<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: June 30, 1999
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Transition Period from to .
-------- --------
Commission File 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
incorporation or organization) identification no.)
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.
Yes X No
--------- ---------
The Company had 3,574,373 shares of common stock outstanding at August 2, 1999.
The aggregate market value of voting stock held by non-affiliates of the Company
at August 2, 1999, was $4,566,036.
Transitional Small Business Disclosure Format (check one): 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 June 30, 1999 and December 31, 1998..................3
Condensed Consolidated Statements of Operations for the three months ended
June 30, 1999 and 1998, respectively.............................................................5
Condensed Consolidated Statements of Operations for the six months ended
June 30, 1999 and 1998, respectively.............................................................6
Condensed Consolidated Statements of Cash Flows for the six months ended
June 30, 1999 and 1998, respectively.............................................................7
Notes to Condensed Consolidated Financial Statements.............................................9
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations...........15
PART II. OTHER INFORMATION
Item 1. Legal Proceedings..........................................................................22
Item 2(c). Recent Sales of Unregistered Securities......................................................23
Item 6. Exhibits and Reports on Form 8-K...........................................................23
</TABLE>
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
2
<PAGE>
DYNATEC INTERNATIONAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
---- ----
(Unaudited)
CURRENT ASSETS:
<S> <C> <C>
Cash and cash equivalents $ 325,038 $
2,268
Trade accounts receivable, net of allowance for doubtful accounts of $38,171
and $30,190, respectively 2,040,558 2,229,157
Accounts receivable - other 1,275 110
Inventories (see Note 2) 3,742,681 4,857,241
Prepaid expenses and other 474,750 316,347
------------- ------------
Total current assets 6,584,302 7,405,123
------------- -------------
LAND, BUILDING AND EQUIPMENT, at cost:
Land 365,860 365,860
Building and improvements 2,218,443 2,214,144
Furniture, fixtures and equipment 3,607,122 3,554,045
------------ -------------
6,191,425 6,134,049
Less accumulated depreciation and amortization 2,517,343 2,336,427
------------- -------------
Net land, building and equipment 3,674,082 3,797,622
------------- -------------
TRADEMARKS AND OTHER INTANGIBLES, net of accumulated amortization of $411,464
and $382,170, respectively 175,808 205,102
-------------- -------------
DEFERRED LOAN COSTS, net of accumulated amortization of $27,678 and
$14,903, respectively 48,968 61,743
------------- -------------
OTHER ASSETS 68,616 69,337
------------- -------------
$10,551,776 $ 11,538,927
============= =============
</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>
June 30, December 31,
1999 1998
---- ----
(Unaudited)
CURRENT LIABILITIES:
<S> <C> <C>
Short-term note payable $ 2,348,733 $ 1,389,223
Convertible debentures 1,736,046 1,667,079
Current portion of long-term debt 192,539 246,855
Current portion of capital lease obligations 18,950 17,881
Accounts payable 950,371 1,518,316
Accounts payable - other - 9,000
Accounts payable-related party - 98,403
Accrued expenses 490,464 637,051
Accrued advertising 94,932 320,000
Accrued royalties payable 61,018 70,246
------------- -------------
Total current liabilities 5,893,053 5,974,054
LONG-TERM DEBT, net of current portion 1,882,148 2,006,518
DEPOSIT FOR STOCK ISSUANCE - 1,000,000
CAPITAL LEASE OBLIGATIONS, net of current portion 36,512 28,654
------------- -------------
Total liabilities 7,811,713 9,009,226
------------- -------------
STOCKHOLDERS' EQUITY (see Note 3):
Common stock, $.01 par value; 100,000,000 shares authorized and 3,498,549
and 2,891,627 shares outstanding, respectively 34,985 28,916
Treasury stock, at cost, 91,515 shares (915,150) (915,150)
Additional paid-in capital 8,179,301 7,041,690
Accumulated deficit (4,559,073) (3,625,755)
------------- ------------
Total stockholders' equity 2,740,063 2,529,701
------------- -------------
$ 10,551,776 $ 11,538,927
============= =============
</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
June 30, 1999 June 30, 1998
------------- -------------
(Unaudited) (Unaudited)
<S> <C> <C>
PRODUCT SALES $ 3,690,094 $ 4,135,972
COST OF SALES 2,169,199 2,562,588
------------- -----------
Gross Margin 1,520,895 1,573,384
------------- -----------
OPERATING COSTS AND EXPENSES:
Selling expenses 834,438 842,919
Research and development 37,812 25,302
General and administrative 783,828 598,103
------------- -----------
Total operating costs and expenses 1,656,078 1,466,324
------------- -----------
Income (loss) from operations (135,183) 107,060
------------- -----------
OTHER EXPENSE:
Interest expense (see Note 4) (272,555) (787,379)
Other expense (77) (326)
------------- ------------
Total other income (expense), net (272,632) (787,705)
------------- ------------
Loss before income tax provision (407,815) (680,645)
INCOME TAX PROVISION - -
------------- ------------
Net loss $ (407,815) $ (680,645)
============= ============
BASIC NET LOSS PER SHARE $ (.12) $ (.24)
============= ============
DILUTED NET LOSS PER SHARE (see Note 2) $ (.12) $ (.24)
============= ============
WEIGHTED AVERAGE SHARES - BASIC AND DILUTED 3,324,140 2,800,821
============= ============
</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>
Six Months Ended Six Months Ended
June 30, 1999 June 30, 1998
------------- -------------
(Unaudited) (Unaudited)
<S> <C> <C>
PRODUCT SALES $ 7,333,773 $ 7,783,758
COST OF SALES 4,377,570 4,636,201
------------ ------------
Gross Margin 2,956,203 3,147,557
------------ ------------
OPERATING COSTS AND EXPENSES:
Selling expenses 1,664,065 1,682,692
Research and development 63,824 35,482
General and administrative 1,615,143 1,093,770
------------ ------------
Total operating costs and expenses 3,343,032 2,811,944
------------ ------------
Income (loss) from operations (386,829) 335,613
------------ ------------
OTHER INCOME (EXPENSE), net:
Interest expense (see Note 4) (545,846) (894,388)
Interest income - 3,340
Other income 3,056 -
Other expense (699) (21,332)
------------ ------------
Total other income (expense), net (543,489) (912,380)
------------ ------------
Loss before income tax provision (930,318) (576,767)
INCOME TAX PROVISION 3,000 -
------------ ------------
Net loss $ (933,318) $ (576,767)
============ ============
BASIC NET LOSS PER SHARE $ (.29) $ (.21)
============ ============
DILUTED NET LOSS PER SHARE (see Note 2) $ (.29) $ (.21)
============ ============
WEIGHTED AVERAGE SHARES - BASIC AND DILUTED 3,218,004 2,800,821
=========== ============
</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>
Six Months Ended Six Months Ended
June 30, 1999 June 30, 1998
------------- -------------
(Unaudited) (Unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES:
<S> <C> <C>
Net loss $ (933,318) $ (576,767)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization 239,229 233,939
Amortization of deferred loan costs 12,774 -
Interest expense on convertible debentures 269,260 624,226
Loss on sale of assets 699 21,332
Changes in assets and liabilities:
Trade accounts receivable 188,599 (1,001,812)
Accounts receivable - other (1,165) 382,403
Inventories 1,114,560 (1,712,002)
Prepaid expenses and other (157,682) 125,991
Trade accounts payable (567,945) (45,416)
Accounts payable - other (107,403) (42,625)
Accrued expenses (221,200) (20,846)
Accrued advertising (225,068) (158,405)
Accrued royalties (9,228) 20,353
Income tax payable 18,000 -
------------- --------------
Net cash used in operating activities (379,888) (2,149,629)
------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from the sale of assets 19,804 47,000
Purchase of property and equipment (82,556) (356,232)
------------- --------------
Net cash used in investing activities (62,752) (309,232)
------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings on line of credit 959,510 307,545
Increase in debt issuance costs - (267,983)
Principal payments on long-term debt (178,686) (704,222)
Payments on capital lease obligations (15,414) (8,387)
Proceeds from capital addition - 580,000
Proceeds from convertible debenture offering - 1,500,000
