discussed above.
INTEREST EXPENSE. Interest expense increased $135,000, or 123.8%, from
$109,000 to $244,000 for the three months ended September 30, 1998 compared to
the three months ended September 30, 1997. This increase was primarily
attributable to interest related to the $1,500,000 Convertible Debenture put
into place during May 1998, as well as the amortization of non-cash interest
expense associated with debt issuance costs.
14
<PAGE>
INTEREST INCOME. Interest income, decreased $3,000, from $3,000 to $-0- for
the three months ended September 30, 1998 compared to the three months ended
September 30, 1997. This decrease was primarily the result of the Company
utilizing its revolving credit facility, under which "draws" are made by the
Company. After a draw is made a corresponding payable is established, when
collections of outstanding accounts receivable are received, collections are
swept, daily, and re-applied against outstanding draws. As a result the Company
does not keep excess cash on hand to invest.
OTHER INCOME. Other income, decreased $516,000, from $516,000 to $-0- for the
three months ended September 30, 1998 compared to the three months ended
September 30, 1997. This decrease is primarily the result of the Company
recognizing a gain on the sale of assets during the three months ended September
30, 1997 that did not recur in 1998.
NET (LOSS) INCOME. The net income decreased by $909,000, or 140.0%, from
$649,000 to a loss of $260,000 for the three months ended September 30, 1998
compared to the three months ended September 30 due to a combination of the
factors described above.
The following are explanations of significant period to period changes for the
nine months ended September 30, 1998 and 1997:
Revenues
TOTAL PRODUCT SALES. Total product sales increased by $1,659,000, or 15.0%,
from $11,087,000 to $12,746,000 for the nine months ended September 30, 1998
compared to the nine months ended September 30, 1997.
TELEPHONE ACCESSORIES. Telephone accessories sales increased $166,000, or
3.6%, from $4,607,000 to $4,773,000 for the nine months ended September 30, 1998
compared to the nine months ended September 30, 1997. The increase in telephone
accessories was primarily attributable to an increase of approximately $75,000
in the Company's "Twisstop" product line and an increase of approximately
$35,000 in "Cord Manager" line. Overall gross margins for telephone accessories
increased to 34.0%, from 26.3% for the nine months ended September 30, 1998 and
1997, respectively as a result of the sales mix.
HARDWARE/HOUSEWARES. Hardware/houseware revenues increased $783,000, or 31.0%,
from $2,528,000 to $3,311,000 for the nine months ended September 30, 1998
compared to the nine months ended September 30, 1997. The increase in
hardware/houseware revenues was primarily attributable to the introduction of
several new drawer organization products, namely "Expand-A-Drawer", which
accounted for approximately $790,000 of this increase, offset in-part by a
decrease in shelf sales. Overall gross margins for products in this category
remained relatively flat for the nine months ended September 30, 1998 compared
to the nine months ended September 30, 1997.
MASS MARKET. Mass market revenues decreased $1,196,000, or 39.2%, from
$3,050,000 to $1,854,000 for the nine months ended September 30, 1998 compared
to the nine months ended September 30, 1997. Substantially all sales in this
area were to Dolgencorp, Inc. The Company received certain orders for crayons
which were subsequently deferred to the fourth quarter of 1998 and the first
quarter of 1999. Gross margins on products sold generally range between ten and
twenty percent, depending on the sales mix.
FLASHLIGHTS. Flashlight revenues increased $230,000, or 37.8%, from $608,000
to $838,000 for the nine months ended September 30, 1998 compared to the nine
months ended September 30, 1997. The increase in flashlight revenues was
primarily attributable to increased military sales, in addition, gross margins
for flashlights improved significantly, from a negative 9.3% for the nine months
ended September 30, 1997 to a positive 29.2%. This improvement was the direct
result of the Company changing the source of manufacturing from the United
States to certain Asian countries.
