<PAGE>
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(X ) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED
JULY 31, 1996
-------------
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
0-18288
-------
DIRECT CONNECT INTERNATIONAL INC.
---------------------------------
(Exact name of registrant as specified in its charter)
Delaware 22-2705223
--------- -----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
266 Harristown Road
Glen Rock, New Jersey 07452
- --------------------- ------
(Address of principal executive (Zip Code)
offices)
Registrant's telephone number, including area code - (201) 445-2101
-------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
---- ----
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of July 31, 1996: 9,062,066.
<PAGE>
DIRECT CONNECT INTERNATIONAL INC. AND SUBSIDIARY
INDEX
PART I. FINANCIAL INFORMATION PAGE NO
Item 1. Financial Statements
Condensed Consolidated
Balance Sheets -
July 31, 1996 and
April 30, 1996 3
Condensed Statements
Of Consolidated
Operations - Three
Months Ended July 31,
1996 and July 31, 1995 4
Condensed Statements
Of Consolidated Cash
Flows - Three Months
Ended July 31, 1996
and July 31, 1995 5
Notes to Financial Statements 6
Item 2. Management's Discussion
and Analysis of Results
of Operations and
Financial Condition 7 - 14
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports
on Form 8-K 15
Signatures 16
2
<PAGE>
PART 1. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
<TABLE>
Direct Connect International Inc. and Subsidiary
Consolidated Balance Sheets
ASSETS
<CAPTION>
July 31, 1996 April 30, 1996
------------- --------------
<S> <C> <C>
(Unaudited)
Current assets
Cash and cash equivalents $168,934 $67,886
Accounts receivable 200,375 20,652
Due from Kidsview, Inc. 1,373,167 194,117
Notes receivable-officers 118,990 111,355
Investments 54,171 54,171
Prepaid financing costs and other expenses 11,607 69,075
------ ------
Total current assets 1,927,244 517,256
--------- -------
Property and equipment , at cost
Furniture and fixtures 43,912 42,543
Molds, tools and dies 275,481 267,498
------- -------
319,393 310,041
Less: accumulated depreciation 241,364 234,813
------- -------
78,029 75,228
------ ------
Investment in Glasgal 1,999,986 2,111,151
Investment in Evolutions Inc. 75,000 75,000
Deferred Income taxes 809,287 809,287
Security deposits 700 700
--------- ---------
2,884,973 2,996,138
--------- ---------
Total assets $4,890,246 $3,588,622
========== ==========
LIABILITIES and STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable $896,446 $947,512
Accrued expenses and taxes payable 120,753 49,825
Notes payable-officers and stockholders 462,764 461,716
Notes payable-other, current portion 1,798,365 1,411,424
Investment, warrants to sell Glasgal 300,000 300,000
------- -------
Total current liabilities 3,578,328 3,170,477
--------- ---------
Stockholders' equity
Convertible preferred stock:
Authorized 5,000,000 shares, $.001
par value; issued and outstanding-
5,000,000 shares 5,000 5,000
Common stock:
Authorized 15,000,000 shares, $.001
par value; issued and outstanding-
9,062,066 shares 9,062 9,062
Capital in excess of par value 5,104,449 5,104,449
Accumulated deficit (3,752,422) (4,646,195)
Unrealized loss on investments (54,171) (54,171)
------- -------
Total stockholders' equity 1,311,918 418,145
--------- -------
Total liabilities and stockholders'
equity $4,890,246 $3,588,622
========== ==========
</TABLE>
3
<PAGE>
<TABLE>
Direct Connect International Inc. and Subsidiary
Consolidated Statements of Operations
<CAPTION>
For the
Three Months Ended
------------------
July 31,1996 July 31,1995
------------ ------------
(Unaudited)
<S> <C> <C>
Revenues:
Sales $171,749 $120,475
-------- --------
Costs and expenses
Cost of goods sold 163,477 63,949
Royalties/licensing fees 15,809 10,225
Product development costs 6,000 ----
Advertising and promotion ---- 65,881
Depreciation 6,551 18,204
General and administrative expenses 234,664 325,193
Less: Management fees (255,000) ----
-------- -------
171,501 483,452
------- -------
Operating income (loss) 248 (362,977)
Gain on sale of securities 916,935 ----
Interest income 65 7,166
Other income 2,278 ----
Interest expense (25,753) (148,720)
------- --------
Net income (loss) $893,773 ($504,531)
======== =========
Income (loss) per common share $.06 ($.06)
==== =====
</TABLE>
4
<PAGE>
<TABLE>
Direct Connect International Inc. and Subsidiary
Consolidated Statements of Cash Flows
