<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10 - Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
- --- EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1997
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
- --- EXCHANGE ACT OF 1934
For the transition period from ____________ to ______________
Commission file No.: 0-18813
ToHQ, INC.
(Exact Name of Registrant as Specified in Its Charter)
New York 13-3541686
---------------------------------- ----------------------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
5016 North Parkway Calabasas, Suite 100, Calabasas, CA 91302
(Address of Principal Executive Offices)
818-591-1310
(Registrant's Telephone Number, including Area Code)
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 the latest practicable date.
Common stock, $0.0001 par value: 6,489,581 shares (as of May 9, 1997).
1
<PAGE> 2
ToHQ, INC. AND SUBSIDIARIES
INDEX
<TABLE>
<CAPTION>
Part I - Financial Information Page
<S> <C> <C>
Item 1 Consolidated Financial Statements:
Consolidated Balance Sheets -
March 31, 1997 and December 31, 1996 3
Consolidated Statements of Operations -
for the Three Months Ended March 31, 1997 and 1996 4
Consolidated Statement of Shareholders' Equity
for the Three Months Ended March 31, 1997 and
the Year Ended December 31, 1996 5
Consolidated Statements of Cash Flows -
for the Three Months Ended March 31, 1997 and 1996 6
Notes to Consolidated Financial Statements 7
Item 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations 10
Part II - Other Information
Item 1 Legal Proceedings 17
Item 6 Exhibit and Reports on Form 8-K 17
Signatures 18
</TABLE>
2
<PAGE> 3
Part I - Financial Information
Item 1. Financial Statements.
ToHQ, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
March 31, December 31,
1997 1996
------------ ------------
(unaudited)
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 12,806,000 $ 2,734,000
Accounts receivable - net 8,276,000 14,186,000
Inventory 1,990,000 1,013,000
Prepaid and deferred royalties 2,699,000 717,000
Software development costs 4,880,000 2,329,000
Prepaid expenses and other current assets 469,000 485,000
------------ ------------
Total current assets 31,120,000 21,464,000
Equipment - net 818,000 581,000
Other long-term assets 751,000 795,000
------------ ------------
TOTAL ASSETS $ 32,689,000 $ 22,840,000
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 3,738,000 $ 3,304,000
Accrued royalties 5,673,000 3,133,000
Advance from bank -- 5,355,000
------------ ------------
Total current liabilities 9,411,000 11,792,000
Commitments and contingencies -- --
Shareholders' equity:
Common stock, par value $.0001, 100,000,000 shares authorized; 6,478,786
shares and 4,739,883 shares issued and outstanding as
of March 31, 1997 and, December 31, 1996 respectively 4,000 4,000
Additional paid-in capital 46,299,000 34,558,000
Cumulative foreign currency translation adjustment (283,000) (52,000)
Accumulated deficit (22,742,000) (23,462,000)
------------ ------------
Total shareholders' equity 23,278,000 11,048,000
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 32,689,000 $ 22,840,000
============ ============
</TABLE>
See notes to consolidated financial statements.
3
<PAGE> 4
ToHQ, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
----------------------------
1997 1996
----------- -----------
<S> <C> <C>
Net sales $11,839,000 $ 6,582,000
----------- -----------
Costs and expenses:
Cost of sales 7,242,000 3,756,000
Royalties 1,543,000 1,197,000
Product development 192,000 215,000
Project abandonment 150,000 125,000
Selling 772,000 537,000
General and administrative 1,179,000 841,000
Operating interest 67,000 96,000
----------- -----------
Total costs and expenses 11,145,000 6,767,000
----------- -----------
Income (loss) from operations 694,000 (185,000)
Interest income (expense), net 30,000 (72,000)
----------- -----------
Income (loss) before income taxes 724,000 (257,000)
Provision for income taxes 4,000 4,000
----------- -----------
Net income (loss) $ 720,000 $ (261,000)
=========== ===========
Net income (loss) per share $ 0.12 $ (0.06)
=========== ===========
Shares used in per share calculation 6,045,000 4,330,000
=========== ===========
</TABLE>
See notes to consolidated financial statements.