TELECOMMUNICATION HEADSETS. Telecommunication headset revenues increased
$1,199,000, or 23,890.0%, from $5,000 to $1,204,000 for the nine months ended
September 30, 1998 compared to the nine months ended September 30, 1997. The
increase was primarily attributable to the Company introducing a new line of
telecommunications products to include wired and wireless telephone headsets,
telephones, conference speakers, and other related products. In the first
quarter of 1998, initial orders for telephonic amplifiers and headsets were
filed with Lucent technologies. Overall gross margins for this product line for
the nine months ended September 30, 1998 were approximately 31.4%. In addition,
the Company has been able to secure pages in several catalogues of major
providers for various office products which began circulating during the second
and third quarters of 1998.
OTHER REVENUE. Other revenue increased $478,000, or 165.2%, from $289,000 to
$767,000 for the nine months ended September 30, 1998 compared to the nine
months ended September 30, 1997. The increase in other revenue was primarily
attributable to the Company recognizing a one-time, up-front license fee of
$580,000 for granting a non-exclusive licensing agreement to Deltec Enterprises,
an Asian supplier for the Company.
OPERATING COSTS AND EXPENSES
15
<PAGE>
SELLING EXPENSES. Selling expenses increased $339,000, or 18.7%, from
$1,816,000 to $2,155,000 for the nine months ended September 30, 1998 compared
to the nine months ended September 30, 1997. The increase in selling expenses
was primarily attributable to an increase in advertising expense of
approximately $188,000, related to the Company securing pages in several office
products providers' catalogues. In addition, the Company experienced an increase
of approximately $136,000 in the cost of shipping products to its customers, and
is addressing this issue by sourcing competative bids from other carriers. These
increases were partially offset by a decrease of approximately $44,000 in travel
and entertainment expense.
RESEARCH AND DEVELOPMENT. Research and development decreased by $115,000, or
50.4%, from $228,000 to $113,000 for the nine months ended September 30, 1998
compared to the nine months ended September 30, 1997. This decrease was
primarily attributable to the completion of the Research and Development related
to the introduction of the Company's new line of telecommunication headset
products.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased $213,000, or 15.7%, from $1,359,000 to $1,572,000 for the nine months
ended September 30, 1998 compared to the nine months ended September 30, 1997.
The increase in general and administrative expenses was due in part to increased
legal and accounting fees related to the Company's registration of securities on
Form SB-2 in connection with its Convertible Debenture and Equity Line-of-Credit
financing agreement which was put into place in May 1998.
TOTAL OPERATING COSTS AND EXPENSES. Total operating costs and expenses
increased by $437,000, or 12.8%, from $3,403,000 to $3,840,000 for the nine
months ended September 30, 1998 compared to the nine months ended September 30,
1997, for the reasons discussed above.
INTEREST EXPENSE. Interest expense, increased $805,000, or 241.7%, from
$333,000 to $1,138,000 for the nine months ended September 30, 1998 compared to
the nine months ended September 30, 1997. This increase was primarily related to
the recognition of a one-time, non-cash charge for the fair value of common
stock warrants and a beneficial conversion premium, totaling $500,000 and
$137,000, respectively, both associated with the issuance of a $1,500,000
Convertible Debenture in May, 1998. Additionally, normal non-cash interest was
recognized on the debenture, as well as the amortization of the fair value of
other common stock warrants issued in connection with the debt.
INTEREST INCOME. Interest income, decreased $6,000, or 66.7%, from $9,000 to
$3,000 for the nine months ended September 30, 1998 compared to the nine months
ended September 30, 1997. This decrease was primarily the result of the Company
utilizing its revolving credit facility, under which "draws" are made by the
Company. After a draw is made a corresponding payable is established, when
collections of outstanding accounts receivable are received, collections are
swept, daily, and re-applied against outstanding draws. As a result the Company
does not keep excess cash on hand to invest.
OTHER INCOME. Other income decreased $607,000, from $607,000 to $-0- for the
nine months ended September 30, 1998 compared to the nine months ended September
30, 1997. This decrease is primarily the result of the Company recognizing a
gain on the sale of assets during the nine months ended September 30, 1997 that
did not recur in 1998.
NET (LOSS) INCOME. The net income decreased by $473,000, or 218.8%, from
$216,000 to a loss of $257,000 for the nine months ended September 30, 1998
compared to the nine months ended September 30, 1997 due to a combination of the
factors described above.