<CAPTION>
For Three Months Ended
----------------------
July 31, 1996 July 31, 1995
-------------- --------------
(Unaudited)
<S> <C> <C>
Cash flows from operating activities
Net income (loss) $893,773 ($504,531)
-------- ---------
Adjustments to reconcile net income (loss)
to net cash provided by (used in) operating
activities:
Depreciation and amortization 6,551 18,204
Gain on sale of Glasgal stock (916,935) ---
(Increase) decrease in assets
Accounts receivable (179,723) (31,132)
Prepaid financing costs and other expenses 57,468 46,716
Inventories --- 16,789
Increase (decrease) in liabilities
Accounts payable (51,066) (83,624)
Accrued expenses and taxes payable 70,928 5,780
------ -----
Total adjustments (1,012,777) (27,267)
---------- -------
Net cash (used in)
operating activities (119,004) (531,798)
-------- --------
Cash flows from investing activities
Notes receivable-officers, increases (7,635) (10,003)
Increase in due from Kidsview, Inc. (1,179,050) ---
Acquisition of property and equipment (9,352) (55,776)
Proceeds from sale of Glasgal stock 1,028,100 ---
--------- ---------
Net cash (used in) investing activities (167,937) (65,779)
-------- -------
Cash flows from financing activities
Notes payable-officers and stockholders 1,048 174
Increase in notes payable-other 386,941 561,478
Decrease in notes payable-other --- (5,000)
-------- ------
Net cash provided by financing activities 387,989 556,652
------- -------
Net increase (decrease) in cash and cash
equivalents 101,048 (40,925)
Cash and cash equivalents at beginning of period 67,886 171,677
------ -------
Cash and cash equivalents at end of period $168,934 $130,752
======== ========
Supplemental disclosure of cash flows information
Cash paid during the three months for interest $25,753 132,220
------- -------
</TABLE>
5
<PAGE>
DIRECT CONNECT INTERNATIONAL INC.
AND SUBSIDIARY
Notes to Financial Statements
1. In the opinion of management, the accompanying unaudited financial
statements contain all adjustments, consisting only of normal recurring
adjustments, necessary to present fairly (a) the financial position as of
July 31, 1996, (b) the results of operations for the three months ended
July 31, 1996 and July 31, 1995 and (c) changes in cash flows for the three
months ended July 31, 1996 and July 31, 1995.
2. Refer to the audited financial statements for the fiscal year ended April
30, 1996 for details of accounting policies and accounts, none of which
have changed significantly in composition since that date.
3. Financial results for the interim period ended July 31, 1996 may not be
indicative of the financial results for the fiscal year ended April 30,
1997.
4. The Company has available carry forward losses applicable to the reduction
of future Federal income taxes aggregating approximately $4,500,000 at
December 31, 1995 and which expire during the years 2003 to 2010.
6
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
Net Sales
Net sales for the three months ended July 31, 1996 were $171,749 as compared to
$120,475 for the same period in the prior fiscal year.
The Company intends to develop additional product lines; however, there can be
no assurance that it will be able to do so on a commercially viable basis. If
such product lines are so developed, the Company may be required to sell or
license such product lines, depending on, among other factors, its financial
resources.
At July 31, 1996, the Company had a backlog of confirmed orders from its
customers of approximately $159,000 all of which were shipped by August 31,
1996.
Gross Profit
Gross Profit percentage for the three months ended July 31, 1996 was 4.81 % as
compared to 46.92% for the three months ended July 31, 1995. This decrease
resulted primarily from discounts and other direct product costs relating to the
product line which was sold.
Royalties/Licensing Fees
Royalties/Licensing fees are variable expenses which increase as sales increase.
In the three month period ended July 31, 1996, the Company paid royalties of
approximately $15,809 (or 9% of sales) and $10,225 (or 8% of sales) in the three
months ended July 31, 1995. The increase in royalties was primarily attributable
to the increase in sales. In order to match revenues with expenses, minimum
royalty guarantees are treated as prepaid expenses and are charged against
income as the related products are sold. For fiscal 1996, the Company is not
obligated to make minimum royalty payments pursuant to any license agreements.
