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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
------------------------------
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended July 31, 1999 Commission File No.: 0-24338
VARIFLEX, INC.
(Exact name of Registrant as specified in its charter)
Delaware 95-3164466
(State or other jurisdiction of (IRS Employer Identification Number)
incorporation or organization)
5152 North Commerce Avenue
Moorpark, California 93021
(Address of principal executive offices)
Registrant's telephone number, including area code:
(805) 523-0322
-----------------------------------------------------
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.001 par value per share
-----------------------------------------------------
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 by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.[_]
The aggregate market value of the Common Stock held by non affiliates of
the Registrant as of October 8, 1999 was approximately $11,128,000 based upon
the closing sale price of the Registrant's Common Stock on such date, as
reported on the Nasdaq National Market. Shares of Common Stock held by each
executive officer and director and each person owning more than 5% of the
outstanding Common Stock of the Registrant have been excluded in that such
persons may be deemed to be affiliates of the Registrant. This determination of
affiliate status is not necessarily a conclusive determination for other
purposes.
Shares of $.001 par value Common Stock outstanding at October 8, 1999:
5,512,418 shares.
-----------------------------------------------------
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's definitive Proxy Statement for its 1999 Annual
Meeting of Stockholders scheduled to be held on December 6, 1999 are
incorporated by reference into Part III of this Form 10-K.
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Statements in this Annual Report on Form 10-K as well as oral statements
that may be made by the Company or by officers, directors or employees of the
Company acting on the Company's behalf, that are not historical fact constitute
"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. All statements, trend analysis and other information contained in
this Form 10-K relative to markets for the Company's products and trends in net
sales, gross margins and anticipated expense levels, as well as other statements
including words such as "anticipate," "plan," "estimate," "expect," "intend" and
other similar expressions, constitute forward-looking statements. These forward-
looking statements involve risks and uncertainties, including, but not limited
to: the risk of reduction in consumer demand for the product categories in which
the Company does business or for the Company's products in particular; the risk
that the Company may not continue to expand and diversify its business and
product lines; the risk of loss of one or more of the Company's major customers;
the risk that the Company may not be able to continue to provide its products at
prices which are competitive or that it can continue to design and market
products that appeal to consumers even if its products are price competitive;
and the risk that the Company may not be able to obtain its products and
supplies on substantially similar terms, including cost. In addition, the
Company's business, operations and financial condition are subject to risks
which are described in the Company's reports and statements filed from time to
time with the Securities and Exchange Commission, including this Report. Actual
results of operations may differ materially from those contained in the forward-
looking statements. For a discussion of factors that might cause such a
difference, see "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Additional Factors That Could Affect Operating Results."
PART I
Item 1. Business.
(a) General Development of Business.
Variflex, Inc. (the "Company") is a leading distributor and wholesaler
in the United States of in-line skates, skateboards, recreational safety
helmets, athletic protective equipment (such as wrist guards, elbow pads and
knee pads used by skaters and skateboarders), snowboards, yo-yo's, and portable
instant canopies, and introduced a springless trampoline in the fourth quarter
of 1999. The Company designs and develops these products which are then
manufactured to the Company's detailed specifications by independent
contractors. The Company distributes its products throughout the United States
and in foreign countries.
The Company was originally incorporated in California in 1977, and
reincorporated in Delaware in March 1994. Unless the context otherwise
requires, references in this Form 10-K to the "Company" refer to Variflex, Inc.
and its subsidiaries.
(b) Financial Information about Industry Segments.
Financial information concerning the Company's business is included in
Items 6, 7, 8 and 14.
(c) Narrative Description of Business.
(1) Products.
The Company's principal products are in-line roller skates, which
feature wheels mounted in a straight line on a composite plastic chassis,
functioning much like the blade on an ice skate. The Company currently sells
various models of in-line skates to the mass market under the Variflex(R) brand.
The Company's in-line roller skates generally consist of a molded
polymer boot with a wheel chassis attached to the bottom of the boot, and high
density polyurethane wheels mounted on bearings and bolted through the wheel
chassis. The boot contains a removable breathable nylon liner which increases
comfort. The wheel chassis is, depending on the model, made of either
fiberglass-filled nylon or various plastics. Each chassis holds three or four
wheels mounted in line, and each pair of skates has either one or two brakes,
consisting of a hard rubber pad mounted on the rear of the chassis.
The Company also markets skateboards and skoot skates. The Company
presently offers different models of skateboards under the Variflex(R) brand and
various models of the Variflex Skoot Skate, which is a skateboard with a
removable handle for young children and beginners. Additionally, the Company
offers a line of skating and skateboarding protective equipment, such as knee
pads, elbow pads and wrist guards.
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The Company has developed and markets its Quik Shade(R) instant canopy,
designed to offer portable shade and shelter for a variety of uses with the
convenience of easy set-up and take-down. The Company presently offers multiple
models of the Quik Shade(R).
The Company also markets a line of skater and recreational safety helmets.
The helmets are marketed to cyclists, skateboarders and in-line skaters. The
Company presently has adult helmet models, young adult models, youth models,
child models and toddler models. Each model features ventilated aerodynamic
designs with adjustable straps, and each comes in a variety of colors and
graphics. The Company's helmets are manufactured by independent contractors
using either a process of injecting a polyurethane foam or expanded polystyrene
(EPS) to form a strong, lightweight protective inner shell bonded to a hard PVC
outer shell. All of the Company's helmets meet or exceed the standards of the
American Society for Testing and Materials (ASTM) and the Consumer Product
Safety Commission (CPSC).
During 1999, the Company entered into an exclusive license agreement with
Product Resource and Development, Inc. to manufacture and market a springless
trampoline that uses an elastic material to provide the bounce and lift. The
agreement gives the Company worldwide rights to the patent pending technology.
The trampolines are being sold under the Airzone(TM) brand.
The Company, during 1999, entered into a license agreement to produce a
line of in-line skates, accessories, snowboards, helmets and yo-yo's under the
"X-Games" brand.
During 1999, the Company terminated its exclusive right to manufacture,
market and distribute all snowboards bearing the Barfoot(TM) brand name.
During 1998, the Company sold the assets of the manufacturing operation of
its wholly-owned subsidiary, Static Snowboards, Inc., and closed the
manufacturing factory, and is sourcing snowboards from independent contractors.
For the fiscal years ended July 31, 1999, 1998 and 1997, these products
comprised the following percentages of the Company's total gross sales:
1999 1998 1997
---- ---- ----
In-line skates 51% 56% 69%
Canopies 18% 9% 1%
Skateboards and scooters 15% 18% 17%
Yo-yo's 6% - -
Recreational safety helmets 5% 7% 5%
Athletic protective equipment 2% 5% 5%
Snowboards 2% 5% 3%
Other 1% (*) (*)
--- --- ---
Total 100% 100% 100%
=== === ===
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(*) Less than one-half of one percent.
The Company's products are marketed in North America primarily through a
network of independent sales representatives and marketing organizations,
through attendance by representatives of the Company at industry trade shows and
through customer visits by Company employees. The Company's current customers
consist primarily of national mass merchandisers, regional mass merchandisers,
catalog houses, major sporting goods chains, major home improvement chains, and
international exporters. The Company's wholly owned subsidiary, Oketa Ltd., is
used to facilitate sales and the shipment of products to international customers
and to customers in the United States who desire to purchase product through
international letter of credit transactions.