LIQUIDITY AND CAPITAL RESOURCES
General
The Company's principal sources of liquidity are cash flows from
operations, cash on hand and available borrowings under the Company's existing
secured revolving credit facilities. At September 30, 1998, the Company had
$169,000 of cash and $3,053,000 million of unused borrowings under its credit
facility. It is expected that the Company's principal uses of cash will be to
provide working capital, finance capital expenditures, meet debt service
requirements and for other general corporate purposes. Based on current
operations and anticipated cost savings through operating efficiencies, the
Company believes that its sources of liquidity will be adequate to meet its
anticipated requirements for working capital, capital expenditures, scheduled
debt service requirements and other general corporate purposes.
16
<PAGE>
On May 22, 1998, the Company closed a transaction that has provided net
capital proceeds of $1,335,000. These funds have been raised pursuant to the
sale by the Company of a Convertible Debenture in the face amount of $1,500,000.
The debentures are convertible into common stock of the Company at the lessor
of: (i) seventy five percent of the average of the three lowest closing bid
prices of the Common Stock during the ten day trading period immediately
preceding the conversion date or (ii) one hundred percent of the closing bid
price on the trading day immediately preceding the closing date of the
agreement. The transaction has been accomplished pursuant to a Convertible
Debenture and Private Equity Line of Credit Agreement (the "Credit Agreement")
between the Company and a group of five investors which have not previously been
shareholders of the Company. In addition, the Company can use a "put" mechanism
to periodically draw down up to $10,000,000. Under the terms of the Credit
Agreement, a minimum of $1,000,000 must be drawn in increments of not less than
$50,000 in exchange for common stock of the Company issued at 80 percent of the
average of the three lowest bid prices during the six day valuation period
consisting of three days prior to the put and ending two days after the put
date. The put mechanism cannot be utilized until after the effective date of
the registration statement for the underlying stock of the Credit Agreement.
Additionally, upon registration of the underlying shares which may be purchased
pursuant to the convertible debentures, the Company will receive an additional
$500,000 of gross sales proceeds (see Note 4 to the financial statements).
On May 27, 1998, the Company obtained a new, secured revolving credit
facility from a financing institution to provide for up to $5,000,000, bearing
interest at a rate of prime plus one percent, with interest payable monthly. The
credit facility is secured by both accounts receivable and inventories. The Note
is due May 26, 2001. Under the terms of the agreement, the Company is required
to maintain financial covenants and ratios, including book net worth, net income
and debt service coverage. At September 30, 1998, the Company was in default of
certain of these covenants, however, the Company has obtained a waiver. The
Company and its lender are currently negotiating an amendment to the agreement
which will amend the terms of certain of the financial covenants and ratios.
SEPTEMBER 30, 1998 COMPARED TO DECEMBER 31, 1997
As of September 30, 1998, the Company had liquid assets (cash and cash
equivalents, accounts receivable trade and other) of $2,422,000, an increase of
5.1%, or $118,000, from December 31, 1997 when liquid assets were $2,304,000.
Cash decreased $169,000, or 50.8%, to $164,000 at September 30, 1998 from
$333,000 at December 31, 1997. This decrease in cash was primarily the result of
the Company utilizing its revolving credit facility, under which "draws" are
made by the Company to fund capital expenditures, purchase inventory and for
general purpose use. After a draw is made a corresponding payable is setup, when
collections of outstanding accounts receivable are made the monies collected are
swept, daily, and re-applied against outstanding draws. Accounts receivable -
trade increased $708,000, or 45.7%, to $2,258,000 at September 30, 1998 from
$1,550,000 at December 31, 1997. This increase is primarily the result of
increased sales during September 1998, offset in part by improved collections.
Accounts receivable other decreased $426,000 to $-0- at September 30, 1998.
This decrease is primarily the result of the Company receiving payment for the
sale of land held by the Company.
Current assets increased by $2,389,000, or 46.9%, to $7,481,000 at
September 30, 1998 from $5,092,000 at December 31, 1997. This increase was
primarily the result of an increase in accounts receivable - trade of $708,000,
discussed above, inventories of $2,268,000, as a result of increasing inventory
related to the Company's new telephone headset and flashlight businesses, the
increase in crayon inventory as a result of the deferral of certain orders from
Dolgencorp, Inc., and stockpiling for fourth quarter sales, offset in part by a
decrease in cash and accounts receivable as discussed above.