Other Income
Other income amounted to approximately $900,000 for the three months ended July
31, 1996 as compared to $7,000 for the three months ended July 31, 1995. This
increase comes from the sale of shares of Glasgal stock by the Company.
General and Administrative Expenses
For the three months ended July 31, 1996, the Company earned a management fee of
$255,000 which covers the monthly reimbursement of the costs incurred by the
Company in connection with its operations as it relates to supporting the
product lines which were sold. Set forth below are the principal components.
7
<PAGE>
General and administrative expenses for the three months ended July 31, 1996
were $234,664 as compared to $325,193 for the three months ended July 31, 1995.
Included in such amount for the three months ended July 31, 1996 were
commissions which amounted to $8,467 as compared to $6,162 for the three months
ended July 31, 1995. This increase resulted primarily from the increase in sales
volume. Letter of credit and foreign office expenses amounted to $13,065 for the
three months ended July 31, 1996 as compared to $2,335 for the three months
ended July 31, 1995. This increase was due to the increase in, and timing of,
general foreign office expenses. Warehouse costs were $365 for the three months
ended July 31, 1996 as compared to $5,212 for the three months ended July 31,
1995.
For the three months ended July 31, 1996, salaries were $109,275 as compared to
$93,434 for the three months ended July 31, 1995. Such increase was due to
general salary increases in the current period.
Professional fees decreased to $12,049 for the three months ended July 31, 1996
as compared to $38,319 for the three months ended July 31, 1995. This decrease
was primarily due to the reduction of professional services required by
regulatory requirements.
Advertising expenses decreased to $-0- for the three months ended July 31, 1996
as compared to $65,881 for the three months ended July 31, 1995. This decrease
was due to the sale of product lines in 1995.
Travel and entertainment expenses increased to $33,218 for the three months
ended July 31, 1996 as compared to $20,352 for the three months ended July 31,
1995. This increase resulted from the Company's efforts to expand sales.
LIQUIDITY AND CAPITAL RESOURCES
During the next twelve months, the Company in addition to meeting its operating
needs will have notes payable, as discussed below, in the amount of
approximately $2,260,000 becoming due. The Company does not believe that it will
be able to pay these obligations out of operating revenues, and, accordingly, it
will have to seek additional financing or sell assets to do so. The Company
anticipates funding its obligations from two principal sources. First, the
Company intends to develop additional product lines which would be promoted and
marketed in a manner similar to the manner in which the Company has utilized for
its Zoo Borns and Tea Bunnies product lines which involved the transfer of such
product lines to Evolutions, Inc. (EVO) as decribed herein. Second, the Company
owns approximately 1,318,973 shares of common stock of Glasgal and may, from
time to time, sell a portion of such shares. For additional information
regarding prior dispositions of Glasgal shares, see the description of such
transactions contained herein. There can be no assurance that the Company will
be able to develop additional product lines, obtain such financing or sell
assets, in which event such obligations will have a material adverse effect upon
the Company's operations. The Company expects to support its operations over the
next five months through funds generated from its management contract with EVO
as described herein. At July 31, 1996, the Company had a cash equivalent balance
of $168,934 as compared to $130,752 at July 31, 1995.
For the three months ended July 31, 1996 the Company used cash from operations
in the amount of $119,004 as compared to $531,798 from operations for the three
8
<PAGE>
months ended July 31, 1995. The Company obtained $387,989 from its financing
activities for the three months ended July 31, 1996 as compared to $556,652 for
the three months ended July 31, 1995. The amount for 1996 resulted primarily
from borrowings using the Company's Glasgal shares as collateral. The amount for
1995 resulted primarily from the private placement of $475,000 of the notes
discussed below.
For the three months ended July 31, 1996, the Company used $167,937 from its
investing activities. Included in that amount were proceeds received in the
amount of $1,028,100 from the sale of 115,000 shares of Glasgal stock. Also
included in that amount was cash used to increase the Company's advances to
Kidsview, Inc. by $1,179,050.
The Company in September 1995, entered into an agreement with EVO, whereby the
Company transferred all rights and interests to its Zoo Borns product line, Tea
Bunnies product line and Kidsview name to a subsidiary of EVO for $750,000 and
shares of common stock of EVO equal to approximately 7% of EVO's then
outstanding common stock (valued at $75,000) with the right to receive
additional shares of common stock equal to approximately 15% of the outstanding
common stock of EVO based on certain performance levels of the Zoo Borns and Tea
Bunnies product lines over the next three years.