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(2) Status of products in development.
The Company frequently changes the cosmetic features of its products, such
as graphics and colors, and attempts to develop new products or new designs for
existing products in response to customer requests or changes in consumer
preferences.
During 1999, the Company introduced its Airzone(TM) springless trampoline.
The Company made its initial shipments of these trampolines in the fourth
quarter of 1999.
During 1999 and 1998, the Company introduced additional models of its Quik
Shade(R) portable instant canopy. This product was initially introduced during
1997, with only one model. A U.S. Patent was issued for the Quik Shade(R) during
1998.
Despite these and other efforts by the Company to update the designs,
features and componentry of existing products and to develop potential new
products or new designs, there can be no assurance that such efforts will be
successful or that such changes or new products will be readily acceptable to
customers and consumers.
(3) Source of materials.
With the exception of some domestically produced yo-yo's, all of the
Company's products are sourced from independent contractors located primarily in
Asia. These suppliers manufacture, assemble and package the Company's products
under the detailed specifications of the Company's management representatives
who visit frequently to oversee quality control and work on cost containment.
The raw materials and subcomponents for these products are manufactured by
independent contractors, most of which are also located primarily in Asia, that
have been procured by the Company's suppliers or, often, by the management of
the Company.
The Company submits purchase orders to its manufacturers for the production
of specific amounts of its products and has not entered into any long-term
contractual agreements. The Company negotiates the cost of its products directly
with its foreign suppliers in U.S. Dollars.
A significant portion of the Company's products, including various models
of its in-line skates, are manufactured in mainland China, which trades with the
United States under a Normal Trade Relations ("NTR") trade status. While the
Company believes that alternative manufacturing sources could be found,
maintaining existing costs will depend upon these products continuing to be
treated under NTR tariff rates. From time to time, the U.S. has threatened to
rescind NTR tariff rates and impose trade sanctions on certain goods
manufactured in China. To date, no such sanctions have been imposed that have
affected the Company or its products; however there can be no assurance with
regard to the possible imposition of sanctions in the future.
(4) Patents, trademarks, licenses, franchises and concessions.
The Company holds or has pending certain design patents and utility
patents. In the course of its business the Company employs various trademarks
and trade names, including its own logos, in the packaging and advertising of
its products. The Company has registered the Variflex(R), Static(R), Quik
Shade(R) and Airzone(TM) trademarks in the United States, and has secured a
worldwide watch to alert the Company to any unauthorized use in any other parts
of the world. Registration of various other trademarks for the Company's
products are pending. The Company has entered into an exclusive license
agreement to manufacture and market a springless trampoline. Also, the Company
has entered into a license agreement to produce "X-Games"-identified
merchandise.
(5) Major customers.
The Company had four customers which have each individually accounted for
more than 10% of the Company's sales in one or more of the past three fiscal
years: the Kmart Corporation, based in Detroit, Michigan; Sears, Roebuck and
Co., based in Chicago, Illinois; Target Stores, based in Minneapolis, Minnesota;
and Toys "R" Us, Inc., based in Paramus, New Jersey.
Collectively, sales to Kmart, Sears, Target and Toys "R" Us represented
approximately 64%, 67%, and 70% of the Company's total gross sales for the
fiscal years ended July 31, 1999, 1998, and 1997, respectively. Kmart, which
accounted for 15% of the Company's gross sales for fiscal 1997, is no longer a
major customer for the Company's in-line skates and skateboards. However, due to
the pricing structure for Kmart, this event had a positive impact on the
Company's gross margin for fiscal 1999 and fiscal 1998.
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(6) Backlog.
The Company had approximately $2,438,000 in unfilled purchase orders as of
September 30, 1999, compared to approximately $3,459,000 as of September 30,
1998. The Company believes that substantially all of these unfilled orders are
firm and will be filled in the 2000 fiscal year. Of the backlog as of September
30, 1999, approximately $200,000 represented orders for products which had not
yet been received from suppliers as of that date. Substantially all of the
remaining $2,238,000 of the backlog at September 30, 1999 represents fall
booking orders of products on hand to be shipped at future dates.
(7) Government contracts.
The Company has no United States or foreign government contracts.
(8) Competition.
The principal competitive factors in each of the Company's product
categories are price and performance. With respect to in-line skates in
particular, the main areas of difference in product performance are in the
weight and strength of the boot and frame, the hardness of the wheels, and the
quality of the wheel bearings. The Company offers a 60-day warranty on its
products with the exception of the Quik Shade(R) instant canopy where a one year
warranty is offered and the Airzone(TM) trampoline where a tiered warranty
averaging two years is offered. Beyond such warranty, the Company does not offer
service on its products, and does not believe that is an important competitive
factor.
Independent research indicates that the Company has a significant market
share in the in-line skate category, particularly in the mass market segment,
where Variflex enjoys name recognition and is considered a market leader. The
Company's primary competitors in the mass market include First Team Sports, Inc.
(Skate Attack), Roller Derby (CAS), Seneca and certain models from Rollerblade,
Inc. (Blade Runner). In the case of athletic protective equipment, Franklin
Sports is the Company's primary competitor in the mass market. Bell Sports Corp.
(Bell and BSI) and Protective Technologies, Inc. (PTI) are the primary
competitors in the recreational safety helmet mass market. For instant canopies,
the Company's primary competitors are International E-Z Up, Inc. and
Enviroworks, Inc. For trampolines, a new category introduced in 1999, the
Company's primary competitors are Jumpking, Inc. and Hedstrom. In addition, the
Company may compete with its primary customers when such customers directly
source products that the Company sells.
While management believes that the quality of its products and the service
it provides to its customers are important factors in retaining accounts, the
Company clearly operates in a highly competitive environment and there are no
significant technological or manufacturing barriers to entry for most product
categories other than the Quik Shade(R) instant canopy and the Airzone(R)
trampoline. Management believes that price is a major competitive factor,
particularly in the mass market. At present, the Company believes that its
products in each category, when compared to competitors' products of comparable
quality, are currently offered at comparable prices to most of its competitors.
However there can be no assurance that other companies, whether new enterprises
or established members of the retail or sporting goods industries, will not be
able to develop products of comparable or higher quality at lower prices, or
that the Company's price structure will not be affected by future circumstances.
(9) Research and development.
Estimated research and development expenses for Company-sponsored research
activities relating to the development of new products, services or techniques
or the improvement of existing products, services or techniques were not
material in fiscal 1999, fiscal 1998 and fiscal 1997.
(10) Effect of environmental regulation.
To the extent that the Company's management can determine, there are no
federal, state or local provisions regulating the discharge of materials into
the environment or otherwise relating to the protection of the environment, with
which compliance by the Company has had or is expected to have a material effect
upon the capital expenditures, earnings or competitive position of the Company.
(11) Employees.
As of July 31, 1999, the Company employed approximately 77 full-time
employees. None of the Company's employees are represented by unions.
5
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Item 2. Properties.