Long-term assets increased $310,000, or 7.2%, to $4,627,000 at September
30, 1998 from $4,317,000 at December 31, 1997. This increase was primarily the
result of deferred loan costs related to the Company's Convertible Debenture and
Equity Line-of-Credit put into place during May 1998, offset in part by normal
recurring amortization of deferred loan costs and other intangibles.
Current liabilities increased by $451,000, or 11.2%, to $4,485,000 at
September 30, 1998 from $4,034,000 at December 31, 1997. This increase was
primarily due to $1,190,000 of borrowing's made under the Company's revolving
credit facility, offset in part by decreases in accrued salaries and benefits,
accrued advertising and the current portion of long-term debt.
The Company's working capital increased by $1,938,000, or 183.2%, to
$2,996,000 at September 30, 1998 from $1,058,000 at December 31, 1997, for the
reasons described above.
The Company used cash of $1,859,000 from operating activities during the
nine months ended September 30, 1998, primarily from increased inventory levels
relating to deferred crayon orders to Dolgencorp, Inc. and the Company's
telephone headset and flashlight businesses.
17
<PAGE>
The Company used cash of $328,000 from investing activities during the nine
months ended September 30, 1998, primarily for capital expenditures relating to
the Company's new accounting and material resource planning integrated software
system implemented in early 1998.
The Company provided $2,018,000 of cash from financing activities during
the nine months ended September 30, 1998, due in part to the Convertible
Debenture offering in May 1998, which stock is currently being registered by the
Company on Form SB-2, as amended, as well as borrowings under the Company's
revolving line-of-credit, less payments made on long-term debt during the
period.
INFLATION
Most of the Company's products are purchased in finished form and packaged
by the supplier or at the Company's headquarters. The Company uses a premixed
plastisol (a petroleum based raw material) to manufacture certain of its
telephone accessory products at its headquarters. The Company anticipates usual,
inflationary increases in the price of its plastic products and does not intend
to pass these increases along to its customers, primarily as a result of other
operating efficiencies gained through changing the sourcing of certain of its
flashlight manufacturing from the United States to Asia. Significant increases
in the cost of plastisol in the future could materially affect the Company's
profitability if these costs cannot be passed on to customers. In general, the
Company does not believe that inflation has had a material effect on its results
of operations in recent years. However, there can be no assurance that the
Company's business will not be affected by inflation in the future.
SEASONALITY
The Company's business follows seasonal trends. As a result the Company
experiences its highest revenues in the fourth quarter as a result of the retail
environment in which most of its customers conduct business. Because the Company
sells its products primarily to major retailers, the Company's sales performance
is significantly dependent on the performance of those retailers. Accordingly,
the fourth quarter is a key determinate to overall profitability for the year.
Therefore, the operating results for any three month period are not
necessarily indicative of the results that may be achieved for any subsequent
three month period or for a full year.
YEAR 2000 COMPLIANCE
The Year 2000 issue is a result of computer programs being written using
two digits rather than four to define the applicable year. Any of the Company's
computer programs that have date-sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in a
system/job failure or miscalculations causing disruptions of operations,
including, among other things, a temporary inability to process transactions,
send invoices, or engage in similar business transactions.
The Company utilizes and is dependent upon computer systems and software to
conduct its business. In the fourth quarter of 1997, the Company began
implementing a new accounting and materials resource planning integrated
software system. The software system, Made2Manage, was designed with the Year
2000 issue in mind, and the Company believes it is year 2000 compliant; however,
the Company utilizes many different software programs to process and summarize
business transactions. The Company is continuing the evaluation of its operating
systems and determining the additional remediation efforts required to ensure
its computer systems will properly utilize dates beyond December 31, 1999.
Preliminary results of this assessment have revealed that remediation efforts
required will vary from system to system. For example, it appears some systems
will not require any additional programming efforts, while others may require
some programming changes.