Proceeds from deposit for stock issuance (see Note 3) - 940,000
------------- --------------
Net cash provided by financing activities 765,410 2,346,953
------------- --------------
NET INCREASE(DECREASE) IN CASH AND CASH EQUIVALENTS 322,770 (111,908)
CASH AND CASH EQUIVALENTS AT BEGINNING OF THE PERIOD 2,268 332,894
------------- --------------
CASH AND CASH EQUIVALENTS AT END OF THE PERIOD $ 325,038 $ 220,986
============= ==============
</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>
Six Months Ended Six Months Ended
June 30, 1999 June 30, 1998
------------- -------------
(Unaudited) (Unaudited)
<S> <C> <C>
Cash paid for interest................................................ $ 310,829 $ 118,818
========= =========
Share certificate cancelled........................................... $ - $ 250,000
========= =========
Debt issuance cost attributable to warrants to placement agent........ $ - $ 426,000
========= =========
Convertible debt discount associated with warrants to investors....... - $ 426,000
========= =========
Conversion of Convertible Debentures and accrued interest for
Common stock....................................................... $ 143,680 $ -
========= =========
Issuance of 500,000 shares of restricted stock........................ $ 500,000 $ -
========= =========
</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., a Utah corporation ("Dynatec" or the
"Company"), is a manufacturer and distributor of consumer products comprising
the following major product lines: telecommunication headsets and amplifiers and
telephone accessories, home storage and organization, flashlights and other
miscellaneous products sold to mass market merchandisers. Dynatec is located in
Salt Lake City, Utah. The Company conducts most of its operations through four
wholly owned subsidiaries: Softalk, Inc., Arnco Marketing, Inc., Nordic
Technologies, Inc. and SofTalk Communications, Inc. Unless specified to the
contrary herein, references to Dynatec or to the Company refer to the Company
and its subsidiaries on a consolidated basis.
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 unaudited condensed
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 June
30, 1999 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, 1998.
The results of operations for the six months ended June 30, 1999 are
not necessarily indicative of the results that may be expected for the remainder
of the year ending December 31, 1999.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Inventories
Inventories, consisting principally of telecommunication headsets and
amplifiers and telephone accessories, home storage and organization,
flashlights, and other miscellaneous products sold to mass market merchandisers
as of June 30, 1999 and December 31, 1998, respectively, are summarized as
follows:
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
----------------- -----------------
<S> <C> <C>
Raw materials............................ $ 1,050,297 $ 902,703
Work-in-Process.......................... 148,553 309,815
Finished Goods........................... 2,543,831 3,644,723
================= =================
$ 3,742,681 $ 4,857,241
================= =================
</TABLE>
9
<PAGE>
DYNATEC INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES-(CONTINUED)
Income Taxes
The Company uses the asset and liability method of accounting for
income taxes. Under this method, deferred tax assets and liabilities are
recognized for the future tax consequences attributable to differences between
the financial statement carrying amounts of existing assets and liabilities and
their respective tax basis. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the years in
which those temporary differences are expected to be settled or recovered. The
effect on deferred tax assets and liabilities of a change in tax rates is
recognized in the period that includes the enactment date.
The Company has recognized no tax benefit for the net operating losses
incurred during the three and six-month periods ended June 30, 1999 due to
uncertainties about the Company's ability to generate future earnings to offset
such losses.
Basic and Diluted Net Loss Per Common Share
Basic net loss per common share is calculated based upon the weighted
average number of common shares outstanding during the periods presented.
In calculating net loss per share for the three and six months ended
June 30, 1999 and 1998, there were warrants and options to purchase 1,150,000
and 1,687,500 potential common shares, respectively, that were not included in
the computation of diluted net loss per share as their effect would have been
anti-dilutive, thereby decreasing the net loss per common share.
Reclassifications
Certain reclassifications have been made in the prior period's
consolidated financial statements to conform with the current year presentation.
(3) STOCKHOLDERS' EQUITY
On February 4, 1999, the Company entered into a deposit payable
conversion agreement, whereby a $1,000,000 deposit received by the Company in
early 1998 and recorded as a liability in the accompanying balance sheet as of
December 31, 1998 was cancelled, and the Company issued 500,000 shares of
restricted common stock to the depositor.
(4) CONVERTIBLE DEBENTURES/EQUITY LINE-OF-CREDIT
On May 22, 1998, the Company closed a transaction that provided net
capital proceeds of $1,335,000. The transaction was accomplished pursuant to a
Convertible Debenture and Private Equity Line of Credit Agreement (the "Credit
Agreement") between the Company and a group of five unaffiliated investors.
These funds were raised pursuant to the sale by the Company of Convertible
Debentures (the "Convertible Debentures") in the aggregate principal amount of
$1,500,000 due May 22, 2001. The Convertible Debentures are convertible into
shares of the Company's common stock at the lesser of: (i) 75% of the average of
the three lowest closing bid prices of the Company's common stock during the
22-trading-day period immediately preceding the conversion date or (ii) $4.624,
which was 100% of the closing bid price on the trading day immediately preceding
the closing date of the agreement.
On June 10, 1999, the five investors who purchased the Convertible
Debentures in 1998 converted $132,500 principal amount of the debentures into
98,604 shares of common stock at the then-applicable conversion price of $1.3438
per share. Additionally, a total of 8,320 shares of common stock were issued
upon the conversion of $11,180 of dividends accrued on the principal amount of
debentures converted on that date. Accordingly, as of June 30, 1999, there was a
total principal amount of outstanding Convertible Debentures of $1,367,500.
Assuming a hypothetical
10
<PAGE>
DYNATEC INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(4) CONVERTIBLE DEBENTURES/EQUITY LINE-OF-CREDIT-(CONTINUED)
conversion of this entire remaining principal amount of the Convertible
Debentures outstanding as of June 30, 1999, and all interest accrued thereon at
the rate of 12% per annum as of June 30, 1999, the Convertible Debentures would
be convertible into approximately 1,195,000 shares of the Company's common
stock. The Convertible Debentures are callable by the holders thereof.
On July 8, 1999, the investors converted $75,000 additional principal
amount of Convertible Debentures into 66,667 shares of common stock, and
converted accrued interest on such principal amount of $10,299 into 9,157 shares
of common stock.
In addition to the sale of the Convertible Debentures, under the Credit
Agreement, the Company also obtained the right to use a "put" mechanism to
periodically draw down up to $10,000,000 of additional equity capital (the
"Equity Line"). Under the terms of the Credit Agreement, the Company was
obligated to draw down a minimum of $1,000,000 of the Equity Line, and all
amounts were to have been drawn in increments of not less than $50,000. In
return for the payment of additional capital under the Equity Line, the Company
would have been required to issue shares of its common stock at a per share
purchase price equal to 80% of the average of the three lowest closing bid
prices of the common stock during a six day valuation period commencing three
days before the draw date and ending two days after the draw date. The Equity
Line could not have been utilized, and the Company would have had no obligation
to exercise any portion of the put mechanism, 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 issued
upon conversion of the Convertible Debentures, the Company was obligated to
issue an additional $500,000 of Convertible Debentures.