As an inducement for EVO to enter into this agreement, the Company issued to EVO
warrants to purchase 350,000 shares of common stock of the Company at exercise
prices of $ .10 per share with respect to 100,000 shares and $ .20 per share
with respect to 250,000 shares. In anticipation of consummating the agreement,
EVO and the Company entered into a lending arrangement under which the Company
signed a promissory note in March 1995 for $750,000 with interest at the annual
rate of 12%. Such note was secured by 133,973 shares of Glasgal stock held by
the Company and by an interest in certain accounts receivable and was due on
September 1, 1996. In July and August 1995, the Company also borrowed from EVO
an aggregate of $350,000 with interest at the annual rate of 12%. Such
obligations were secured by certain accounts receivable and were due on October
31, 1995. Upon consummation of the agreement, all these obligations were
cancelled.
The Company recognized a gain of approximately $846,000 as a result of this
transaction.
As part of the agreement, the Company will manage these product lines and will
receive an amount equal to its monthly operating costs, up to $100,000, for such
period of time as the Company is managing such product lines. The Company is
providing the services of Peter Schneider, President of the Company, for such
management. This management arrangement may terminate in September 1996 but
could be extended for up to two additional years depending on certain
performance levels of such product lines. For the three months ended July 31,
1996, the Company received fees from EVO in connection with this management
arrangement amounting to $255,000.
On May 28, 1996, the Company established a margin account with the brokerage
firm of Cowen & Company (Cowen). In that connection, the Company delivered
300,000 shares of common stock of Glasgal held by the Company to Cowen and
borrowed $500,000 against such account.
9
<PAGE>
On June 10, 1996, the Company sold (at $9.00 per share) 115,000 shares of common
stock of Glasgal held by the Company in its margin account. The Company received
net proceeds from such sale aggregating approximately $1,000,000. The Company
used approximately one-half of the proceeds to pay off its margin loan of
approximately $500,000.
The net proceeds from the transactions referred to above (approximately
$1,000,000) was invested in common stock of Evolutions, Inc. (EVO) at $2.50 per
share, and warrants exercisable at $3.50 per share to purchase common stock of
EVO. The Company also intends to make an additional equity investment in EVO of
approximately $800,000 on the same terms, which will include the transfer by the
Company of 106,667 shares of Glasgal common stock held by the Company, in EVO
common stock and warrants to purchase common stock, which is expected to occur
during the fiscal quarter ending October 31, 1996. As an inducement for such
investments, the Company will receive additional warrants to purchase 400,000
additional shares of EVO common stock exercisable at $2.50 per share.
To expand its business, the Company will have to seek additional financing and
there can be no assurance that it will be able to obtain such financing. No
assurance can be given as to the number of outstanding warrants, which represent
a potential source of funds, that will be exercised. The Company is exploring
alternatives to utilizing its equity investments in connection with financing
its operations and developing new products.
In order to arrive at the completed stage, the Company's products must go
through the following processes: product concept and design, product development
and engineering, pre-production approval and product manufacture and
distribution.
In order to supplement its cash flow, the Company, on March 6, 1991, entered
into loan agreements with several investors whereby the Company borrowed an
aggregate of $282,000 for six months with interest at the semiannual rate of
14.5%. As part of such transaction, the Company issued to such investors, in a
private placement, an aggregate of 17,000 shares of its common stock, on a
restricted basis, for an aggregate consideration of approximately $22,000. In
October 1991, the Company paid off $32,000 (plus accrued interest) with respect
to such loans. At such time the Company renegotiated the balance of such loans
(plus accrued interest) and issued new notes, maturing in one year, amounting to
approximately $290,000 including interest thereon at the annual rate of 10%. In
September 1992 the Company delivered 200,000 shares of common stock to one of
such investors in exchange for the contemplated cancellation of substantially
all the balance of such loans. The Company under the terms of this arrangement
remains contingently liable for the prior obligation depending on the future
stock price and salability of the shares. The investor has been unable to sell
the shares for a price of at least $1.625 and, accordingly, the shares can be
returned to the Company. The Company is obligated to pay such investor the value
of the note, plus accrued interest, aggregating approximately $395,100 at July
31, 1996. If the Company is unable to pay this obligation out of operating
revenues, it will have to seek additional financing or sell a portion of its
equity holdings in Glasgal to do so. There can be no assurance that the Company
will be able to obtain such financing or sell such equity, in which event this
obligation would have a material adverse effect upon the Company's operations.