4
<PAGE> 5
ToHQ, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
For the Year Ended December 31, 1996 and
the Three Months Ended March 31, 1997
<TABLE>
<CAPTION>
Cumulative
Foreign Retained
Additional Currency Earnings
Preferred Common Common Paid-in Translation (Accumulated
Stock Stock Amount Capital Adjustment Deficit) Total
--------- ---------- -------- ------------ ----------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1996 325 4,217,391 $4,000 $ 33,317,000 $ (360,000) $(25,363,000) $ 7,598,000
Exercise of warrants and options -- 272,115 -- 712,000 -- -- 712,000
Conversion of preferred stock to
Common Stock (325) 127,717 -- -- -- -- --
Issuance of stock -- 122,660 -- 529,000 -- -- 529,000
Net income -- -- -- -- -- 1,901,000 1,901,000
Foreign currency translation adjustment -- -- -- -- 308,000 -- 308,000
----- --------- ------ ------------ ---------- ------------- -----------
Balance at December 31, 1996 -- 4,739,883 4,000 34,558,000 (52,000) (23,462,000) 11,048,000
Issuance of common stock for cash -- 1,725,000 -- 11,697,000 -- -- 11,697,000
Exercise of options -- 13,903 -- 44,000 -- -- 44,000
Net income -- -- -- -- -- 720,000 720,000
Foreign currency translation adjustment -- -- -- -- (231,000) -- (231,000)
----- --------- ------ ------------ ---------- ------------- -----------
Balance at March 31, 1997 (unaudited) -- 6,478,786 $4,000 $ 46,299,000 $ (283,000) $ (22,742,000) $23,278,000
===== ========= ====== ============ ========== ============= ===========
</TABLE>
See notes to consolidated financial statements.
5
<PAGE> 6
ToHQ, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
-------------------------------
1997 1996
------------ ------------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $ 720,000 $ (261,000)
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Depreciation and amortization 111,000 54,000
Provision for doubtful accounts, discounts and returns 1,159,000 694,000
Changes in operating assets and liabilities:
Accounts receivable 6,206,000 3,004,000
Inventory and inventory deposits (1,012,000) 338,000
Prepaid and deferred royalties and
software development costs 469,000 1,058,000
Prepaid expenses and other current assets 15,000 (81,000)
Accounts payable and accrued expenses 466,000 (2,025,000)
Accrued royalties (2,463,000) (671,000)
Accrued returns and allowances (1,598,000) (1,378,000)
------------ ------------
Net cash provided by operating activities 4,073,000 732,000
Cash flows used in investing activities:
Acquisition of equipment (306,000) (25,000)
------------ ------------
Cash flows from financing activities:
Payment on advance from bank (5,355,000) --
Net proceeds from issuance of common stock 11,697,000 --
Proceeds from exercise of options and warrants 44,000 182,000
------------ ------------
Net cash provided by financing activities 6,386,000 182,000
Effect of exchange rate changes on cash (81,000) (29,000)
------------ ------------
Net increase in cash 10,072,000 860,000
Cash and cash equivalents - beginning of period 2,734,000 1,895,000
------------ ------------
Cash and cash equivalents - end of period $ 12,806,000 $ 2,755,000
============ ============
Supplemental disclosure of cash flow information:
Cash paid during the period for income taxes $ 4,000 $ 3,700
============ ============
Cash paid during the period for interest $ 36,000 $ 84,000
============ ============
</TABLE>
See notes to consolidated financial statements.
6
<PAGE> 7
ToHQ, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Unaudited Interim Financial Information. The financial statements
included herein have been prepared by the Company, without audit, pursuant to
the rules and regulations of the Securities and Exchange Commission. Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with generally accepted accounting principles have been
condensed or omitted pursuant to such rules and regulations. While the Company
believes that the disclosures made are adequate to make the information
presented not misleading, it is recommended that these financial statements be
read in conjunction with the consolidated financial statements and the notes
thereto included in the Company's Annual Report on Form 10-K for the year ended
December 31, 1996.