The Company's principal facility is a leased 104,000 square foot concrete
tilt-up building comprising the Company's corporate headquarters and executive
offices, as well as serving as the United States distribution center for the
Company's products, located at 5152 North Commerce Avenue, Moorpark, California,
approximately forty miles northwest of Los Angeles, California. The Company also
subleases in an immediately adjacent building approximately 27,000 square feet
consisting primarily of additional warehouse space. The leases for these
facilities expire December 31, 2000 and June 30, 2000, respectively, after which
management believes new leases can be negotiated, at those locations or for
other equivalent space, on satisfactory terms. The Company also stores inventory
in temporary facilities from time to time as required due to the timing of
shipments.
The Company's subsidiary, Static Snowboards, Inc., leased a facility of
approximately 30,000 square feet, located in Huntington Beach, California which
expires September 30, 2000. With the closure of the Static manufacturing
operation, the Company has sublet this facility.
Management believes that the Company's present facilities will be adequate
for the near future.
Item 3. Legal Proceedings.
In March 1998, the Company was served with two lawsuits entitled: (i) Mark
C. Carter and International E-Z Up, Inc. v. Variflex, Inc. and Service
Merchandise Co., Inc. (Case No. 98-0167 WJR (RNBx)) in the United States
District Court for the Central District of California in Los Angeles and (ii)
James P. Lynch and KD Kanopy, Inc. v. Variflex, Inc. (Civil Action No. 98-D-477)
in the United States District Court of Colorado. The first Complaint (a)
alleges, among other things, that the Company's Quik Shade(R) product infringes
a patent owned by the plaintiff and used in a competing instant set-up,
collapsible canopy product, and infringes plaintiff's trade dress, and (b) prays
for unspecified monetary damages, treble damages, punitive damages, costs and
attorney's fees, an injunction and the destruction of all allegedly infringing
products. The second Complaint (a) alleges that the Company's Quik Shade(R)
product infringes two patents owned by the plaintiff and (b) prays for an
accounting, general damages, treble damages, an injunction and costs and
attorney's fees. The Company has filed an answer in both lawsuits denying the
allegations of the Complaints and has filed counterclaims in both lawsuits
seeking declarations of patent invalidity and non-infringement as to the
plaintiffs' patents, as well as damages against the plaintiffs for alleged
antitrust violations and restitution for unfair competition violations.
On September 8, 1999 the Court allowed plaintiffs Carter and E-Z Up to
amend their Complaint to state an additional claim against the Company for
alleged infringement of an additional patent. The Company has answered this
amended Complaint, denying its material allegations, and pleading an amended
counterclaim for similar alleged wrongs as previously pleaded in its
counterclaim.
In September 1998, the Company received a demand for defense and
indemnification of Service Merchandise Company, Inc. in that action entitled
Mark C. Carter, et. al. v. Service Merchandise Company, Inc., (Case No. C98-
03274 DLJ ENB) in the United States District Court for the Northern District of
California. The Complaint in this action is virtually identical to the
Complaint against Service Merchandise in the above-referenced action by Carter
in the Central District of California in Los Angeles. The Company has agreed to
indemnify and defend Service Merchandise (which is a retailer of the Company's
product) in this action. Service Merchandise filed an answer to the Complaint
in the Central District of California (Los Angeles) action. Thereafter, the
plaintiff dismissed without prejudice the Northern District of California
action, and the claim proceeded in the Los Angeles action. Thereafter, Service
Merchandise filed a Chapter 11 bankruptcy petition, so the case is now stayed as
to that defendant only. No party has taken action to obtain an order for relief
from the automatic stay as to defendant Service Merchandise.
The Los Angeles action has had extensive discovery taken, with a trial date
set for February 8, 2000. Recently the Denver action was ordered transferred to
the federal court in Los Angeles, with a recommendation for consolidation with
the previously pending Los Angeles action. The Los Angeles court has not yet
acted to consolidate the two actions. The transfer of the Denver action to Los
Angeles and the addition of the new patent in suit probably will result in a 60
to 75 day continuance of the existing trial date by agreement of the parties,
subject to the approval of the Court.
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In the Carter action, SAFECO Insurance Company of America has agreed to
provide a defense with a reservation of rights. SAFECO denies coverage for the
patent claims and reserves rights as to trade dress and advertising injury
claims, asserting numerous defenses to coverage. On September 28, 1999 SAFECO
filed, and on October 11, 1999 caused to be served on the Company, a Complaint
for Declaratory Relief entitled SAFECO Insurance Company of America vs.
Variflex, Inc., et al., (Case No. BC217286) in the Superior Court of the State
of California for the County of Los Angeles ("the Coverage Action"). The
Coverage Action asserts a single cause of action for declaratory relief by which
SAFECO seeks a declaration concerning seven different theories of defense to
coverage liability in the underlying Carter action. The Company has not yet
answered the Coverage Action, but it will do so on or before November 10, 1999.
The Company intends vigorously to defend the coverage action. Further, based on
a recent judicial decision, the Company also will tender to SAFECO the defense
of the Lynch action referenced above.
The Company believes it has meritorious defenses to the claims alleged in
the Carter and Lynch Complaints and intends to conduct a vigorous defense. The
Company also intends to vigorously pursue its counterclaims. An unfavorable
outcome in the above matters could have a material and adverse effect on the
Company's business prospects and financial condition.
In addition, even if the ultimate outcome in both cases is resolved in
favor of the Company, the defense of such litigation may involve considerable
costs, which could be material, and could divert the efforts of management,
which could have a material and adverse effect on the Company's business and
results of operations.
From time to time the Company is involved in other claims and lawsuits
arising in the ordinary course of its business. In the opinion of management,
all of these claims and lawsuits are covered by insurance or these matters will
not have a material and adverse effect on the Company's business, financial
condition, results of operations or cash flows.
Item 4. Submission of Matters to a Vote of Security Holders.
No matters were submitted to a vote of the Company's stockholders during
the quarter ended July 31, 1999.
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Executive Officers and Directors of the Company
The following sets forth the names and ages of executive officers and
directors of the Company as of October 20, 1999, in addition to information
regarding their positions with the Company, their periods of service in such
positions, and their business experience for the past five years.
Name and Age of Current Positions with Company and Principal
Executive Officer Occupations for the Past Five Years
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Mark S. Siegel Chairman of the Board and Director since November 1997;
Age 48 President of REMY Investors & Consultants, Inc., a
private investment and financial management company,
and its affiliates (collectively, "Remy") since its
founding in 1993.
Raymond H. Losi, II Chief Executive Officer since November 1997; Chief
Age 47 Operating Officer of the Company since January 1992;
Director of the Company since 1985; President of the
Company from 1992 to August 1998; Vice President of
Procurement for the Company from 1984 to January 1992;
Director of Product Development for the Company since
its inception in August 1977. Mr. Losi is the son of
Raymond H. Losi, who is a director of the Company.
Steven L. Muellner President of the Company since August 1998; President
Age 49 and Co-Chief Executive Officer of Applause Enterprises,
a gift and toy company, from July 1996 to May 1998;
Executive Vice President, Sales and Marketing for
Caradon Doors & Windows, Ltd., a door and window
manufacturing company, from January 1995 to June 1996;
President of LouverDrape, a window coverings company,
from August 1992 to August 1994.
Roger M. Wasserman Chief Financial Officer of the Company since May 1998
Age 57 and Treasurer of the Company since June 1998;
Controller of several divisions of Kellwood Company, a
major apparel wholesaler and distributor, from July
1995 to May 1998; Financial Consultant from October
1993 to July 1995.