On June 25, 1999, the Company and the investors entered into a Modification
Agreement ("Modification Agreement"), under which the parties agreed to cancel
the Equity Line and all of the parties' respective obligations thereunder. The
parties to the Modification Agreement also agreed to cancel the investors'
obligation to purchase and the Company's obligation to sell the additional
$500,000 principal amount of Convertible Debentures upon the effectiveness of
the registration statement. Additionally, the Modification Agreement provides
for the modification and temporary abatement of the Company's obligation to pay
cash liquidated damages of $45,000 per month resulting from the Company's
obligation to have the registration statement declared effective on or before
August 28, 1998. Pursuant to the terms of the Credit Agreement, the Company paid
liquidated damages from September 23, 1998 through and including February 23,
1999 in the aggregate amount of $210,000, of which $135,000 was paid during the
six-month period ended June 30, 1999. Under the Modification Agreement, the
Company is to accrue a total of $180,000 of liquidated damages for the period
from February 24, 1999 through and including June 23, 1999, which accrued amount
is payable at any time after October 1, 1999, upon request for payment therefor
by the Investors, in shares of the Company's common stock. The number of shares
of common stock issuable upon such payment shall be determined by dividing the
total amount of damages accrued by 100% of the average of the closing bid prices
of the Company's common stock during the five trading day period immediately
preceding the date of such payment. Additionally, under the Modification
Agreement, the Company's obligation to pay liquidated damages under the Credit
Agreement is abated from June 24, 1999 through September 23, 1999, provided that
the registration statement is declared effective on or before October 31, 1999.
Additional liquidated damages in the amount of $45,000 will accrue for the
period between September 24, 1999 and October 23, 1999 if the Registration
Statement is not declared effective before that period. If the registration
statement is not declared effective on or before October 31, 1999, the
Modification Agreement's provisions providing for the payment of liquidated
damages in stock and the abatement of liquidated damages from June 23, 1999 to
September 23, 1999 and the provisions allowing the Company to pay liquidated
damages in common stock rather than cash may be rescinded at the option of the
investors. Except to the extent specifically modified by the Modification
Agreement, the terms and conditions of the Credit Agreement and the documents
and instruments incorporated in the Credit Agreement shall continue in force.
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:
11
<PAGE>
DYNATEC INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(4) CONVERTIBLE DEBENTURES/EQUITY LINE-OF-CREDIT-(CONTINUED)
<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>
Under the Credit Agreement, the Company was obligated to issue 50,000
additional Series A warrants to both the placement agent and the investors,
collectively, upon the issuance of the additional $500,000 of Convertible
Debentures. Because under the Modification Agreement the Company will not issue
the additional $500,000 of Convertible Debentures, the Company will not issue
additional Series A warrants. Of the warrants that were issued, 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. This allocation was
based on the relative notional amounts of the two elements of the Credit
Agreement as of the date of the Credit Agreement. The value of the warrants
issued to the investors was written off in 1998 as a one-time, non-cash debt
issuance cost, because the warrants were immediately exercisable. The value of
the warrants issued to the placement agent and allocated to the Convertible
Debentures, and $500,000, representing the intrinsic value of the beneficial
conversion premium, were written off as non-cash expense in the fourth quarter
of 1998, when the Convertible Debentures became callable by the investors.
The Company also issued, as part of the transaction involving the
Credit Agreement, consideration of up to 80,000 shares of its common stock as a
fee to the placement agent. Of these shares, 20,000 were issued at the time of
the closing. The remaining 60,000 shares were deposited into escrow and were to
be released in 6,000 share increments as each $1,000,000 was drawn down under
the Equity Line established under the Credit Agreement. Because under the
Modification Agreement the Equity Line was cancelled, and therefore the
placement agent never would have been entitled to the 60,000 additional shares
of common stock deposited in escrow, the escrow was terminated, and the 60,000
shares of common stock were returned to the Company for cancellation.
(5) BUSINESS SEGMENT INFORMATION
During 1998, the Company adopted SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information". Information as to the
operations of the Company in different business segments is set forth below
based on the nature of the products and services offered. Management evaluates
performance based on several factors, of which the primary financial measure is
business segment operating income before interest, taxes, depreciation and
non-cash amortization of intangible assets ("EBITDA"). The accounting policies
of the business segments are the same as those described in the summary of
significant accounting policies.
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------------------------------- --------------------------------
REVENUES: 1999 1998 1999 1998
- ----------------------------------------------------- --------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Telecommunication Headsets and Amplifiers and
Telephone Accessories....................... $ 1,937,000 $ 1,879,000 $ 3,772,000 $ 4,122,000
Home Storage and Organization.................... 1,181,000 1,096,000 2,171,000 2,196,000
Flashlights...................................... 188,000 445,000 399,000 636,000
Miscellaneous/Mass Market........................ 384,000 716,000 992,000 830,000
--------------- -------------- -------------- --------------
Total..................................... $ 3,690,000 $ 4,136,000 $ 7,334,000 $ 7,784,000
=============== ============== ============== ==============
</TABLE>
12
<PAGE>
DYNATEC INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(5) BUSINESS SEGMENT INFORMATION-(CONTINUED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------------------------------- --------------------------------
OPERATING INCOME (LOSS): 1999 1998 1999 1998
- ----------------------------------------------------- --------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Telecommunication Headsets and Amplifiers and
Telephone Accessories....................... $ 39,000 $ 84,000 $ 19,000 $ 378,000
Home Storage and Organization.................... (88,000) (32,000) (226,000) (21,000)
Flashlights...................................... (60,000) 23,000 (186,000) (76,000)
Miscellaneous/Mass Market........................ (26,000) 32,000 6,000 55,000
--------------- -------------- -------------- --------------
Total..................................... $ (135,000) $ 107,000 $ (387,000) $ $336,000
=============== ============== ============== ==============
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------------------------------- --------------------------------
DEPRECIATION AND AMORTIZATION (1): 1999 1998 1999 1998
- ----------------------------------------------------- --------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Telecommunication Headsets and Amplifiers and
Telephone Accessories....................... $ 71,000 $ 81,000 $ 143,000 $ 136,000
Home Storage and Organization.................... 43,000 47,000 81,000 74,000
Flashlights...................................... 7,000 19,000 15,000 24,000
--------------- -------------- -------------- --------------
Total..................................... $ 121,000 $ 147,000 $ 239,000 $ 234,000
=============== ============== ============== ==============
</TABLE>
(1) Amortization includes all amortization relating to product license rights,
non-compete agreements and purchased patents.
Information as to the assets and capital expenditures of the Company is as
follows:
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31, 1998
ASSETS: 1999
- ---------------------------------------------------- ------------------ --------------------
<S> <C> <C>
Telecommunication Headsets and Amplifiers and
Telephone Accessories......................... $ 5,341,000 $ 4,794,000
Home Storage and Organization.................... 3,182,000 3,200,000
Flashlights...................................... 1,110,000 1,729,000
Miscellaneous/Mass Market........................ 1,366,000
-
------------------ --------------------
Total assets for reportable segments...... 9,633,000 11,089,000
Other Assets..................................... 870,000 388,000
Deferred Loan Costs And Other Assets Not
Allocated To Segments....................... 49,000 62,000
================== ====================
Total..................................... $ 10,552,000 $ 11,539,000
================== ====================
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------------------------------- --------------------------------
CAPITAL EXPENDITURES: 1999 1998 1999 1998
- ----------------------------------------------------- --------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Telecommunication Headsets and Amplifiers and
Telephone Accessories....................... $ 22,000 $ 104,000 $ 64,000 $ 210,000
Home Storage and Organization.................... 13,000 60,000 35,000 112,000
Flashlights...................................... 3,000 25,000 8,000 34,000
Miscellaneous/Mass Market........................ - - - -
--------------- -------------- -------------- --------------
Total..................................... $ 38,000 $ 189,000 $ 107,000 $ 356,000
=============== ============== ============== ==============
</TABLE>
13
<PAGE>
DYNATEC INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(5) BUSINESS SEGMENT INFORMATION-(CONTINUED)
Information as to the Company's operations in different geographical areas is as
follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------------------------------- --------------------------------
REVENUES: 1999 1998 1999 1998
- ----------------------------------------------------- --------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
United States.................................... $ 3,671,000 $ 4,090,000 $ 7,259,000 $ 7,714,000
Other (1)........................................ 19,000 46,000 75,000 70,000
--------------- -------------- -------------- --------------
Total..................................... $ 3,690,000 $ 4,136,000 $ 7,334,000 $ 7,784,000
=============== ============== ============== ==============
</TABLE>
(1) Includes Canada, Europe and other miscellaneous.