In the opinion of management, such unaudited financial statements
include all adjustments (consisting only of normal recurring adjustments)
necessary to present fairly the information set forth herein. The results for
the three months ended March 31, 1997 are not necessarily indicative of the
results to be expected for the full year or for any interim period.
Net Income Per Share. Net income per share has been computed using the
weighted average number of common shares and common share equivalents (which
consists of warrants and options, to the extent they are dilutive). The
difference between primary and fully diluted earnings per share is not
significant.
Cash and Cash Equivalents. The Company considers all highly liquid
investments with an original maturity of three months or less to be cash
equivalents.
Recently Issued Accounting Pronouncements. The Financial Accounting
Standards Board issued Statement of Financial Accounting Standard Number 128
Earnings Per Share ("FAS 128"), in February 1997. This statement specifies the
computation of earnings per share ("EPS") as basic EPS, consisting of the
weighted average shares outstanding and diluted EPS, consisting of weighted
average shares and all dilutive potential common shares that were outstanding
during the period. The Company does not expect the impact of adopting FAS 128
to be material for the quarter ended March 31, 1997.
7
<PAGE> 8
2. ACCOUNTS RECEIVABLE
Accounts receivable are due primarily from domestic and foreign
retailers and distributors, including mass merchants and specialty stores.
Accounts receivable at March 31, 1997 and December 31, 1996 are composed of the
following:
<TABLE>
<CAPTION>
March 31, December 31,
1997 1996
------------ ------------
<S> <C> <C>
Accounts receivable - domestic $ 7,930,000 $ 13,428,000
Other accounts receivable - primarily foreign 4,139,000 5,004,000
Other receivables 5,000 112,000
Allowance for foreign doubtful accounts (1,195,000) (1,294,000)
Allowance for foreign discounts and returns (383,000) (292,000)
Allowance for domestic doubtful accounts,
discounts and returns (2,220,000) (2,772,000)
------------ ------------
Accounts receivable - net $ 8,276,000 $ 14,186,000
============ ============
</TABLE>
3. CAPITAL STOCK TRANSACTIONS
On February 14, 1997, the Company completed a public offering
of 1,500,000 shares of the Company's Common Stock. In conjunction with the
offering, the Company granted to the underwriters an overallotment option,
exercisable within 30 days of the date of February 11, 1997, to purchase up to
225,000 additional shares of the Common Stock at the public offering price of
$7.50 per share. On March 11, 1997, the underwriters exercised their
overallotment option. All of these shares were newly issued and sold on behalf
of the Company.
The net proceeds of the 1,725,000 shares sold by the Company,
approximately $11.7 million, will be used for general corporate purposes
including obtaining licenses for, and development expenses related to, new
titles and the repayment of amounts outstanding under the Company's revolving
credit facility. A portion of the proceeds may also be used to fund acquisitions
related to the Company's business. [Following the repayment of indebtedness
under the Company's revolving credit facility and pending the use of the balance
of such proceeds for such other purposes, the Company will invest such proceeds
principally in United States government securities, short-term certificates of
deposit, money market funds or other short-term, interest bearing investments.]