Paula Coffman Vice President of Operations since April 1999; Vice
Age 35 President of Administrative Services for the Company
from January 1993 to April 1999; Product and Sales
Planning Manager for the Company from December 1991 to
January 1993.
Warren F. Marr Vice President of Sales for the Company since January
Age 58 1990.
Kenneth N. Berns Secretary and Director of the Company since October
Age 39 1998; Employed by Remy since December 1994; partner of
Ridge Properties Ltd., a real estate development and
management company, from January 1993 to December 1994.
Michael T. Carr Director of the Company since March 1998; President and
Age 46 Chief Executive Officer of Weider Publications, Inc., a
publisher of several consumer magazines and specialty
publications, from April 1990 to April 1999.
Loren Hildebrand Director of the Company since February 1994; President
Age 60 of Creative Consultants, which provides consulting
services to the toy industry, since 1992; Executive
Vice President of Lewis Galoob Toys, Inc., toy
manufacturer, from May 1994 to September 1997.
Raymond H. Losi Director of the Company since its inception in August
Age 76 1977; Chairman of the Board from 1977 until November
1997; Chief Executive Officer of the Company from
August 1989 until November 1997; President of the
Company from 1977 until August 1989. Mr. Losi is the
father of Raymond H. Losi II, who is an officer and
director of the Company.
8
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PART II
Item 5. Market for Company's Common Equity and Related Stockholder Matters.
(a) Market Information.
The high and low last sale prices for the Company's Common Stock, as
reported on the Nasdaq National Market, during each of the quarters of the
fiscal years ended July 31, 1998 and 1999 were as follows (per share):
High Low
---- ---
Quarter ended:
October 31, 1997 5 3 3/4
January 31, 1998 6 13/16 3 7/8
April 30, 1998 6 1/4 4 13/16
July 31, 1998 6 4 3/4
October 31, 1998 5 1/8 4 1/8
January 31, 1999 6 4 3/4
April 30, 1999 6 4 1/2
July 31, 1999 6 1/2 4 1/2
The Company's Common Stock is traded on the Nasdaq National Market under
the symbol "VFLX." As of October 8, 1999, the closing sale price of the
Company's Common Stock on the Nasdaq National Market was $5.75.
(b) Holders.
There were 110 holders of record of the Company's Common Stock on October
8, 1999.
(c) Dividends.
The Company has never paid cash dividends and has no present intention to
pay cash dividends in the foreseeable future. The Delaware General Corporation
Law also restricts the Company's ability to pay dividends. The Delaware General
Corporation Law provides that a Delaware corporation may pay dividends either
(1) out of the corporation's surplus (as defined by Delaware law), or (2) if
there is no surplus, out of the corporation's net profit for the fiscal year in
which the dividend is declared or the preceding fiscal year. Any determination
in the future to pay dividends will depend on the Company's financial condition,
capital requirements, results of operations, contractual limitations, legal
restrictions and any other factors the Board of Directors deem relevant.
9
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Item 6. Selected Financial Data.
The following selected consolidated financial data with respect to the
Company's consolidated financial position as of July 31, 1999 and 1998 and
results of operations for the years ended July 31, 1999, 1998 and 1997 has been
derived from the Company's audited consolidated financial statements appearing
elsewhere in this Annual Report. This information should be read in conjunction
with such consolidated financial statements and the notes thereto. The selected
financial data with respect to the Company's consolidated financial position as
of July 31, 1997, 1996 and 1995 and results of operations for the years ended
July 31, 1996 and 1995 has been derived from the Company's audited consolidated
financial statements, which are not presented in this Annual Report.
<TABLE>
<CAPTION>
(In thousands, except per share data)
----------------------------------------------
1999 1998 1997 1996 1995
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Operations Data:
Net sales $ 37,370 $ 43,148 $ 51,661 $ 72,379 $100,317
Pre-tax income (loss) 983 (2,704) (3,083) 680 11,193
Net income (loss) 803 (3,488) (1,805) 564 6,921
Net income (loss) per share:
Basic $ 0.14 ($0.58) ($0.30) $ 0.09 $ 1.15
Diluted $ 0.14 ($0.58) ($0.30) $ 0.09 $ 1.15
Weighted avg. shares outstanding:
Basic 5,817 6,025 6,025 6,025 6,005
Diluted 5,860 6,025 6,025 6,039 6,039
Balance Sheet Data:
Total assets $ 40,617 $ 44,755 $ 47,893 $ 49,405 $ 51,221
Working capital 34,072 39,283 40,210 28,346 31,022
Long-term obligations - - - - 103
Stockholders' equity 35,561 39,872 43,100 44,812 44,359
</TABLE>
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Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
The following discussion should be read in conjunction with the
information under "Selected Financial Data" and the Company's Consolidated
Financial Statements and Notes thereto and other financial data, included
elsewhere in this Annual Report. Certain statements under this caption
constitute "forward-looking statements" under Section 27A of the Securities Act
of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as
amended, which involve risks and uncertainties. The Company's actual results of
operations may differ materially from the results discussed in these forward-
looking statements. For additional information concerning factors that might
cause such a difference, see "Additional Factors That Could Affect Operating
Results."
Results of Operations
Year Ended July 31, 1999 Compared to Year Ended July 31, 1998
Net Sales. Net sales for the fiscal year ended July 31, 1999 totaled
$37,370,000, a decrease of $5,778,000, or 13% from fiscal 1998 net sales of
$43,148,000. Decreases in volume with respect to the Company's in-line skate,
athletic protective equipment, skateboard and scooter, helmet and snowboard
categories, offset to a lesser degree by increases in volume in the yo-yo and
instant canopy categories, were the primary factors leading to the decline in
total sales. Net sales were also adversely affected slightly during fiscal 1999
by a sales price decline in some of the Company's product categories.
With respect to in-line skates, gross sales for fiscal 1999 totaled
$19,876,000, a decrease of approximately $5,050,000, or 20%, compared to fiscal
1998, as unit volume in fiscal 1999 totaled 1,340,000 units, a decrease of
approximately 167,000, or 11%. The average price per unit (gross revenues
divided by units sold) of the Company's in-line skates was approximately $14.83
during fiscal 1999, compared to $16.54 for fiscal 1998. The decrease in in-line
skate sales was primarily due to the fact that Kmart Corporation, which
accounted for approximately $1,900,000 of the Company's gross sales for fiscal
1998 accounted for no sales for fiscal 1999, and is no longer a major customer
for the Company's in-line skates and skateboards, and a reduction in in-line
skate sales to Sears, Roebuck and Co. of approximately $2,300,000 between fiscal
1999 and fiscal 1998, since Sears exited the in-line skate business during
fiscal 1999.
Gross sales for athletic protective equipment during fiscal 1999
totaled $758,000, a decrease of approximately $1,415,000, or 65%, compared to
fiscal 1998, as unit volume in fiscal 1999 was 108,000 units, a decrease of
approximately 333,000, or 76%. The Company's decline in sales of these products
is directly related to the direct sourcing of athletic protective equipment by
the Company's larger customers.