The Company has initiated formal communications with all of its significant
suppliers and larger customers to determine the extent to which the Company is
vulernable to those third parties' failure to remediate their own Year 2000
issue. However, there can be no guarantee that the systems of other companies on
which the Company's systems rely will be timely converted, or that a failure to
convert by another company, or a conversion that is incompatible with the
Company's systems, would not have a material adverse effect on the Company. The
Company is also assessing the impact of Year 2000 on embedded systems comprised
mainly of HVAC (heating, ventilation and air conditioning), telephone and alarm
systems, and such assessment will be completed by the end of 1998.
18
<PAGE>
For those systems identified as non-compliant, the Company has begun and,
in certain cases, completed remediation efforts. The Company will utilize both
internal and external resources to reprogram, or replace, the software for Year
2000 modifications. The Company plans to complete the Year 2000 project before
March 31, 1999. The total estimated cost of the Year 2000 project is to be
between $150,000 and $200,000 and is being funded through operating cash flows
and its existing $5,000,000 secured credit facility. Of this project cost,
approximately $110,000 is attributable to the purchase of new software or
equipment which will be capitalized. The remaining $40,000 to $90,000 will be
expensed as incurred. In a number of instances, the Company may decide to
install new software or upgrade versions of current software programs which are
Year 2000 compliant. In these instances, the Company may capitalize certain
costs of the new systems in accordance with current accounting guidelines.
The Company presently believes that with modifications to existing software
and conversions to new software for those systems which it believes may be
affected, the Year 2000 issue can be mitigated. However, if such modifications
and conversions are not made, or are not completed timely, the Year 2000 issue
could have a material adverse impact on the operations of the Company.
The costs of the project and the date on which the Company plans to
complete the Year 2000 modifications are based upon management's best estimates,
which were derived utilizing numerous assumptions of future events including the
continued availability of certain resources, third party modification plans and
other factors. However, there can be no guarantee that these estimates will be
achieved and actual results could differ materially from those plans. Specific
factors that might cause such material differences include, but are not limited
to, the availability and cost of personnel trained in this area, the ability to
locate and correct all relevant computer codes, and similar uncertainties.
19
<PAGE>
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
- --------------------------
On June 16, 1998, Canaccord Capital Corporation ("Canaccord"), a Canadian
broker/dealer, filed an action against the Company in the U.S. District Court in
Salt Lake City, Utah. The action seeks an order compelling the issuance of
125,000 shares of Dynatec stock. Canaccord and the Company agree that the
Company, or its transfer agent, had erroneously over-issued shares of stock to
Canaccord in early 1997. In September 1997, Canaccord tendered certificates for
other shares in acknowledgment of a separate over-issuance. Management of the
Company believed that an additional 125,000 shares had been over issued. The
disputed certificate was subsequently returned to the transfer agent and
cancelled under the direction of the Board of Directors of the Company. This
action was taken by the Company based upon the understanding of management that
the entity believed by the Company to be holding the beneficial interest in the
certificate had not paid for the shares, and was not a holder in due course or a
"protected person" under applicable Uniform Commercial Code provisions. On
August 3, 1998, the Court entered an order granting the preliminary injunction
in favor of Canaccord and compelling the issuance of a stock certificate to
Canaccord's designee for the disputed 125,000 shares of stock. If one of the
other entities now named in the litigation should subsequently establish a right
to the issuance of 125,000 shares of the stock of the Company, Dynatec may be
required to issue additional shares. Related to the forgoing litigation, a claim
for an additional 125,000 shares of the stock of the Company had been made by
Katori Consultants, Ltd., a Philippines corporation. The answer and third party
complaint of Dynatec named Katori Consultants, Ltd. As a third party defendant
so that such additional claim could be addressed as part of the single legal
action. On October 21, 1998, Katori Consultants, Ltd. Gave written notice to
Dynatec that it relinquished any claim to additional shares of common stock of
the Company. Dynatec intends to continue to pursue its claim for damages and
declaratory relief in this litigation.