8
<PAGE> 9
4. INCOME TAXES
Net Operating Loss Carryforwards. At December 31, 1995, for federal
income tax purposes the Company had reported approximately $17.5 million of NOL
carryforwards incurred since 1993. The December 31, 1996 tax return has not been
prepared and as such, the net operating loss figures have not been adjusted for
1996 taxable income. The sale of 1,500,000 shares of Common Stock offered by the
Company on February 11, 1997 resulted in an "ownership change" of the Company
for purposes of Sections 382 and 383 of the Internal Revenue Code of 1986, as
amended. As a result, the amount of the NOL carryforwards available to reduce
the Company's federal income tax liability in future years in which the Company
has taxable income will be limited to an annual amount equal to (i) the fair
market value of the Company's capital stock immediately prior to the
consummation of the offering on February 11, 1997, multiplied by (ii) the
"long-term tax exempt rate" published by the Internal Revenue Service for the
month in which the offering was consummated. Based upon a long-term tax exempt
rate for February 1997 of 5.48% and an assumed market price of the Common Stock
immediately prior to consummation of this offering of $8.56 per share (the last
reported sale price of the Common Stock on February 10, 1997), such amount is
estimated to be approximately $2,225,000 per year.
---------------------------------
9
<PAGE> 10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
The Company develops, publishes and distributes interactive
entertainment software ("Software") for the market dominant hardware platforms
("Platforms") sold by Nintendo, Sega and Sony (the "Manufacturers"). For the
three months ended March 31, 1997, sales of Nintendo Software constituted 77% of
the Company's net sales, Sega Software sales were 3%, and the remaining 20% were
derived from sales of Sony PlayStation titles.
Although there remains a large installed base of 16-bit Platforms, the
Company believes that growth in the Software market will be derived principally
from games developed for the more advanced Platforms. Accordingly, the Company
intends to devote an increasing portion of its resources to the development of
titles for 32-bit and 64-bit Platforms and PCs. In the three months ended March
31, 1997 and 1996, respectively, 20% and 17% of the Company's net sales were
made up of 32-bit titles. There were no 64-bit sales in either period.
The Company's business cycle generally commences with the securing of a
license to publish one or more titles based upon entertainment projects (such as
movies, television programs and arcade games), sports and entertainment
personalities, or popular sports, trends or concepts ("Property") that have high
public visibility or recognition or that reflect the trends of popular culture.
Such licenses typically require an advance payment to the licensor and a
guarantee of minimum future royalties. See "-- Recovery of Prepaid Royalties,
Guarantees and Capitalized Development Costs." After securing the Property, the
Company commences Software development for the title. Upon completion of
development and approval of the title by the Manufacturer, the Company orders
products and generally causes a letter of credit to be opened in favor of the
Manufacturer.
Revenue Fluctuations and Seasonality. The Company has experienced and
may continue to experience significant quarterly fluctuations in net sales and
operating results due to a variety of factors, including the timing of releases
of new titles by the Company, the popularity of both new titles and titles
released in prior periods, fluctuations in the mix of titles with varying profit
margins, the timing of customer orders, the timing of shipments by the
Manufacturers, fluctuations in the size and rate of growth of consumer demand
for Software for various Platforms, the timing of the introduction of new
Platforms and the accuracy of retailer's forecasts of consumer demand. The
Company's expenses are based, in part, on its expectations of future revenues
and, as a result, operating results would be disproportionately and adversely
affected by a decrease in sales or a failure by the Company to meet its sales
expectations. In addition, the Software market is highly seasonal, with sales
typically significantly higher during the fourth quarter (due primarily to the
increased demand for interactive games during the year-end holiday buying
season). There can be no assurance that the Company can maintain consistent
profitability on a quarterly or annual basis.
10
<PAGE> 11
Profit margins may vary over time as a result of a variety of other
factors. Profit margins for cartridge products can vary based on the cost of the
memory chip used for a particular title. As Software has grown more complex, the
trend in the Software industry has been to utilize chips with greater capacity
and thus greater cost. CD-ROMs have significantly lower per unit manufacturing
costs than cartridge-based products. However, such savings may be offset by
typically higher development costs for titles published on CD-ROMs; such higher
costs result from the creation of increased and enhanced content to take
advantage of the greater storage capacity available on CD-ROMs.