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------------------------------- --------------------------------
OPERATING INCOME (LOSS): 1999 1998 1999 1998
- ----------------------------------------------------- --------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
United States.................................... (135,000) 107,000 (387,000) 336,000
=============== ============== ============== ==============
</TABLE>
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
ASSETS: 1999 1998
- ----------------------------------------------------- -------------- -----------------
<S> <C> <C>
United States.................................... $ 10,139,000 $ 11,089,000
Asia............................................. 413,000 450,000
-------------- -----------------
Total..................................... $ 10,552,000 $ 11,539,000
============== =================
</TABLE>
(6) STOCK OPTIONS
The Company has established three stock option programs under which it
has granted both non-qualified and incentive stock options to employees, board
members, and certain related entities. Under the Company's 1996-1997
non-qualified stock option program (the "Non-Qualified Plan"), the Company
granted options to acquire 1,640,000 shares of common stock. The 1996 Incentive
Option Plan ("1996 Plan") provides for grants of qualified stock options to
acquire a maximum of 300,000 shares of common stock, of which 200,000 options
have been granted to date. The exercise price of options granted to employees
under either option program equals the market price on the date of grant, and as
a result no compensation expense has been recognized in the accompanying
financial statements. In January 1999, the Company's former Chairman and CEO,
and holder of 900,000 of the options granted in December 1996 (500,000 shares)
and January 1997 (400,000 shares) under the Non-Qualified Plan, agreed to cancel
those options. In addition to the non-qualified options granted to employees to
date, the Company granted non-qualified options to purchase 537,500 shares of
common stock to Muito Bem Ltd., an entity controlled by a shareholder and former
CEO of the Company, at a strike price of $2.50 per share in December 1996. The
shareholder and former executive officer of the Company who owns Muito Bem, Ltd.
agreed in January 1999 to cancel all stock options issued to Muito Bem, Ltd..
Additionally, in December 1996, the Company granted a total of 200,000
non-qualified stock options to WAC Research, Inc., an entity owned, in part, by
a shareholder and the former CEO of the Company, which options were granted in
exchange for the reduction of royalties payable by the Company to WAC on sales
of the Softalk products and for reimbursement to the Company of certain travel
expenses incurred by the Company's former CEO.
In May 1999, the Company's Board of Directors adopted the Company's
1999 Stock Option And Incentive Plan (the "1999 Plan"). Under the 1999 Plan, a
total of 640,000 shares were reserved for issuance in the form of non-qualified
stock options or qualifying Incentive Stock Options. On June 8, 1999, the
compensation committee of the Company's Board of Directors granted stock options
under the 1999 Plan to purchase a total of 572,000 shares of common stock to
various executives, employees and directors of the Company. Such options were as
non-qualified options having terms of 10 years from the date of grant. All such
options have an exercise price of $1.625 per share, which was 100% of the fair
market value on the grant date.
14
<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 six-month
period ended June 30, 1999 and 1998, 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 Six Months Ended
--------------------------------------- -----------------------------------------
% OF % OF
CHG CHG
FROM FROM
JUNE JUNE 1998 TO JUNE JUNE 1998 TO
30, 1999 30, 1998 1999 30, 1999 30, 1998 1999
----------- ----------- ------- ----------- ----------- --------
Unaudited Statement of Operations Data:
<S> <C> <C> <C> <C> <C> <C>
Product sales $ 3,690,000 $4,136,000 (10.8)% $7,334,000 $7,784,000 (5.8)%
Cost of sales 2,169,000 2,563,000 (15.4) 4,378,000 4,637,000 (5.6)
----------- ----------- ----------- -----------
Gross margin 1,521,000 1,573,000 (3.3) 2,956,000 3,147,000 (6.1)
-----------
Operating Costs and Expenses:
Selling expenses 834,000 843,000 (1.0) 1,664,000 1,683,000 (1.1)
Research and development 38,000 25,000 49.4 64,000 35,000 82.9
General and administrative 784,000 598,000 31.1 1,615,000 1,094,000 47.6
----------- ----------- ----------- -----------
Total operating costs and expenses 1,656,000 1,466,000 13.0 3,343,000 2,812,000 18.9
----------- ----------- ----------- -----------
Other Income (Expense), net:
Interest expense (273,000) (788,000) (65.4) (545,000) (894,000) (39.0)
----------- ----------- ----------- -----------
Interest income - - - - 3,000 -
----------- ----------- ----------- -----------
Other (expense) - - - (1,000) (21,000) (96.7)
----------- ----------- ----------- -----------
Other income - - - 3,000 - -
----------- -----------
Net income (loss) $ (408,000) $ (681,000) (40.1)% $ (930,000) $ (577,000) 61.2%
=========== =========== =========== ===========
Unaudited Supplemental Information:
Revenue by product line type:
Telecommunication headsets and
amplifiers and telephone accessories $ 1,937,000 $1,879,000 3.1% $3,772,000 $4,122,000 (8.5)%
Home storage and organization 1,181,000 1,096,000 7.7 2,171,000 2,196,000 (1.1)
Miscellaneous/Mass market 384,000 716,000 (46.4) 992,000 830,000 19.5
Flashlights..... 188,000 445,000 (57.7 399,000 636,000 (37.3)
----------- ----------- ----------- -----------
Total product sales $ 3,690,000 $4,136,000 (10.8)% $7,334,000 $7,784,000
=========== =========== =========== =========== (5.8)%
</TABLE>
The following are explanations of significant period to period changes for the
three months ended June 30, 1999 and 1998:
Revenues
Total Product Sales. Total product sales decreased by $446,000, or
10.8%, from $4,136,000 to $3,690,000 for the three months ended June 30, 1999
compared to the three months ended June 30, 1998.
Telecommunication Headsets and Amplifiers and Telephone Accessories.
Sales of telecommunication headsets and amplifiers and telephone accessories
increased $58,000, or 3.1%, from $1,879,000 to $1,937,000 for the three months
ended June 30, 1999 compared to the three months ended June 30, 1998. This
increase was primarily attributable to a $74,000 increase in sales of telephone
shoulder rests as well as an increase in sales of $64,000 in telephone
accessories. This increase was partially offset by a decrease in sales of
telephone headsets and amplifiers as a result of lower office supply catalogue
sales. Overall gross margins in this category increased to 54.8% from 44.3% for
the three months ended March 31, 1999, as a result of the sales mix and more
efficient production processes.
Home Storage and Organization. Home storage and organization revenues
increased $85,000, or 7.7%, from $1,096,000 to $1,181,000 for the three months
ended June 30, 1999 compared to the three months ended June 30, 1998. The
increase is primarily attributable to an increase of $20,000 in the
"Expand-A-Drawer" product line, $59,000 in doorstops and $73,000 in the
15
<PAGE>
"Expand-A-Shelf" product line, offset in part by a decrease of $62,000 in
several of the Company's other miscellaneous organizational products, namely
shoe organizers and ironing boards. Overall gross margins for products in this
category increased from 32.7% to 36.3% for the three months ended March 31,
1999.