10
<PAGE>
Given the nature of the Company's business, the length of the typical product
cycle in the toy business, the need to respond rapidly to developments in the
marketplace and to, if necessary, make rapid changes in product lines and
strategic plans to meet the rapid changes in the marketplace, the Company's
planning historically has been limited to approximately a twelve month
time-frame at any given time. It is anticipated that the Company will continue
to operate in a similar fashion in the future. Accordingly, analyses of long
term liquidity and capital requirements are not meaningful.
In 1992, the Company, in order to regain listing on the NASDAQ Small Cap System,
to provide for operating requirements and in contemplation of a possible change
in the nature of the Company's business, completed a private placement of
securities in October 1992, in which investors subscribed for 100 Units, each
Unit consisting of 50,000 shares of Convertible Preferred Stock and 25,000 1992
Warrants to purchase shares of Common Stock, for a total of $3,000,000. Such
private placement was closed in two stages, the first of which involved the
purchase of 52-1/2 Units and closed in July 1992, with the balance of the Units
offered (47-1/2 Units) being purchased in October 1992. As a result of the
consummation of such private placement, (a) the Redeemable Class A Warrant
exercise price has been adjusted from $1.00 per share to $ .53 per share and the
number of shares of Common Stock issuable upon exercise of Redeemable Class A
Warrants has been increased from 3,438,900 shares to 6,488,517 shares of Common
Stock so that each holder of a Redeemable Class A Warrant will be able to
purchase 1.8868 shares of Common Stock for $1.00 upon exercise of each Warrant
and (b) the Redeemable Class B Warrant exercise price has been adjusted from
$1.50 per share to $ .75 per share and the number of shares of Common Stock
issuable upon exercise of Redeemable Class B Warrants has been increased from
1,719,450 shares to 3,438,900 shares of Common Stock so that each holder of a
Redeemable Class B Warrant will be able to purchase one share of Common Stock
per warrant upon exercise of such Warrant.
In November 1992, the Company signed a merger agreement with Glasgal
Communications, Inc. (Glasgal), a privately held company which provides network
design, hardware and software, carrier facilities and support services for
organizations in a diverse range of industries. The Company and Glasgal
terminated the proposed merger agreement in December 1993 and entered into a
stock purchase agreement described below.
In November 1992, the Company, in contemplation of the Glasgal merger, entered
into a loan agreement with Glasgal whereby the Company loaned Glasgal
$1,000,000, due on December 31, 1993, as extended, at an annual interest rate
equal to two percent above the prime rate. An aggregate of $400,000 (also due on
December 31, 1993 as extended) was loaned to Glasgal in March, June, August and
September 1993. All the loans were secured by 50.1% of the stock of Glasgal held
by Ralph Glasgal, Glasgal's principal stockholder, and a second priority
security interest in, among other things, Glasgal's accounts receivable,
inventory and equipment. The purpose of this loan was to satisfy partially
Glasgal's short-term cash needs pending the proposed merger with the Company
(which was not consummated - see below), which cash needs Glasgal estimated to
be between $2.1 million and 2.6 million. These short-term cash needs related
specifically to (i) Glasgal's financing of the implementation of its business
plan, (ii) its financing of an increased level of inventory, (iii) a reduction
in the average age of its trade payables, (iv) its financing of the shortfall
between a prior mortgage and a new bridge loan, and (v) to meet certain balance
sheet requirements of prospective new lenders.