Recovery of Prepaid Royalties, Guarantees and Capitalized Development
Costs. The Company typically enters into agreements with licensors of Properties
and developers of titles that require advance payments of royalties and/or
guaranteed minimum royalty payments. There can be no assurance that the sales of
products for which such royalties are paid will be sufficient to cover the
amount of these required royalty payments. The Company capitalizes its prepaid
royalties, and capitalizes Software development costs upon the establishment of
technological feasibility of the title under development. Amortization of these
payments and costs is determined on a title-by-title basis based on the greater
of (i) the ratio of current gross revenues for a title to the sum of its current
and anticipated gross revenues, or (ii) the straight-line method over the
estimated remaining economic life of the title. The Company analyzes such
capitalized costs quarterly and writes off as project abandonment losses those
capitalized payments and costs (and expenses any unpaid guaranteed minimum
royalties) when, based on the Company's estimate, future revenues will not be
sufficient to recover such costs. As of March 31, 1997, the Company had prepaid
royalties and capitalized development costs of approximately $7.6 million. If
the Company were required to write off a material portion of its prepaid
royalties or capitalized development costs, the Company's results of operations
could be adversely affected.
Discounts, Allowances and Returns; Inventory Management. At the time of
product shipment, the Company establishes provisions against the gross revenues
generated by such shipment based on estimates of future returns of, other
customer accommodations and doubtful accounts that may be granted with respect
to, such products, based on the Company's historical experience, retailer
inventories of the titles and other factors. For the three months ended March
31, 1997, provisions of approximately $3.8 million were taken against gross
sales made, and for the year ended December 31, 1996, the Company's aggregate
reserves against accounts receivable for returns, customer accommodations and
doubtful accounts were approximately $5.2 million.
Net Operating Loss Carryforwards. At December 31, 1995, for federal
income tax purposes the Company had reported approximately $17.5 million of NOL
carryforwards incurred since 1993. The December 31, 1996 tax return has not been
prepared and as such, the net operating loss figures have not been adjusted for
1996 taxable income. The sale of 1,500,000 shares of Common Stock offered by the
Company on February 11, 1997 resulted in an "ownership change" of the Company
for purposes of Sections 382 and 383 of the Internal Revenue Code of 1986, as
amended. As a result, the amount of the NOL carryforwards available to reduce
the Company's federal income tax liability in future years in which the Company
has
11
<PAGE> 12
taxable income will be limited to an annual amount equal to (i) the fair
market value of the Company's capital stock immediately prior to the
consummation of the offering on February 11, 1997, multiplied by (ii) the
"long-term tax exempt rate" published by the Internal Revenue Service for the
month in which the offering was consummated. Based upon a long-term tax exempt
rate for February 1997 of 5.48% and an assumed market price of the Common Stock
immediately prior to consummation of this offering of $8.56 per share (the last
reported sale price of the Common Stock on February 10, 1997), such amount is
estimated to be approximately $2,225,000 per year.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the
components of the Company's net sales and its consolidated operating data as a
percentage of net sales:
<TABLE>
<CAPTION>
THREE MONTHS
ENDED MARCH 31,
1997 1996
--------- --------
<S> <C> <C>
Domestic sales 59.7 % 70.6
Foreign sales 40.3 29.4
----- -----
Net sales 100.0% 100.0%
Costs and expenses:
Cost of sales 61.2% 57.1%
Royalties 13.0 18.2
Product development 1.6 3.3
Project abandonment 1.3 1.9
Selling 6.5 8.2
General and administrative 10.0 12.8
Operating interest 0.6 1.4
----- -----
Total costs and expenses 94.2 102.9
----- -----
Income (loss) from operations 5.8 (2.9)
Interest income (expense), net 0.3 (1.1)
----- -----
Income (loss) before income taxes 6.1 (4.0)
===== =====
Net income (loss) 6.1% (4.0)%
===== =====
</TABLE>
12
<PAGE> 13
The following table sets forth, for the three months ending March 31,
1997 and 1996, the titles released during such periods for the Platforms
indicated:
<TABLE>
<CAPTION>
MARCH 31,
-------------------------
1997 1996
----------- -----------
<S> <C> <C>
PlayStation 1 1
SNES 5 --
Genesis 2 --
Game Boy 1 2
----------- -----------
Total 9 3
=========== ===========
</TABLE>
COMPARISON OF THE THREE MONTHS ENDED MARCH 31, 1997, TO THE THREE MONTHS ENDED
MARCH 31, 1996
The Company's net sales increased to $11,839,000 in the three months
ended March 31, 1997, from $6,582,000 in the same period of 1996, primarily as a
result of an increase in the number of new titles released in 1997. For the
three months ended March 31, 1997, net sales of the Company's WCW Vs the World,
Super Empire Strikes Back and Super Return of the Jedi titles were $2,117,000
(17.9% of the net sales), $1,736,000 (14.7% of net sales), and $1,674,000 (14.1%
of net sales), respectively. In total, nine new titles were released in the
three months ended March 31, 1997 accounting for $6,882,000 or 58% of net sales
as compared to three new titles being released in the same period of 1996
accounting for $3,092,000 or 47% of net sales.