Miscellaneous and Mass Market. Miscellaneous and mass market revenues
decreased $332,000, or 46.4%, from $716,000 to $384,000 for the three months
ended June 30, 1999 compared to the three months ended June 30, 1998. This
decrease was primarily the result of the Company's December 24, 1998 agreement
with Grandway China ("Grandway"), a Hong Kong enterprise. The agreement provided
for the transfer of inventory, distribution and sales rights of products that
the Company was then supplying to Dolgencorp. Upon execution, Grandway agreed to
purchase the approximately $1,800,000 of inventory earmarked for sale to
Dolgencorp. As of June 30, 1999, Grandway had purchased the entire remaining
inventory. Gross margins on products in this category decreased from 28.2% to a
negative 6.8% for the three months ended March 31, 1999 as a result of the
"pass-through" effect.
Flashlights. Flashlight revenues decreased $257,000, or 57.7%, from
$445,000 to $188,000 for the three months ended June 30, 1999 compared to the
three months ended June 30, 1998. This decrease was primarily the result of the
shipment of two purchase orders being deferred until the beginning of the third
quarter of 1999. Overall gross margins for products in this category decreased
from 40.8% to 30.2% for the three months ended March 31, 1999, as a result of
various changes made to certain flashlight products to increase the quality of
these products. Management is addressing this decrease by working with its Asian
supplier to effectively source various components from more reliable
sub-assembly vendors.
Operating Costs and Expenses
Selling Expenses. Selling expenses decreased $9,000, or 1.0%, from
$843,000 to $834,000 for the three months ended June 30, 1999 compared to the
three months ended June 30, 1998. This decrease is due in part to a decrease in
royalty and commission payments due to lower sales on commissionable and royalty
based products, offset by increases in trade show expenditures due to the
Company participating in more regional trade shows.
Research and Development. Research and development increased by
$13,000, or 49.4%, from $25,000 to $38,000 for the three months ended June 30,
1999 compared to the three months ended June 30, 1998. This increase was
primarily attributable to the addition of a full time Vice President of Research
and Development.
General and Administrative Expenses. General and administrative
expenses increased $186,000, or 31.1%, from $598,000 to $784,000 for the three
months ended June 30, 1999 compared to the three months ended June 30, 1998. The
increase in general and administrative expenses was primarily the result of
approximately $127,000 in general corporate legal expense, $20,000 in employee
recruitment, as well as approximately $36,000 in travel related expenses from
increased international travel associated with strengthening Asian supplier
relationships.
Total Operating Costs and Expenses. Total operating costs and expenses
increased by $190,000, or 13.0%, from $1,466,000 to $1,656,000 for the three
months ended June 30, 1999 compared to the three months ended June 30, 1998, for
the reasons discussed above.
Interest Expense. Interest expense decreased $515,000, or 65.4%, from
$788,000 to $273,000 for the three months ended June 30, 1999 compared to the
three months ended June 30, 1998. This decrease 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 $1,500,000 of Convertible
Debentures (the "Convertible Debentures") in May 1998. During the three months
ended June 30, 1999, liquidated damages were assessed against the Company in the
amount of $135,000 due to the Company's failure to have effective a registration
statement covering the shares of common stock issuable upon conversion of the
Convertible Debentures with the time specified in a registration rights
agreement executed in connection with the sale of the Convertible Debentures.
Net Loss. The net loss decreased by $273,000, or 40.1%, from $681,000
to $408,000 for the three months ended June 30, 1999 compared to the three
months ended June 30, 1998 due to a combination of the factors described above.
The following are explanations of significant period to period changes for the
six months ended June 30, 1999 and 1998:
Revenues
Total Product Sales. Total product sales decreased by $450,000, or
5.8%, from $7,784,000 to $7,334,000 for the six months ended June 30, 1999
compared to the six months ended June 30, 1998.
16
<PAGE>
Telecommunication Headsets and Amplifiers and Telephone Accessories.
Sales of telecommunication headsets and amplifiers and telephone accessories
decreased $350,000, or 8.5%, from $4,122,000 to $3,772,000 for the six months
ended June 30, 1999 compared to the six months ended June 30, 1998. Of this
decrease, $215,000 was attributable to the loss of a private label customer for
the Company's "Twisstop" product. Additionally, sales of the Company's Universal
and Softalk II products decreased $44,000 and $39,000, respectively. Sales of
telephone amplifiers and headsets decreased by $261,000. These decreases were
offset in part by increases in sales of the Softalk product of $23,000, the Cord
Manager and other Twisstop sales of $180,000. Overall gross margins for
telephone accessories increased to 55.5% from 47.3% for the six months ended
June 30, 1999, as a result of the sales mix and a more efficient production
processes.
Home Storage and Organization. Home storage and organization revenues
decreased $25,000, or 1.1%, from $2,196,000 to $2,171,000 for the six months
ended June 30, 1999 compared to the six months ended June 30, 1998. Although
sales were relatively flat for the period. Overall gross margins for this
product category decreased from 31.0% to 29.9% for the three months ended June
30, 1999, as a result of the sales mix.
Miscellaneous and Mass Market. Miscellaneous and mass market revenues
increased $162,000, or 19.5%, from $830,000 to $992,000 for the six months ended
June 30, 1999 compared to the six months ended June 30, 1998. This increase was
primarily the result of the Company's December 24, 1998 agreement with Grandway
China ("Grandway"), a Hong Kong enterprise. The agreement provided for the
transfer of inventory, distribution and sales rights of products that the
Company was then supplying to Dolgencorp. Upon execution, Grandway agreed to
purchase the approximately $1,800,000 of inventory earmarked for sale to
Dolgencorp. As of June 30, 1999, Grandway had purchased the entire remaining
inventory. Overall gross margins for products in this category decreased from
27.0% to 0.6% for the six months ended June 30, 1999 as a result of the
"pass-through" effect.
Flashlights. Flashlight revenues decreased $237,000, or 37.3%, from
$636,000 to $399,000 for the six months ended June 30, 1999 compared to the six
months ended June 30, 1998. This decrease was primarily the result of the
shipment of two purchase orders being deferred until the beginning of the third
quarter of 1999. Overall gross margins for products in this category decreased
from 35.7% to 22.7% for the six months ended June 30, 1999, as a result of
various changes made to certain of its flashlight products to increase the
quality of these products. Management is addressing this decrease by working
with its Asian supplier to effectively source various components from more
reliable sub-assembly vendors.
Operating Costs and Expenses
Selling Expenses. Selling expenses decreased $19,000, or 1.1%, from
$1,683,000 to $1,664,000 for the six months ended June 30, 1999 compared to the
six months ended June 30, 1998. This decrease is due in part from a decrease in
royalty and commission payments due to lower sales on commissionable and royalty
based products, offset by increases in advertising expense as the result of the
Company securing additional pages in certain office product catalogues and trade
show expenditures due to the Company participating in more regional trade shows.
Research and Development. Research and development increased by
$29,000, or 82.9%, from $35,000 to $64,000 for the six months ended June 30,
1999 compared to the six months ended June 30, 1998. This increase was primarily
attributable to the addition of a full time Vice President of Research and
Development.