Gross sales of skateboards and scooters during fiscal 1999 totaled
$5,767,000, a decrease of approximately $1,990,000, or 26%, compared to fiscal
1998, on total volume of 492,000 units, a decrease of approximately 86,000, or
15%. The decrease is primarily due to an industry-wide decline in consumer
demand compared to the prior year, as well as a reduction in skateboard sales to
Kmart Corporation of approximately $450,000 between fiscal 1999 and fiscal 1998.
Gross sales of recreational safety helmets during fiscal 1999 totaled
$1,926,000, a decrease of approximately $1,186,000, or 38%, compared to fiscal
1998, while unit volume decreased approximately 152,000, or 38%, to a total of
250,000 units during fiscal 1999. The decrease in helmet sales is primarily due
to a significant increase in margin protection programs being offered by the
Company's competitors.
Gross sales of snowboards and snowboarding accessories, such as
bindings, leashes and miscellaneous apparel items, during fiscal 1999 totaled
$943,000, a decrease of approximately $1,142,000, or 55%, compared to fiscal
1998, while unit volume of snowboards decreased approximately 5,800, or 20%, to
a total of 23,400 units during fiscal 1999. The decrease in snowboard and
snowboarding accessories sales is primarily due to the Company's decision to
reduce emphasis in this product category and to terminate its exclusive right to
manufacture, market and distribute all snowboards bearing the Barfoot(TM) brand
name during 1999.
Gross sales of yo-yo's totaled $2,151,000 during fiscal 1999, which
was the Company's first year in this product category.
Gross sales of portable instant canopies during fiscal 1999 totaled
$7,084,000, an increase of approximately $3,013,000, or 74%, compared to fiscal
1998, on total volume of 84,000 units, an increase of approximately 43,000, or
105%. The increase in Quik Shade(R) instant canopy sales is primarily due to
increased distribution in major home improvement chains, regional mass
merchandisers and major sporting goods chains.
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Sales to the Company's four largest accounts during fiscal 1999
represented 69% of the Company's gross sales in fiscal 1999, compared to 67% for
the four largest accounts during fiscal 1998. The increase is the result of
several factors including the addition of The Home Depot as one of the Company's
four largest accounts as a significant customer for the Quik Shade(R) Canopy,
partially offset by the deletion of Kmart during 1998 as a major customer for
the Company's in-line skates and skateboards.
By product category, in-line skates, athletic protective equipment and
helmets accounted for 51%, 2% and 5%, respectively, of the Company's total gross
sales during fiscal 1999, compared to 56%, 5% and 7%, respectively, during
fiscal 1998. Skateboards and scooters accounted for 15% of the Company's total
gross sales during fiscal 1999, compared to 18% during fiscal 1998. Portable
instant canopies represented 18% of total gross sales during 1999, compared to
9% in the prior year. Snowboards and snowboarding accessories represented 2% of
total gross sales during fiscal 1999, compared to 5% in fiscal 1998. Yo-yo's
represented 6% of total gross sales during 1999, the first year of sales.
Gross Profit. Gross profit for the fiscal year ended July 31, 1999
increased by $881,000 compared to the fiscal year ended July 31, 1998,
representing a 13% increase. The Company's gross profit margin as a percentage
of net sales was 20.1% in fiscal 1999, compared with 15.3% in fiscal 1998. The
increase in gross margin percentage is due to several factors, including the
impact of increased sales of the higher margin Quik Shade(R) canopies and yo-
yo's, as well as lower product costs as a result of beneficial sourcing during
fiscal 1999, and the decrease in sales to Kmart Corporation during fiscal 1999
which had a positive impact on the Company's gross margin. There can be no
assurance that the Company can continue to obtain its products from suppliers at
sufficiently low costs to fully offset the downward pressure on sales prices in
order to sustain or improve present gross profit margins.
Operating Expenses. The Company's operating expenses (consisting of
selling and marketing expenses and general and administrative expenses) for
fiscal 1999 totaled $8,613,000, or 23.0% of net sales. Operating expenses for
fiscal 1998 were $10,780,000, or 25.0% of net sales.
Selling and marketing expenses decreased by $762,000, or 16%, to
$4,118,000 for fiscal 1999 compared to fiscal 1998. Selling and marketing
expenses for fiscal 1999 amounted to 11.0% of net sales, compared to 11.3% in
the prior year. The decrease in dollar amount is primarily due to decreases in
various expenses, such as co-op advertising and sales commissions, that are
directly related to sales and decreased correspondingly with the lower sales
level described in the Net Sales section, partially offset by an increase in
promotional advertising expense.
General and administrative expenses decreased by $410,000, or 8%, to
$4,495,000 for fiscal 1999 compared to fiscal 1998. General and administrative
expenses for fiscal 1999 amounted to 12.0% of net sales, compared to 11.4% in
fiscal 1998. During fiscal 1998, non-cash consulting expenses of $702,000 were
recognized in connection with the Company entering into consultation agreements,
and issuing stock warrants as compensation under the agreements, with REMY
Capital Partners IV, LP, a private investment partnership ("Remy") and Raymond
H. Losi, the Company's co-founder and former Chairman of the Board. As
compensation under these agreements, Remy and Mr. Losi received warrants to
purchase 400,000 and 200,000 shares, respectively, of the Company's common
stock. Excluding such consulting expenses, the Company's general and
administrative expense for fiscal 1999 increased $292,000, or 7% compared to
fiscal 1998, due primarily to an increase in legal expenses related to the legal
proceedings described in "Item 3. Legal Proceedings," partially offset by a
decrease in computer consulting expense. The Company anticipates that it will
continue to incur significant legal expenses related to this matter.
During fiscal 1998 the Company recognized an impairment loss of
$995,000 for write-downs of fixed assets and a write-off of the remaining
unamortized balance of goodwill relating to the snowboard operations of its
wholly-owned subsidiary, Static Snowboards, Inc. Static's operating losses and
the continuing challenges facing the snowboard industry in general led to the
conclusion that impairment of the subsidiary's assets had occurred. In fiscal
1998, the Company sold certain assets of Static, resulting in no significant
gain or loss, and closed its manufacturing facility with the intention of
sourcing snowboards from independent contractors located in Asia.
Other Income (Expense). Other income for the fiscal year ended July
31, 1999 was $2,098,000, an increase of $639,000, or 44%, compared to fiscal
1998. This increase is due to an increase in interest income as a result of a
change during the third quarter of fiscal 1998 in the investment of marketable
securities from lower yielding tax-exempt securities to higher yielding taxable
securities, of which 60% was invested in high-yield bond funds.
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Provision for Income Taxes. The Company's effective tax rate for
fiscal 1999 is less than the federal statutory rate due to changes in the
valuation allowance. The provision for income taxes for fiscal 1998 consists of
the valuation allowance established against the prior year net deferred tax
asset. No tax benefit was recorded for the fiscal 1998 net operating losses due
to either the non-deductibility of certain charges included in the net operating
loss or the uncertainty of realizing the tax benefits of such losses under
Statement of Financial Accounting Standard No. 109 "Accounting for Income
Taxes."
Recent Results. Net sales for the three months ended July 31, 1999,
which represents the fourth quarter of the Company's fiscal year, were
$7,473,000, a decrease of 10%, compared to $8,286,000 for the corresponding
period of the prior year. For the quarter, sales of in-line skates, athletic
protective equipment, skateboards and scooters and helmets were down 21%, 80%,
49% and 40%, respectively, while portable instant canopies increased 53% in
comparison to the fourth quarter of the prior year. These fluctuations were due
to similar factors as discussed above in the year-over-year comparisons for each
of these product categories.