Foreign net sales grew to $4,776,000 in the first quarter of 1997, from
$1,933,000 in the same period of 1996 as a result of a distribution agreement
between the Company and Midway Games, Inc. This agreement included the
distribution rights to Ms. Pacman, NBA Hangtime and Midway's Arcades Greatest
Hits, for certain 16-bit Platforms. These titles accounted for 8.3% or $982,000
of net sales.
Cost of sales increased as a percentage of net sales during the first
quarter of 1997 to 61.2% from 57.1% in the same period of 1996, primarily as a
result of the increase in foreign sales, for which margins are generally lower,
to 40.3% of net sales from 29.4% of net sales in the first quarter of 1996.
Royalty expense as a percentage of net sales decreased to 13.0% for the
three months ended March 31, 1997 from 18.2% for 1996. License agreements for
titles released in 1996 provided for royalties at higher rates, particularly the
Company's licenses for Disney's Pocahontas and In The Hunt. Additionally,
royalties relating to the Midway distribution agreements were included in cost
of sales rather than royalty expense.
For the three months ended March 31, 1997, selling expenses increased
by $235,000 compared to the three months ended March 31, 1996, as a result of
increased marketing efforts
13
<PAGE> 14
for new titles and an increase in retail cooperative advertising. Selling
expenses decreased as a percentage of net sales to 6.5% in 1997 as compared to
8.2% in 1996.
General and administrative expenses for the three months ended March
31, 1997, decreased as a percentage of net sales to 10.0% from 12.8% for the
same period of 1996, but increased in dollar terms by $338,000 over 1996. The
increased expenses were due in part to increased warehousing costs in 1997 as a
result of the increased sales volume over the same period in 1996.
Operating interest, which consists of interest and fees paid to the
Company's bank and fees paid to other issuers of letters of credit, decreased as
a percentage of net sales to 0.6% for the three months ended March 31, 1997,
from 1.4% of net sales for the same period of 1996. The decline is a result of
the use of funds generated by the Public Offering, which was completed on
February 14, 1997. See "-- Liquidity and Capital Resources."
LIQUIDITY AND CAPITAL RESOURCES
The Company's principal uses of cash are product purchases, guaranteed
payments to licensors, advance payments to developers and the costs of internal
Software development. In order to purchase products from the Manufacturers, the
Company must generally open letters of credit in their favor. As of March 31,
1997, the Company had obligations with respect to future guaranteed minimum
royalties of $5,673,000, substantially all of which was payable within the
subsequent twelve months. As of March 31, 1997, the Company had obligations with
respect to open letters of credit of $1,856,000.
The amount of the Company's accounts receivable is subject to
significant seasonal variations due to the seasonality of sales, and is
typically highest at the end of the year. As a result, the Company's working
capital requirements are greatest during its third and fourth quarters. The
Company believes that the proceeds from its recently completed offering,
together with funds provided by operations and funds available under the
Company's revolving credit facility with Imperial Bank, will be adequate to meet
the Company's anticipated requirements for operating expenses, product
purchases, guaranteed payments to licensors and Software development through
1997. However, to the extent accounts receivable, inventories and guarantees and
advance payments increase as a result of growth of the Company's business, the
Company could require additional working capital to fund its operations. The
Company does not anticipate making material capital expenditures in 1997.