General and Administrative Expenses. General and administrative
expenses increased $521,000, or 47.6%, from $1,094,000 to $1,615,000 for the six
months ended June 30, 1999 compared to the six months ended June 30, 1998. The
increase in general and administrative expenses was primarily the result of
approximately $120,000 in non-recurring legal expense incurred as a result of
the Company's internal investigation which concluded on January 14, 1999 as well
as $82,000 in additional legal expense related to various general corporate
matters, as well as approximately $210,000 in combined severance paid to the
Company's former Chairman and CEO who resigned on January 14, 1999 and the
former President of the Company who resigned effective March 17, 1999.
Additionally, travel expenditures increased by approximately $58,000 resulting
from increased international travel associated with strengthening Asian supplier
relationships.
Total Operating Costs and Expenses. Total operating costs and expenses
increased by $531,000, or 18.9%, from $2,812,000 to $3,343,000 for the six
months ended June 30, 1999 compared to the six months ended June 30, 1998, for
the reasons discussed above.
Interest Expense. Interest expense decreased $349,000, or 39.0%, from
$894,000 to $545,000 for the six months ended June 30, 1999 compared to the six
months ended June 30, 1998. This decrease was primarily related to the
17
<PAGE>
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 $1,500,000 of Convertible
Debentures (the "Convertible Debentures") in May 1998. During the six months
ended June 30, 1999, liquidated damages were assessed against the Company in the
amount of $258,000 due to the Company's failure to have effective a registration
statement covering the shares of common stock issuable upon conversion of the
Convertible Debentures with the time specified in a registration rights
agreement executed in connection with the sale of the Convertible Debentures.
Interest Income. Interest income, decreased $3,000, from $3,000 to $-0-
for the six months ended June 30, 1999 compared to the six months ended June 30,
1998. 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 Expense. Other expense decreased $20,000, from $21,000 to $1,000
for the six months ended June 30, 1999 compared to the six months ended June 30,
1998. This decrease was primarily the result of a loss on the sale of equipment
sold by the Company in the six months ended June 30, 1998 that did not occur in
the six months ended June 30, 1999.
Other Income. Other income, increased $3,000, from $-0- to $3,000 for
the six months ended June 30, 1999 compared to the six months ended June 30,
1998.
Net Loss. The net loss increased by $353,000, or 61.2%, from $577,000
to $930,000 for the six months ended June 30, 1999 compared to the six months
ended June 30, 1998 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 borrowing under the Company's existing secured
revolving credit facilities. On May 27, 1998, the Company obtained a secured
revolving credit facility from a regional financing institution 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 the Company's accounts
receivable and inventories. The note underlying the revolving credit line is due
May 26, 2001. Under the terms of the loan agreement, the Company is required to
maintain financial covenants and ratios, including book net worth, net income
and debt service coverage. On June 30, 1999, the Company and its lending
institution entered into a Fourth Amendment to the Credit Agreement (the "Fourth
Amendment"). Pursuant to the Fourth Amendment, certain definitions have been
modified, as follows: (i) the maximum line decreased from $5,000,000 to
$4,000,000; (ii) the inventory advance rate decreases from 48% to 40% between
July1, 1999 and October 1, 1999; (iii) the accounts receivable advance rate
decreased from 85% to 78%; and (iv) the volume rebate accrual increased from
$15,000 on June 1, 1999 to $300,000 at January 1, 2000. This accrual goes to
$-0- when the volume rebates are paid in February 2000, and will begin to accrue
over the remainder of calendar year 2000 to the maximum $300,000 amount. At June
30, 1999, the Company was in default of certain of these covenants, however, the
Company presently is negotiating and anticipates that it will be able to obtain
a waiver from the lending institution. The Company and the lending institution
are negotiating an amendment to the loan agreement that will change the terms of
certain of the financial covenants and ratios for the remainder of 1999 and for
calendar year 2000. The interest rate presently applicable to the revolving
credit line is prime plus three percent, with interest payable monthly. At June
30, 1999, the Company had $325,000 of cash and $1,651,000 of availability under
its credit facility. The Company anticipates that its 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 during the next
twelve months.
On July 21, 1999, the Company entered into an agreement to sell its
corporate headquarters facility for $3,200,000. This transaction is anticipated
to close no later than 90 days from the date of the agreement. Simultaneous with
the sale, the Company will enter into a 20-year leaseback agreement with the
purchasing party. The net proceeds to the Company will be approximately
$1,200,000, after paying long-term debt secured by the building, broker and
legal fees, and other ancillary charges. The proceeds from the sale will be used
for working capital purposes. The party that agreed to purchase the building is
not affiliated with or related to the Company or any of its officers or
directors.
On May 22, 1998, the Company closed a transaction that provided net
capital proceeds of $1,335,000. The transaction was accomplished pursuant to a
Convertible Debenture and Private Equity Line of Credit Agreement (the "Credit
18
<PAGE>
Agreement") between the Company and a group of five unaffiliated investors.
These funds were raised pursuant to the sale by the Company of Convertible
Debentures in the aggregate principal amount of $1,500,000. The Convertible
Debentures are convertible into the Company's common stock at the lesser of: (i)
75% of the average of the three lowest closing bid prices of the common stock as
quoted on the Nasdaq SmallCap Market during the 22 trading-day period
immediately preceding the conversion date or (ii) $4.624, which was 100% of the
closing bid price on the trading day immediately preceding the closing date of
the Credit Agreement. In addition to the sale of the Convertible Debentures, the
Company also obtained the right to use a "put" mechanism to periodically draw
down up to $10,000,000 of additional equity capital the ("Equity Line"). Under
the terms of the Credit Agreement, the Company was obligated to draw down a
minimum of $1,000,000 under the Equity Line, and all amounts were to have been
drawn in increments of not less than $50,000. In return for the payment of
additional capital under the Equity Line, the Company would have been required
to issue shares of its common stock at a per share purchase price equal to 80%
of the average of the three lowest closing bid prices of the common stock during
a six day valuation period commencing three days before the draw date and ending
two days after the draw date. The Equity Line could not have been utilized, and
the Company had no obligation to exercise any portion of the put mechanism,
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 issued upon conversion of the Convertible Debentures, the
Company was obligated to issue an additional $500,000 of Convertible Debentures
(see Note 4 to the condensed consolidated financial statements). The Company
filed a registration statement on Form SB-2 as required by the Credit Agreement
and has filed two pre-effective amendments to that registration statement.
However, the registration statement is not effective as of the date of this
report, and there can be no assurance that the registration statement will be
declared effective.
On June 25, 1999, the Company and the investors entered into a
Modification Agreement ("Modification Agreement"), under which the parties
agreed to cancel the Equity Line and all of the parties' respective obligations
thereunder. The parties to the Modification Agreement also agreed to cancel the
investors' obligation to purchase and the Company's obligation to sell the
additional $500,000 principal amount of Convertible Debentures upon the
effectiveness of the registration statement. Additionally, the Modification
Agreement provides for the modification and temporary abatement of the Company's
obligation to pay cash liquidated damages of $45,000 per month resulting from
the Company's obligation to have the registration statement declared effective
on or before August 28, 1998. Pursuant to the terms of the Credit Agreement, the
Company paid liquidated damages from September 23, 1998 through and including
February 23, 1999 in the aggregate amount of $210,000, of which $135,000 was
paid in the six-month period ended June 30, 1999. Under the Modification
Agreement, the Company is to accrue a total of $180,000 of liquidated damages
for the period from February 24, 1999 through and including June 23, 1999, which
accrued amount is payable at any time after October 1, 1999, upon request for
payment therefore by the Investors, in shares of the Company's common stock. The
number of shares of common stock issuable upon such payment shall be determined
by dividing the total amount of damages accrued by 100% of the average of the
closing bid prices of the Company's common stock during the five trading day
period immediately preceding the date of such payment. Additionally, under the
Modification Agreement, the Company's obligation to pay liquidated damages under
the Credit Agreement is abated from June 24, 1999 through September 23, 1999,
provided that the registration statement is declared effective on or before
October 31, 1999. Additional liquidated damages in the amount of $45,000 will
accrue for the period between September 24, 1999 and October 23, 1999 if the
Registration Statement is not declared effective before that period. If the
registration statement is not declared effective on or before October 31, 1999,
the Modification Agreement's provisions providing for the payment of liquidated
damages in stock and the abatement of liquidated damages from June 23, 1999 to
September 23, 1999 and the provisions allowing the Company to pay liquidated
damages in common stock rather than cash may be rescinded at the option of the
Investors. Except to the extent specifically modified by the Modification
Agreement, the terms and conditions of the Credit Agreement and the documents
and instruments incorporated in the Credit Agreement shall continue in force.