11
<PAGE>
In order to provide for additional working capital, to meet expenses related to
the Glasgal merger, and to be in position to assist Glasgal in solving its
immediate cash flow problems in contemplation of the merger, the Company entered
into lending arrangements with several individuals under which the Company
issued notes aggregating $780,000 plus interest thereon at the annual rate of 8%
in private placements pursuant to an exemption from registration under Section
4(2) of the Act. Such notes matured between December 31, 1993, as extended, and
December 31, 1995. At July 31, 1996, such notes amounted to $812,000 including
accrued interest thereon. As an inducement for making such loans, it was
intended that the holders would have an opportunity to convert such notes into
equity securities when the Company next undertook a private placement, the terms
of which had not been determined, provided that the holders met suitability
requirements thereof. The Company believes that all of such holders either were
officers of the Company or relatives of officers of the Company who in all cases
were deemed to be suitable investors or other individuals who had preexisting
personal relationships with officers or directors of the Company and, in
addition, would have been deemed "accredited investors" as such term is defined
in Rule 501 of Regulation D under the Act if an exemption had been sought under
Regulation D. In view of the Company's default in payment of its obligations
under the notes and its inability of afford the noteholders an opportunity to
convert such notes into equity securities, several of the noteholders have
recently contacted the Company and have threatened to commence litigation
against the Company to enforce the Company's obligations under the notes. The
company intends either to pay off the obligations or to convert the notes
(including accrued interest thereon) into Common Stock at a rate of five shares
of Common Stock per dollar subject to stockholder approval of an increase in
authorized shares of Common Stock in connection with a proposed meeting of
stockholders. There can be no assurance that the Company will be able to
effectuate such payment or conversion. Litigation by noteholders to enforce the
notes would materially adversely affect the Company's operations.
In addition, the Company in February 1993 accepted a subscription from an
unaffiliated non-U.S investor to purchase 1,500,000 shares of Common Stock, in a
private placement, for an aggregate consideration of $300,000. The Company
believes that such private placement did not result in any further adjustments
of any outstanding warrants, options or convertible stock.
The Company, after termination of the Glasgal merger, entered into a common
stock purchase agreement (the "Agreement") with Glasgal governing certain equity
investments which the Company has made, and in the future intends to make, in
Glasgal common stock. Pursuant to the Agreement, in January 1994 the Company
converted outstanding indebtedness of Glasgal owed to the Company into equity of
Glasgal which, upon consummation of the Glasgal merger with Sellectek
Incorporated, resulted in the Company owning approximately 28% of the
outstanding shares of Glasgal or 18.5% on a fully diluted basis. In addition,
the Agreement gives Glasgal the right to require the Company to purchase an
additional number of shares of common stock of Glasgal equal to 13.5% of the
then outstanding shares (the "Additional Shares"), or 10% on a fully diluted
basis, for an aggregate of approximately $8.4 million after giving effect to
certain warrant solicitation fees (the "Additional DCI Investment"). Glasgal may
require this purchase if, and then only to the extent that, the Company receives
proceeds from the exercise of existing Company warrants. There can be no
12
<PAGE>
assurance that any or all of such warrants will be exercised. The Company has
issued warrants to the public to purchase 6,448,517 shares of Common Stock at
$.53 per share, warrants to purchase 3,438,900 shares of Common Stock at $ .75
per share, and warrants to purchase 2,500,000 shares of Common Stock at $1.00
per share. Such warrants will expire in 1997, as extended. The Company has the
right to retain the first $500,000 of warrant exercise proceeds; however, such
amount must be used by the Company to purchase shares of Common Stock of Glasgal
if the aggregate amount of warrant exercise proceeds applied to the purchase of
Glasgal common stock, after the earlier of the expiration of exercise of all
warrants or 24 months after the effectiveness of the registration statement
covering the Common Stock underlying the warrants, is less than $8.4 million. In
view of the fact that, at the present time and throughout 1996, the price of the
Common Stock has been substantially below the exercise price of the warrants, it
is impossible to predict the timing of exercise of any of the outstanding
warrants, or if such warrants will ever be exercised. The Company anticipates
such an event will not arise for at least two years and that, should such
eventuality arise, the Company will attempt to meet such obligation either
through loans (which may be secured by all or a portion of its Glasgal equity),
equity financings or some combination thereof. If Glasgal does not require the
Additional DCI Investment, the Company may still purchase, on the same terms, up
to one-half of the Additional Shares.
In November 1993, the Company issued to several investors secured promissory
notes aggregating $500,000 with interest thereon at the annual rate of 8%. Such
notes were secured by all the assets of the Company and matured on September 30,
1994, as extended, and were paid off on October 6, 1994. As an inducement for
such investors to make such loan, the Company issued to such investors warrants,
which expire on November 23, 1998, to purchase an aggregate of 750,000 shares of
Common Stock at an exercise price of $ .05 per share, as adjusted. The proceeds
from such transaction were loaned to Glasgal to fulfill certain commitments to
Glasgal. Such loan to Glasgal was made on the same terms as the previous loans
to Glasgal referred to hereinabove. As an inducement to extend the maturity date
of such notes to September 30, 1994, the Company issued an aggregate of 500,000
additional warrants ("1994 Warrants") to the holders of such notes on the same
terms and conditions as the 1993 Warrants except that the exercise price of the
1994 Warrants is $ .20 per share.
On October 6, 1994, the Company consummated a lending arrangement with BW
Capital Corporation ("BW"), an independent lender organized to invest in
unregistered securities and small capitalization companies which was the largest
shareholder of Sellectek prior to its merger with Glasgal. The Company, which
was introduced to BW in connection with the Glasgal/Sellectek merger, has no
relationship with BW other than in connection with such lending arrangement.