The Company's net income for the quarter ended July 31, 1999 was
$246,000 or $0.04 per share, compared with a net loss of $699,000, or $0.12 per
share for the corresponding period of the prior year. The decrease in loss is
primarily due to an increase in gross profit margin as a percentage of net sales
of 1.5% as a result of a higher margin sales product mix for the quarter ended
July 31, 1999 versus the quarter ended July 31, 1998, decreased advertising
expenses as discussed above in the year-over-year comparisons, and decreased
legal expenses during the quarter.
Year Ended July 31, 1998 Compared to Year Ended July 31, 1997
Net Sales. Net sales for the fiscal year ended July 31, 1998 totaled
$43,148,000, a decrease of $8,513,000, or 16% from fiscal 1997 net sales of
$51,661,000. Decreases in volume and average selling prices with respect to the
Company's in-line skate, athletic protective equipment, skateboards and scooter
categories, offset to a lesser degree by increases in volume in the helmet and
instant canopy categories, were the primary factors leading to the decline in
total sales. Net sales were also adversely affected during fiscal 1998 by
competitive pressures, which caused sales prices to decline in many of the
Company's product categories.
With respect to in-line skates, gross sales for fiscal 1998 totaled
$24,926,000, a decrease of approximately $12,006,000, or 33%, compared to fiscal
1997, as unit volume in fiscal 1998 totaled 1,507,000 units, a decrease of
approximately 520,000, or 26%. The average price per unit (gross revenues
divided by units sold) of the Company's in-line skates was approximately $16.54
during fiscal 1998, compared to $18.22 for fiscal 1997. The decrease in in-line
skate sales was primarily due to a continuing industry-wide decline in consumer
demand compared to the prior year, as well as to the fact that Kmart
Corporation, which accounted for 15% of the Company's gross sales for fiscal
1997 only accounted for 5% for fiscal 1998, and is no longer a major customer
for the Company's in-line skates and skateboards.
Gross sales for athletic protective equipment during fiscal 1998
totaled $2,173,000, a decrease of approximately $524,000, or 19%, compared to
fiscal 1997, while unit volume in fiscal 1998 was 441,000 units, a decrease of
approximately 75,000, or 15%. The Company's sales of these products generally
correlate with sales of in-line skates; thus the decrease in sales of protective
equipment also is primarily attributable to the factors discussed above.
Gross sales of bicycle and recreational safety helmets during fiscal
1998 totaled $3,112,000, an increase of approximately $604,000, or 24%, compared
to fiscal 1997, while unit volume increased approximately 55,000, or 16%, to a
total of 402,000 units during fiscal 1998. The increase in helmet sales is
primarily due to the introduction of the new 3-D recreational helmets during
fiscal 1998.
Gross sales of skateboards and scooters during fiscal 1998 totaled
$7,757,000, a decrease of approximately $1,516,000, or 16%, compared to fiscal
1997, on total volume of 578,000 units, a decrease of approximately 91,000, or
14%. The decrease is primarily due to a reduction in skateboard sales to Kmart
Corporation of $1,533,000 between fiscal 1998 and fiscal 1997, since Kmart is no
longer a major customer for this product category.
Gross sales of snowboards and snowboarding accessories, such as
bindings, leashes and miscellaneous apparel items, during fiscal 1998 totaled
$2,085,000, an increase of approximately $602,000, or 41%, compared to fiscal
1997, while unit volume of snowboards increased approximately 19,500, or 201%,
to a total of 29,200 units during fiscal 1998. The increase in snowboard and
snowboarding accessories sales is primarily due to the introduction of this
product category to the major mass market merchandisers during fiscal 1998.
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Gross sales of portable instant canopies totaled $4,071,000 during
fiscal 1998, which was the Company's first full year in the category. Gross
sales for fiscal 1997 totaled $441,000. The Company sold a total of
approximately 41,000 Quik Shade(R) instant canopies in 1998 compared to
approximately 5,000 in the prior year, with the major portion of sales primarily
due to the Company opening a national program in the home improvement
distribution market.
Sales to the Company's four largest accounts, each of which is a major
mass market merchandiser, represented 67% of the Company's gross sales in fiscal
1998, compared to 70% in fiscal 1997. The decrease is the result of several
factors including the deletion of Kmart Corporation during the year as a major
customer for the Company's in-line skates and skateboards. This decrease in
sales was partially offset by the addition of The Home Depot, which was not one
of the Company's four largest accounts, as a significant customer for the Quik
Shade(R) Canopy.
By product category, in-line skates, athletic protective equipment and
helmets accounted for 56%, 5% and 7%, respectively, of the Company's total gross
sales during fiscal 1998, compared to 69%, 5% and 5%, respectively, during
fiscal 1997. Skateboards and scooters accounted for 18% of the Company's total
gross sales during fiscal 1998, compared to 17% during fiscal 1997. Portable
instant canopies represented 9% of total gross sales during 1998, compared to 1%
in the prior year. Snowboards and snowboarding accessories represented 5% of
total gross sales during fiscal 1998, compared to 3% in fiscal 1997.
Gross Profit. Gross profit for the fiscal year ended July 31, 1998
decreased by $100,000 compared to the fiscal year ended July 31, 1997,
representing a 1% decrease. The Company's gross profit margin as a percentage of
net sales was 15.3% in fiscal 1998, compared with 13.0% in fiscal 1997. The
increase in gross margin percentage is due to several factors, including the
impact of the addition to the sales product mix of Quik Shade(R) canopies which
had a higher margin, as well as lower product costs as a result of beneficial
sourcing during fiscal 1998, the effects of higher than usual amounts of close-
out sales during fiscal 1997 and the decrease in sales to Kmart Corporation
during fiscal 1998 which had a positive impact on the Company's gross margin due
to the pricing structure for Kmart. There can be no assurance that the Company
can continue to obtain its products from suppliers at sufficiently low costs to
fully offset the downward pressure on sales prices in order to sustain or
improve present gross profit margins.
Operating Expenses. The Company's operating expenses (consisting of
selling and marketing expenses and general and administrative expenses) for
fiscal 1998 totaled $10,780,000, or 25.0% of net sales. Operating expenses for
fiscal 1997 were $10,599,000, or 20.5% of net sales.
Selling and marketing expenses decreased by $1,464,000, or 23%, to
$4,880,000 for fiscal 1998 compared to fiscal 1997. Selling and marketing
expenses for fiscal 1998 amounted to 11.3% of net sales, compared to 12.3% in
the prior year. The decrease in amount and as a percentage of net sales is
primarily due to decreased advertising expenses for co-op programs with certain
of the Company's major customers as a result of the elimination or reduction of
certain advertising programs that were fixed dollar allowances, or replacement
of such programs with volume-based programs.