The Company has received a telephonic contact from the SEC indicating that
the SEC anticipates filing an administrative proceeding in the later part of
calendar year 1998 against various individuals and entities which had engaged in
business transaction with a British Columbia corporation and/or a non-U.S.
business trust. The SEC representative indicated that the Company and its chief
executive officer may be named in such agency action. The Company has submitted
a Wells Submission to the SEC to clarify its position as to why it and its CEO
should not be named in the administrative proceeding. The Company did enter into
two 1994 subscription agreements with the British Columbia corporation and two
simultaneous subscription agreements with the business trust in early 1995.
However, none of the transactions were fully consummated and the Company
received no consideration with regard to the transactions. The Company believes
that its actions involving the four referenced subscription agreements are
significantly different from the transactions engaged in with such entities by
other public companies. In this regard, the Company insisted on the use of a
different restrictive legend on its stock certificates which were to be held in
escrow pursuant to the proposed transactions. Further, the Company made a press
release on the day following the first such transaction, and mailed Form 8-K
reports to the SEC on the day following each of the transactions. Such actions
were intended to immediately put all third parties, and the investigating
public, on notice of the unpaid nature of the subscriptions. A formal Wells
Submission was submitted by the Company to explain the position of the Company.
Management believes that, although agency action is possible, such action may
not be likely after the SEC has reviewed the Wells Submission of the Company.
The Board of Directors of the Company has unanimously approved an
investigation of the foregoing transactions and matters, the Company's'
relationship and practices with the Company's' transfer agent, certain related
party transactions and other issues which were subject of a recent preliminary
inquiry conducted by certain members of the Board of Directors, the actions of
officers of the Company with regard to such matters, and other related and
unrelated corporate activities to assure that proper safeguards and policies are
in place or are implemented which will assist the Board of Directors in
monitoring the business activities of the Company. The Board is to be assisted
in this review by independent outside counsel who will coordinate his efforts
with current counsel.
On February 12, 1998, Fuji Corporation filed a claim with the International
Trade Commission seeking a cease and desist order against approximately 30
entities. The relief sought is to enlist the aid of the U.S. Customs Department
in preventing the importation of single-use cameras which are manufactured by
any of the entities named as defendants in the proceeding and which infringe the
patents of Fuji. The Company does not manufacture single-use cameras, but
merely distributes to warehouses in Asia cameras which have been refurbished and
reloaded in mainland China. The Company has engaged intellectual property
counsel to vigorously defend the position of the Company.
20
<PAGE>
The Company is not a party to any legal proceedings which, in the opinion
of management of the Company, after consultation with legal counsel, is material
to the Company's business, financial condition or results of operations beyond
amounts provided for in the accompanying financial statements.
The Company's products are subject to regulation by numerous governmental
authorities, including, without limitation, federal, state and local laws and
regulations governing health, sanitation, environmental protection, safety and
hiring and employment practices.
ITEM 5. OTHER INFORMATION
- ---------------------------
For a period of approximately one year, the NASD has requested from the
Company, through several letters, certain documents related to the
aforementioned litigation, stock transactions and related matters. The Company
is traded on the NASDAQ SmallCap market and has a contractual obligation to
provide such requested information. The Company has cooperated in providing such
documentation.
The Board of Directors of the Company has unanimously approved an
investigation of the matters referred to in the Legal Proceedings section above,
the Company's relationship and practices with the Company's transfer agent,
certain related party transactions and other issues which were the subject of a
recent preliminary inquiry conducted by certain members of the Board of
Directors, the actions of officers of the Company with regard to such matters,
and other related and unrelated corporate activities to assure that proper
safeguards and policies are in place or are implemented which will assist the
Board of Directors in monitoring the business activities of the Company. The
Board is to be assisted in this review by independent outside counsel who will
coordinate those efforts with the Company's current corporate counsel.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
- ----------------------------------------
(a) Exhibits
EXHIBIT NO. DESCRIPTION
- ----------- -----------
27 Financial data schedule (for SEC use only)
(b) FORMS 8-K
None
21
<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.
DYNATEC INTERNATIONAL, INC.
/S/DONALD M. WOOD NOVEMBER 11, 1998
- ----------------- ------------------
Donald M. Wood Date
CHAIRMAN & CEO
/S/PAUL A. BOYER NOVEMBER 11, 1998
- ---------------- ------------------
Paul A. Boyer Date
SENIOR VICE PRESIDENT & CFO
22
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