Under the terms of such arrangement, the Company issued to BW a secured
promissory note in the principal amount of $1,600,000 bearing interest at the
rate of 11% per annum (the "Note"). The Note was secured by collateral
consisting of 2,000,000 shares of Glasgal common stock owned by the Company and
all dividends and other distributions of any kind in respect of such shares. The
Note matured on October 6, 1995 and was subsequently paid. As an inducement for
BW to make such loan to the Company, the Company transferred to BW 270,000
shares of Glasgal common stock owned by the Company. The Company also paid an
investment banker, Brookehill Equities, $100,000 as compensation for its
services in connection with arranging the loan. Under the terms of the lending
arrangement, because the Note was not prepaid in full on or before July 6, 1995,
13
<PAGE>
the Company transferred to BW an additional 270,000 shares of Glasgal common
stock owned by the Company. The Company used the proceeds from such loan to pay
off existing secured indebtedness aggregating $750,000 including $30,000 paid to
Joseph Salvani, the Company's Chairman, and for general corporate purposes.
Prior to entering into the lending arrangement with BW, the Company sought
alternative financing for several months and had discussions with other
potential sources of financing. In the opinion of management, the BW proposal
offered the Company the best financing terms of the limited alternatives then
available to the Company. In establishing the collateral for the loan, BW took
into account the fact that, notwithstanding a market price at that date of
approximately $4 per share for Glasgal common stock, in view of the fact that
the shares to be delivered as collateral were restricted and that the market for
Glasgal common stock generally was then illiquid, if it were forced to liquidate
the collateral it was unlikely that BW would realize an amount close to the
reported per share market value for such stock. From the Company's standpoint,
the BW Loan, while not on favorable terms, represented the best terms available
to the Company and management believed that it was in the best interest of the
Company to proceed with such borrowing in order to be able to develop its
product lines and to reduce outstanding debt that was then due. Among the
alternatives considered by the Company at the time of the BW loan was the sale
of a portion of its Glasgal stock. In view of the restrictions on the transfer
of such stock as well as the illiquidity of the market for the shares, the
Company's options with respect to any such sale were limited. The Company did
receive a verbal offer to purchase approximately two million shares of the
Glasgal common stock, to be accomplished through a private placement exempt from
registration under Regulation S under the Federal securities laws, at a price
per share of approximately $ .80. The Company rejected such an offer as less
favorable than the BW alternative. Similarly, the inducement fees incurred in
connection with the BW transaction, while onerous, viewed in the context of the
overall BW transaction, were deemed the best alternative available to the
Company in order for it to continue to fund the development of its toy business
and preserve as much of its Glasgal equity as possible.
DEFERRED INCOME TAX ASSETS
Deferred income tax assets as of July 31, 1996 and April 30, 1996 have been
reduced to $809,287 by a valuation allowance of $983,802 due to uncertainties
concerning their realization.
14
<PAGE>
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
Exhibits - None
Reports on Form 8-K:
Form 8-K, dated May 1, 1996, regarding changes in registrant's
certifying accountant
Form 8-K, dated May 28, 1996, regarding creation of a margin
account
Form 8-K, dated June 10, 1996, regarding sale of shares of
Glasgal Communications, Inc. and proposed investment
in Evolutions, Inc.
Form 8-K, dated June 24, 1996, regarding sale of shares of
Glasgal Communications, Inc. and investment in
Evolutions, Inc.
15
<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.
DIRECT CONNECT INTERNATIONAL INC.
(Registrant)
Date:September 13, 1996 By /s/Peter L. Schneider
------------------- ---------------------
Peter L. Schneider
President and Chief
Operating Officer
Date:September 13, 1996 By /s/Barry A. Rosner
------------------ ------------------
Barry A. Rosner
Treasurer and Chief
Financial Officer
16