For the three months ended March 31, 1997, the Company's net cash
provided by operating activities was $4,073,000, compared to $732,000 for the
same period in 1996, as a result of net income plus collections of receivables.
14
<PAGE> 15
For the three months ended March 31, 1997, the Company's net cash used
in investing activities was $306,000 (primarily as a result of the installation
of an upgraded computer network and accounting software package), compared to
$25,000 for the same period in 1996.
For the three months ended March 31, 1997, the Company's net cash
provided by financing activities was $6,386,000, compared to $182,000 for the
same period in 1996. Financing activities were primarily the receipt of the
proceeds from the public offering of 1,725,000 shares of the Company's Common
Stock.
Credit Facilities. In July 1996, the Company terminated its factoring
and credit agreement and entered into a new financing and banking arrangement
with Imperial Bank (the "Imperial Agreement"). Under the Imperial Agreement, the
Company may draw down working capital advances and open letters of credit in an
aggregate amount not to exceed the lesser of $9,000,000, or an amount equal to
the sum of 70% of eligible accounts receivable, 50% of eligible inventory and
50% of the amount of letters of credit opened by the Company in favor of the
Manufacturers. The portion of the borrowing base that consists of eligible
inventory may not exceed $1,500,000. Advances under the Imperial Agreement bear
interest at the bank's prime lending rate plus 1.25%. The Company has granted
the bank a security interest in its domestic accounts receivable and
inventories. The Imperial Agreement matures on June 30, 1997, subject to earlier
termination. As of March 31, 1997, the Company had no advances under the
Imperial Agreement and open letters of credit from Imperial Bank of $1,856,000.
The Imperial Agreement contains customary covenants including, among
others, restrictions on the incurrence of debt, encumbrances on or sales of
assets, mergers and acquisitions, payments of dividends and capital
expenditures. Financial covenants include the maintenance of (i) a current ratio
of not less than 1.4 to 1, (ii) profitable operations on a fiscal year basis,
(iii) minimum tangible net worth of $7,000,000, (iv) a ratio of debt to tangible
net worth of not greater than 1.75 to 1, and (v) minimum working capital of
$5,000,000.
The Company has also entered into agreements with two additional
lenders (the "North American Lender" and the "European Lender") pursuant to
which such lenders have agreed to issue letters of credit ("L/Cs") on the
Company's behalf to the Manufacturers for the purchase of products for the
Company's North American operations (up to a maximum of $5,000,000) and the
Company's European operations (up to a maximum of $2,500,000), respectively.
Each of these lenders receives a fee for the issuance of such L/Cs, and each
lender retains title to the products financed by such lender until such time as
such products are sold to the Company's customers. The North American Lender has
a security interest in the domestic assets of the Company subordinate to the
security interest of the Company's bank. The term of the agreement with the
North American Lender expires on September 15, 1997, subject to automatic
renewals on such date and every six months thereafter, unless terminated by
either party. The European Lender has a first priority security interest in all
of the Company's European subsidiary's receivables, inventory and other assets.
The agreement with the European Lender may be terminated at any
15
<PAGE> 16
time by such lender. As of March 31, 1997, there were no open letters of credit
issued by the North American or the European lender.
Public Offering. On February 14, 1997, the Company completed a public
offering of 1,500,000 shares of the Company's Common Stock. In conjunction with
the offering, the Company granted to the underwriters an overallotment option,
exercisable within 30 days of the date of February 11, 1997, to purchase up to
225,000 additional shares of the Common Stock at the public offering price. On
March 11, 1997, the underwriters exercised their overallotment option.
All of these shares were newly issued and sold on behalf of the Company.