General and administrative expenses increased by $650,000, or 15%, to
$4,905,000 for fiscal 1998 compared to fiscal 1997. General and administrative
expenses for fiscal 1998 amounted to 11.4% of net sales, compared to 8.2% in
fiscal 1997. The dollar increase is primarily due to non-cash consulting
expenses of $702,000 recognized in connection with the Company entering into
consultation agreements, and issuing stock warrants as compensation under the
agreements, with REMY Capital Partners IV, LP, a private investment partnership
("Remy") and Raymond H. Losi, the Company's co-founder and former Chairman of
the Board. As compensation under these agreements, Remy and Mr. Losi received
warrants to purchase 400,000 and 200,000 shares, respectively, of the Company's
common stock. Excluding such consulting expenses, the Company's general and
administrative expense for fiscal 1998 decreased $52,000 or 1% compared to
fiscal 1997, due primarily to minor changes in various expenses.
During fiscal 1998 the Company recognized an impairment loss of
$995,000 for write-downs of fixed assets and a write-off of the remaining
unamortized balance of goodwill relating to the snowboard operations of its
wholly-owned subsidiary, Static Snowboards, Inc. Static's operating losses and
the continuing challenges facing the snowboard industry in general led to the
conclusion that impairment of the subsidiary's assets had occurred. In fiscal
1998, the Company sold certain assets of Static, resulting in no significant
gain or loss, and closed its manufacturing facility with the intention of
sourcing snowboards from independent contractors located in Asia.
Other Income (Expense). Other income for the fiscal year ended July
31, 1998 was $1,459,000, an increase of $660,000, or 83%, compared to fiscal
1997. This increase is due to a decrease in interest expense of $39,000
resulting from no short-term borrowings during fiscal 1998 compared to fiscal
1997, as well as an increase in interest income of $621,000 due primarily to a
change during the year in the investment of marketable securities from lower
yielding tax-exempt securities to higher yielding taxable securities, of which
60% was invested in high-yield bond funds, compared to fiscal 1997.
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Provision for (Benefit from) Income Taxes. The provision for income
taxes for fiscal 1998 consists of the valuation allowance established against
the prior year net deferred tax asset. No tax benefit was recorded for the
fiscal 1998 net operating losses due to either the non-deductibility of certain
charges included in the net operating loss or the uncertainty of realizing the
tax benefits of such losses under Statement of Financial Accounting Standard No.
109 "Accounting for Income Taxes." The Company's effective tax rate and
provision (benefit from) income taxes in fiscal 1997 differed from the federal
statutory rate primarily due to interest income, some of which is exempt from
federal income taxes due to the nature of the investments from which it is
derived.
Liquidity and Capital Resources
Since its initial public offering, the Company has funded its
activities principally from cash flow generated from operations and credit
facilities with institutional lenders. In June 1994, the Company completed an
initial public stock offering, issuing a total of 1,500,000 new common shares
which raised approximately $20,723,000 in proceeds to the Company, net of fees
and expenses. A portion of these proceeds was used by the Company to pay off
borrowings on its line of credit and for other working capital purposes. The
remainder was invested in marketable securities.
The Company has a credit agreement with a major bank providing a $6.5
million revolving line of credit, for the issuance of commercial letters of
credit. The agreement, which expires December 31, 1999, is unsecured. The
agreement requires that the Company satisfy certain financial covenants. Over
the past several years, borrowings have varied, typically reaching highest
levels in the pre-Christmas periods. However, more recently the Company has
borrowed against its line of credit less frequently due to the ability to
finance operations internally from cash and marketable securities available for
sale. Balances on the line of credit are classified as current liabilities on
the Company's balance sheet.
Cash and marketable securities available for sale totaled $25,235,000
as of July 31, 1999, compared to $27,669,000 as of July 31, 1998. Net working
capital as of July 31, 1999 was $34,072,000 compared to $39,283,000 as of July
31, 1998, and the Company's current ratio was 7.7:1 as of July 31, 1999,
compared to 9.0:1 as of July 31, 1998. The decreases in working capital and
current ratio are primarily due to decreases in cash of approximately $3,100,000
used for the purchase of treasury stock during fiscal 1999 and $1,000,000 used
as payment pursuant to entering into a trampoline license agreement in December,
1998, as well as due to cash used in and generated from operations, particularly
via increases and decreases in inventory and increases in and collections of
accounts receivable, that result in daily fluctuations in short-term
investments.
The Company had no long-term debt as of July 31, 1999 and 1998. The
Company had net stockholders' equity of $35,561,000 as of July 31, 1999,
compared to $39,872,000 as of July 31, 1998, with such decrease due primarily to
the purchase of treasury stock and a decrease in accumulated other comprehensive
income due to unrealized losses on investments in marketable securities, offset
by the operating results for the fiscal year ended July 31, 1999. Management
believes that inflation has not had a significant impact upon the Company's
costs and prices during the past three fiscal years.
Capital expenditures for fiscal 1999 totaled $110,000, compared to
$308,000 during fiscal 1998. The decrease is primarily due to $145,000 of 1998
machinery and equipment expenditures for the snowboard plant closed during
fiscal 1998. Of the fiscal 1999 total, approximately $25,000 represented
machinery and equipment expenditures for computer equipment and $68,000
represented production molds compared to $14,000 and $75,000, respectively, for
such expenditures during the prior year.
Future Liquidity and Financial Position
The Company intends to continue to focus upon building and maintaining
its existing product lines, including its new line of Quik Shade(R) instant
canopies and its new introduction of Airzone(TM), a springless trampoline. The
Company also plans to continue to devote resources toward the pursuit and
development of new products. In addition, management continues to explore the
possibility of making selected acquisitions of other companies or products which
would offer a strategic fit with the Company's existing products and its
sourcing and distribution channels in the mass market. The Company also is
considering expanding international distribution and developing additional
distribution arrangements in order to take further advantage of growth
opportunities which management believes exist for its products outside the
United States.
The Board of Directors has authorized the repurchase of up to
750,000 shares of the Company's Common Stock commencing in October 1999 for an
aggregate purchase price of up to $4,875,000. The Company currently anticipates
repurchasing all properly tendered shares of Common Stock by the end of December
1999. The Company believes that all funds required for the repurchase of Common
Stock will be obtained from the Company's available cash and marketable
securities.
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Management believes that its current cash position, funds available
under existing banking arrangements, and cash generated from operations will be
sufficient to meet the Company's presently projected cash and working capital
requirements for the next fiscal year assuming continued financial performance
at present levels.
Foreign Exchange
Management does not believe that the fluctuation in the value of the
dollar in relation to the currency of its suppliers has in the last three fiscal
years had any significant material and adverse impact on the Company's ability
to purchase products at agreed upon prices. Typically, the Company and its
suppliers negotiate prices in U.S. Dollars and payments to suppliers are also
made in U.S. Dollars. Nonetheless, there can be no assurance that the value of
the dollar will not have an impact upon the Company in the future.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
The Company is exposed to changes in interest rates primarily from its
investments in short-term instruments and money market funds and in available-
for-sale securities, which consist of bond mutual funds. These investments are
subject to risks associated with the level of volatility within the various
financial markets, changes in interest rates, the condition of the United States
and world economies and many other factors. Available-for-sale securities are
reported by the Company at fair value.
Additional Factors That Could Affect Operating Results
The following factors, together with other risk factors discussed in
Management's Discussion and Analysis of Financial Condition and Results of
Operations and other information contained elsewhere herein, should be
considered carefully in evaluating the Company and its business.
Reliance on Major Customers. In the past three fiscal years, the
Company has had several customers which accounted for a majority of the
Company's sales. As is customary in the industry, the Company does not have
long-term contracts with any of its customers. The loss of, or a reduction in
business from, any of its major customers could have a material and adverse
effect on the Company's business results of operations and financial condition.