June 30, 1999 Compared to December 31, 1998
As of June 30, 1999, the Company had liquid assets (cash and cash
equivalents and trade accounts receivable) of $2,366,000, an increase of 6.0%,
or $135,000, from December 31, 1998 when liquid assets were $2,231,000. Cash
increased $323,000, or 16,150.0%, to $325,000 at June 30, 1999 from $2,000 at
December 31, 1998. This increase in cash was primarily the result of the Company
utilizing its revolving credit facility, under which the Company makes "draws"
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, the
next day, and re-applied against outstanding draws. The increase in cash
resulted from the fact that the amounts in the account as of June 30, 1999 were
not yet swept and applied against outstanding draws. Trade accounts receivable
decreased $188,000, or 8.4%, to $2,041,000 at June 30, 1999 from $2,229,000 at
December 31, 1998. This decrease is primarily the result of lower sales and
improved collections.
19
<PAGE>
Current assets decreased by $821,000, or 11.1%, to $6,584,000 at June
30, 1999 from $7,405,000 at December 31, 1998. This decrease was primarily the
result of a decrease in accounts receivable-trade of $188,000, discussed above.
Inventory levels decreased by $1,115,000 primarily due to the Company's December
24, 1998 agreement with Grandway China ("Grandway"), a Hong Kong enterprise,
whereby Grandway agreed to make guaranteed minimum monthly inventory draws of
$103,000 or cost plus three percent until the remaining approximately $1,000,000
of inventory is purchased. As of June 30, 1999, Grandway had purchased the
entire remaining inventory. The decrease in current assets was offset in part by
an increase in cash as discussed above.
Long-term assets decreased $166,000, or 4.0%, to $3,968,000 at June 30,
1999 from $4,134,000 at December 31, 1998. This decrease was primarily the
result of recurring depreciation of building and equipment, and amortization of
deferred loan costs, and other intangibles.
Current liabilities decreased by $1,081,000, or 1.4%, to $5,893,000 at
June 30, 1999 from $6,974,000 at December 31, 1998. This decrease was primarily
the result of the Company entering into a "Deposit Payable Conversion Agreement"
dated February 4, 1999 between the Company and Touchstone Transport Services,
Inc., an entity located in the Philippines. During the first quarter of 1998, in
connection with an ongoing offering of the Company's common stock to offshore
investors under Regulation S of the Securities Act of 1933, the Company received
a wire transfer in the amount of $1,000,000. However, no specific subscription
agreement or other contract was ever prepared or executed in connection with
this wire transfer, and the Company never issued any securities in conjunction
with the transfer. Subsequently, the wire transfer was recorded as a payable.
The Company had the use of the transferred funds for approximately ten months,
in exchange for which it neither issued any securities nor paid any principal or
interest in respect of the payable. In January 1999, the Company requested that
the depositor of the $1,000,000 wire transfer agree to convert the payable that
had been recorded into shares of the Company's restricted common stock. The
depositor agreed to convert the payable into 500,000 shares of the Company's
restricted common stock, which were issued to an entity affiliated with the
depositor. Additionally, accrued advertising decreased $225,000 and trade
accounts payable decreased $568,000. These decreases were offset in part by an
increase of $960,000 in short-term notes payable as a result of additional
borrowings under the Company's revolving line of credit.
The Company's working capital decreased by $740,000, or 51.7%, to
$691,000 at June 30, 1999 from $1,431,000 at December 31, 1998, for the reasons
described above.
The Company used net cash of $380,000 in operating activities during
the six months ended June 30, 1999, primarily as a result of the net loss
incurred during the period, offset in part from decreased inventory levels and
trade accounts receivable.
The Company used net cash of $87,000 in investing activities during the
six months ended June 30, 1999, primarily for capital expenditures relating to
the Company's Year 2000 remediation efforts.
The Company provided net cash of $790,000 from financing activities
during the three months ended June 30, 1999, primarily due to borrowings under
the Company's revolving line-of-credit, offset in part by 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 is seasonal. The Company typically experiences
its highest sales volume in the fourth quarter of each year 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.
20
<PAGE>
Year 2000 Compliance
The Year 2000 problem relates to the inability of many computer
programs and microchip-based products and equipment to operate properly on dates
approaching and following December 31, 1999. This inability to operate correctly
results from the use in many computer programs and embedded microchip code of a
two-digit rather than a four-digit date field. Thus, non Year 2000 compliant
software and firmware may misinterpret a date entry of "00" as 1900, rather than
2000, resulting in, among other things, a temporary inability to process
transactions, send invoices, or engage in similar business transactions.
The Company uses 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 purchased with the Year
2000 issue in mind, and is represented by its manufacturer to be Year 2000
compliant in all material respects. Consequently, the Company believes its core
enterprise resource planning and accounting systems will not be affected by the
Year 2000 problem. However, the Company uses many different software programs to
process and summarize business transactions. The Company has completed its Year
2000 evaluation and remediation of these various internal computer systems.
Based on its efforts to date, the Company presently believes that the Year 2000
problem will not materially affect the operation of its internal computer
systems, hardware, software or its internal operations that are dependent, in
material part, on embedded microchips or computer controllers, including the
HVAC, security and telephone systems located at the Company's headquarters.
There can be no assurance, however, that the Company's internal systems and
operations will not be adversely affected by the Year 2000 problem.
In its evaluation and remediation program, the Company utilized both
internal and external resources to reprogram or replace non-compliant software
for Year 2000 modifications. The total cost of the Year 2000 project to date is
approximately $193,000, which has been funded through operating cash flows and
the Company's existing $4,000,000 secured credit facility. Of this cost,
approximately $120,000 was attributable to the purchase of new software or
equipment that will be capitalized. The remaining $73,000 has been expensed as
incurred. The Company does not anticipate incurring additional material expenses
related to its Year 2000 remediation efforts in respect of its internal systems
and operations.
The Company has initiated formal communications with all of its
significant suppliers and customers to determine the extent to which the Company
is vulnerable to those third parties' failure to remediate their own Year 2000
problems. Additionally, in March 1999, the Company, through its own information
technology personnel and its Chief Financial Officer, conducted on-site reviews
of certain of its key Asian suppliers to ascertain, to the extent possible, the
Company's exposure to manufacturing delays or stoppages as a result of those
suppliers' failure to remediate their Year 2000 problems. Based on those
efforts, the Company does not presently anticipate that its operations will be
adversely affected as a result of the Year 2000 problem as it may affect the
Company's key suppliers' internal systems. However, there can be no assurance
that the systems of other companies on which the Company relies for products and
services will be timely assessed and, where appropriate remediated, or that
other companies' failure to become Year 2000 compliant would not have a material
adverse effect on the Company, its operations and financial condition. The
Company does not presently have a completed contingency plan to address
operational difficulties in the event the Company's Year 2000 evaluation and
remediation efforts to date prove to be unsuccessful.