The net proceeds of the 1,725,000 shares sold by the Company, of $11.7
million, will be used for general corporate purposes including obtaining
licenses for, and development expenses related to, new titles and the repayment
of amounts outstanding under the Company's revolving credit facility. A portion
of the proceeds may also be used to fund acquisitions related to the Company's
business.
-------------------------------------------
16
<PAGE> 17
Part II - Other Information
Item 1. Legal Proceedings
On January 13, 1997, a complaint was filed in
Illinois state court by Studio e, Inc. ("Studio
e"), a video game software development company,
against Inland Productions, Inc., its two
principals and the Company. The Company acquired
25% of Inland in June 1996 shortly after its
formation for consideration consisting of $300,000
in cash and 52,660 shares of Common Stock with a
value at such time of approximately $300,000; and
the Company has contracted with Inland for the
development of Turner's World Championship
Wrestling for the PlayStation and Nintendo 64. The
complaint alleges, among other things, that the
defendants misappropriated trade secrets of Studio
e, caused delays in the development of one of
Studio e's titles, and as a result were
responsible for Studio e's loss of future
business. The complaint seeks, among other
remedies, to enjoin the Company's alleged use of
Studio e's trade secrets and damages in an
unspecified amount. The complaint makes additional
allegations and seeks additional damages and other
remedies against Inland and Inland's principals.
The Company denies all allegations of wrongdoing
asserted against it in the complaint and intends
to vigorously defend against such claims. On March
12, 1997, the Company filed an answer to the
complaint denying all allegations of wrongdoing
asserted against it. The Company also filed a
counterclaim against Studio e alleging trade
defamation and libel and intentional interference
with prospective economic advantage, and a
cross-claim for indemnification against Inland.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits.
Exhibit 27 Financial Data Schedule.
(b) Reports on Form 8-K
A Current Report on Form 8-K dated March 28,
1997 was filed with the Securities and
Exchange Commission, (reporting under Item
7, of Form 8-K, the Company's cautionary
statement regarding forward looking
statements, (as amended by the Form 8-K/A
filed with the Securities and Exchange
Commission May 6, 1997).
17
<PAGE> 18
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.
Dated: May 14, 1997 ToHQ, INC.
By: /s/ Brian J. Farrell
--------------------------------
Brian J. Farrell
President and Chief
Executive Officer
ToHQ, INC.
By: /s/ Deborah A. Lake
---------------------------------
Deborah A. Lake
Vice President Finance
and Administration
Principal Accounting Officer
18
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET, THE CONSOLIDATED STATEMENTS OF OPERATIONS AND THE
CONSOLIDATED STATEMENTS OF CASH FLOWS AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS FOUND IN THE FORM 10-Q AS FILED WITH THE
SEC ON MAY 14, 1997.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> MAR-31-1997
<CASH> 12,806,000
<SECURITIES> 0
<RECEIVABLES> 12,074,000
<ALLOWANCES> 3,798,000
<INVENTORY> 1,990,000
<CURRENT-ASSETS> 31,120,000
<PP&E> 1,485,000
<DEPRECIATION> 667,000
<TOTAL-ASSETS> 32,689,000
<CURRENT-LIABILITIES> 9,411,000
<BONDS> 0
0
0
<COMMON> 4,000
<OTHER-SE> 23,274,000
<TOTAL-LIABILITY-AND-EQUITY> 32,687,000
<SALES> 11,839,000
<TOTAL-REVENUES> 11,839,000
<CGS> 7,242,000
<TOTAL-COSTS> 7,242,000
<OTHER-EXPENSES> 3,903,000
<LOSS-PROVISION> 44,000
<INTEREST-EXPENSE> 36,000
<INCOME-PRETAX> 724,000
<INCOME-TAX> 4,000
<INCOME-CONTINUING> 720,000
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 720,000
<EPS-PRIMARY> 0.12
<EPS-DILUTED> 0.12
</TABLE>