Forward Looking Statements
The foregoing Management's Discussion and Analysis of Financial
Condition and Results of Operations contains certain forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended, which are
intended to be covered by the safe harbors created thereby. Although the Company
believes that the assumptions underlying the forward-looking statements
contained herein are reasonable, any of the assumptions could be inaccurate, and
therefore, there can be no assurance that the forward-looking statements will
prove to be accurate. Factors that could cause actual results to differ from
results discussed in forward-looking statements include, but are not limited to,
potential increases in inventory costs, competition, and the Company's ability
to obtain additional working capital to fund future growth.
21
<PAGE>
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On July 6, 1999, the Company filed a lawsuit in Third District Court
for the State of Utah in Salt Lake City against Dale C. Gledhill, a former vice
president of the Company ("Gledhill"). The complaint alleges that, upon the
termination of his employment with the Company, Gledhill immediately and for the
benefit of himself or other parties unrelated to the Company, commenced using
information identifying the Company's sources of supply, vendors, manufacturer's
representatives, all of which information derived significant independent
economic value from not being generally known to, and not being readily
ascertainable by proper means by, other persons who could obtain economic value
from its disclosure or use and, as such is confidential and proprietary to the
Company. The complaint also alleges that Gledhill breached his fiduciary duty to
the Company and misappropriated corporate opportunities. The complaint asserts
claims for breach of fiduciary duty, misappropriation of trade secrets, breach
of contract, tortious interference, unfair competition, usurpation of corporate
opportunity, accounting, and defamation. The Company seeks injunctive relief in
the form an a court order prohibiting Gledhill from engaging in unfair
competition and unauthorized use of the Company's trade secrets and money
damages in an unspecified amount.
On March 19, 1999, Alpha Tech Stock Transfer Company ("Alpha Tech")
filed a lawsuit against the Company in Utah state court in Salt Lake City, Utah.
Alpha Tech was the Company's stock transfer agent for a period of approximately
ten years until the Company terminated its relationship with Alpha Tech in
January 1999. American Stock Transfer, New York, New York presently is the
Company's stock transfer agent. Alpha Tech's complaint alleges that the Company
breached its service contract with Alpha Tech by failing to pay $132,165 to
Alpha Tech for transfer agent services rendered and reimbursement for legal
expenses incurred by Alpha Tech. Alpha Tech has not yet served the complaint;
the Company learned about the complaint through an unrelated third party. The
Company disputes the claims of Alpha Tech's complaint. If process is served, the
Company intends to vigorously defend the suit.
On February 22, 1999, the Company received a demand letter from counsel
for Mag Instrument, Inc., a manufacturer and distributor of flashlights and one
of the Company's competitors ("Mag"). In the letter, Mag accused the Company of
infringing certain of Mag's patents and committing false advertising and unfair
competition. Attached to the demand letter was a copy of a complaint filed in
the U.S. District Court for the Central District of California on February 19,
1999. The complaint alleges that the Company has infringed three patents owned
by Mag, and seeks (i) an order enjoining the Company from infringing Mag's
patents, (ii) the delivery to the Court of all flashlights which infringe Mag's
patents, (iii) that the Company identify all entities who have purchased,
distributed or sold any infringing products, (iv) that the Company deliver to
the Court all documents reflecting or relating to the purchase, sale or
distribution of any flashlights which infringe Mag's patents, (v) money damages
sustained by Mag by reason of the alleged patent infringement, including
interest, costs, and attorney's fees. The demand letter specified that the
complaint was filed as a "precaution," and that Mag will refrain from serving
the complaint on the Company pending the receipt of certain assurances from the
Company. During the quarter ended June 30, 1999, Mag and the Company agreed to
pursue their efforts to settle the dispute and, pending such discussions, the
complaint would be dismissed without prejudice upon the joint stipulation of the
parties. The Company has expressly agreed with Mag, however, that if the pending
disputes are not settled, Mag may refile the complaint in the same court and
venue.
On August 6, 1999, the Company settled litigation with a Canadian
brokerage firm captioned as Canaccord Capital Corporation ("Canaccord") vs.
Dynatec International, Inc., Civil No. 2:98-cv-420C, that had been pending in
the United States District Court for the District of Utah. Canaccord initially
sued seeking injunctive relief and money damages stemming from the Company's
allegedly wrongful cancellation of 125,000 shares of the Company's common stock
in January 1998. Canaccord claimed that it suffered damage from a market
shortage and deficiency to various accounts which had previously been sold by
Canaccord as a result of the allegedly wrongful cancellation of shares. On July
17, 1998, the District Court entered a preliminary injunction requiring the
Company to reissue 125,000 shares in the name of CEDE & Company, as the market
clearing house, to replace the alleged market shortage. The court preserved
Canaccord's remaining claims for money damages and the return of an additional
block of shares alleged to have been wrongfully cancelled. The Company named
various third party defendants to whom it believes the shares may have been
improperly issued and is seeking either recovery of the shares or the recovery
of damages. Pursuant to the global settlement, the Company and the other parties
to the litigation stipulated to the dismissal of the lawsuit and the entry by
the court of an order making its preliminary injunction order permanent.
The Company is involved in various other claims and legal actions
arising in the ordinary course of business. In the opinion of management, the
ultimate disposition of these other matters will not have a material adverse
effect on the Company's operations or financial condition.
22
<PAGE>
Item 2(c). Recent Sales of Unregistered Securities
During the three month period ended June 30, 1999, the Company sold the
following equity securities that were not registered under the Securities Act of
1933:
Conversions of Convertible Debentures
On June 10, 1999, five investors who purchased a total of $1,500,000 of
the Company's convertible debentures in May 1998 converted total principal
amount of $132,500 of the debentures into 98,604 shares of common stock at the
then-applicable conversion price of $1.3438 per share. Additionally, a total of
8,320 shares of common stock were issued upon the conversion of $11,180 of
dividends accrued on the principal amount of debentures converted on that date.
The Company issued such shares without registration under the Securities Act of
1933 in reliance on Section 4(2) of the Securities Act, and the rules and
regulations promulgated under that section including Regulation D. Such shares
of common stock were issued as restricted securities and the certificate
representing such shares was stamped with a standard legend to prevent any
resale without registration under the Securities Act or pursuant to an
exemption, except for that portion of such shares as were subject to sales under
Rule 144 under the Securities Act.
Stock Options
On June 8, 1999, the compensation committee of the Company's Board of
Directors granted stock options to purchase a total of 572,000 shares of common
stock to various executives, employees and directors of the Company. Such
options were granted pursuant to the Company's 1999 Stock Option And Incentive
Plan, and were granted as non-qualified options having terms of 10 years from
the date of grant. All such options have an exercise price of $1.625 per share,
which was 100% of the fair market value on the grant date. Such options were
granted without registration under the Securities Act, although the Company
intends to file a registration statement on Form S-8 covering the shares of
common stock issuable upon the exercise of such options.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit No. Description
10 Modification Agreement between the Company, the investors
who acquired the Convertible Debentures, and the placement
agent, dated as of June 25, 1999, incorporated by reference
from Amendment No. 2 to the Company's Registration Statement
on Form SB-2, filed July 2, 1999 (File No. 333-57921).
27 Financial data schedule (for SEC use only).
(b) Forms 8-K
None
23
<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/ Frederick W. Volcansek, Sr. August 12, 1999
- -------------------------------------- ---------------
Frederick W. Volcansek, Sr. Date
Chairman & Chief Executive Officer
/s/ Paul A. Boyer August 12, 1999
- -------------------------------------- ---------------
Paul A. Boyer Date
Senior Vice President &
Chief Financial Officer
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