In addition, because a large percentage of the Company's accounts receivables
are due from the major customers, the failure of any of them to make timely
payments with respect to its account could have a material and adverse effect on
the Company's results of operations and financial condition.
Competition from Other Manufacturers/Developers of Products; Price
Sensitivity of Customers. The Company operates in a highly competitive
environment and there are no significant technological or manufacturing barriers
to entry for most product categories other than the Quik Shade(R) instant canopy
and the Airzone(TM) trampoline. While the Company believes that the principal
competitive factors in its market are price, quality of product, brand
recognition, accessibility and customer service, the Company's primary
customers, mass merchandisers, are extremely price sensitive. As a result, the
Company must continually monitor and control its costs while refining its
products to maintain its market position. There can be no assurance that the
Company can continue to provide its products at prices which are competitive or
that it can continue to design and market products that appeal to consumers even
if price competitive. Many of the Company's current and potential competitors
have longer operating histories, larger customer bases, greater brand
recognition and significantly greater financial, marketing and other resources
than the Company. In addition, smaller retailers may be acquired by, receive
investments from or enter into other commercial relationships with larger, well-
established and well-financed companies. The Company also competes to a lesser
degree with manufacturers of specialty or premium priced products.
The Company's primary competitors in the mass market include First
Team Sports, Inc. (Skate Attack), Roller Derby (CAS), Seneca and certain models
from Rollerblade, Inc. (Blade Runner). In the case of athletic protective
equipment, Franklin Sports is the Company's primary competitor in the mass
market. Bell Sports Corp. (Bell and BSI) and Protective Technologies, Inc. (PTI)
are the primary competitors in the recreational safety helmet mass market. For
instant canopies, the Company's primary competitors are International E-Z Up,
Inc. and Enviroworks, Inc. For trampolines, a new category introduced in 1999,
the Company's primary competitors are Jumpking, Inc. and Hedstrom. In addition,
the Company may compete with its primary customers when such customers directly
source products that the Company sells.
At present, the Company believes that its products in each category,
when compared to competitors' products of comparable quality, are currently
offered at comparable or lower prices than most or all of its competitors.
However there can be no assurance that other companies, whether new enterprises
or established members of the retail or sporting goods industries, will not be
able to develop products of comparable or higher quality at lower prices, or
that the Company's price structure will not be affected by future circumstances.
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Shifting and Uncertain Consumer Demand. The Company must continually
anticipate the emergence of, and adapt its products to, the popular demands of
consumers. In the past, a substantial amount of the Company's net sales have
been generated by sales of in-line skates, skateboards and athletic protective
equipment. Since then the Company has developed other product lines, including
safety helmets, snowboards, yo-yo's, trampolines and portable canopies. No
assurance can be given, however, that consumer demand for these products in
general or the Company's products in particular will continue into the future. A
reduction in the demand for these products could have a material and adverse
effect on the Company's results of operations.
Quik Shade(R) is a line of instant portable canopies recently
introduced by the Company. No assurance can be given that the market for these
instant canopies will continue or that the Company's product offerings in this
market will become or remain competitive.
Also in fiscal 1998, Static Snowboards, Inc., the Company's wholly-
owned subsidiary, experienced operating losses, primarily due to the continuing
challenges facing the snowboard industry in general. Accordingly, an impairment
loss totaling $995,000, representing the excess of the carrying value over the
estimated fair market value of assets, was recognized during the second quarter
for write-downs of fixed assets and write-off of the remaining unamortized
balance of goodwill relating to such subsidiary. During 1998 the assets of the
Static manufacturing operation were sold and the manufacturing plant was closed,
with the intention of sourcing snowboards from independent contractors.
Government Regulations Could Hurt the Company's Business. The consumer
retail industry is regulated by many agencies including but not limited to, the
Consumer Product Safety Commission and the California Department of Food and
Agriculture Division of Measurement Standards. Existing legislation or
regulation and any new laws or regulations could hurt the Company's business.
The nature of any new laws and regulations and the manner in which existing and
new laws and regulations may be interpreted and enforced cannot be fully
determined. The enforcement of existing laws and regulations and the adoption of
any future laws or regulations might decrease the demand for the Company's
products, impose taxes or other costly technical requirements or otherwise
increase the cost of doing business which could hurt the Company's business. The
Company cannot predict the impact, if any, that future regulation or regulatory
changes may have on the Company's business.
Fluctuations in the Company's Quarterly Operating Results May
Negatively Affect the Company's Stock Price. The Company's quarterly results may
fluctuate from quarter to quarter in the future due to a variety of factors, not
all of which are under the Company's control. Some of the factors that could
cause the Company's revenues and operating results to fluctuate include the
following:
. inventory returns;
. the timing and magnitude of capital expenditures;
. increasing operating expenses;
. changes in the prices for the Company's products;
. the compensation of the Company's sales personnel based on
achievement of periodic sales quotas;
. fluctuations in the duration of the sales cycle for the Company's
products;
. the announcement or introduction of new or enhanced products by
the Company's competitors or by the Company; and
. conditions specific to the consumer retail industries and general
economic factors.
It is possible that in some future periods the Company's results of
operations may fall below the expectations of public market analysts and
investors. This could result in a decline in the value of the Company's common
stock.
Reliance on Foreign Suppliers to Source the Company's Products. The
Company's products are primarily sourced from suppliers located in Asia with
whom the Company does not have long-term contractual agreements. If the Company
were unable to develop and maintain relationships with suppliers that would
allow it to obtain sufficient quantities of merchandise on acceptable commercial
terms, its business, prospects, financial condition and results of operations
would be materially and adversely affected. Moreover, the Company may not be
able to obtain its products and supplies on substantially similar terms,
including cost, in order to sustain its operating margins. Although management
presently believes that other suppliers could be obtained in such instances,
there can be no assurance that the Company would be able to obtain products and
supplies on substantially similar terms, including cost, in the future. In
addition, purchasing products from foreign suppliers subjects the Company to the
general risks of doing business abroad. These risks include potential delays in
shipment, work stoppages, adverse
17
<PAGE>
fluctuations in currency exchange rates, changes in import duties and tariffs,
changes in foreign regulations and political instability.
A significant portion of the Company's products, including various
models of its in-line skates, are manufactured in mainland China, which trades
with the United States under a Normal Trade Relations ("NTR") trade status.
While the Company believes that alternative manufacturing sources could be
found, maintaining existing costs will depend upon these products continuing to
be treated under NTR tariff rates. From time to time, the U.S. has threatened to
rescind NTR tariff rates and impose trade sanctions on certain goods
manufactured in China. To date, no such sanctions have been imposed that have
affected the Company or its products, however there can be no assurance with
regard to the possible imposition of sanctions in the future.
In addition, the current market crisis in Asia may have a material and
adverse impact upon the Company's ability to procure products from suppliers.
However, the Company may be able to move production quickly to alternate sources
in response to economic or political circumstances that might arise in any
particular country.
Product Liability Claims; Insurance. Due to the nature of its
products, the Company is subject to product liability claims, including claims
for serious personal injury or death. Coverage is on a claims-made basis, and is
subject to certain deductibles. Although the Company believes that it has
adequate liability insurance for risks arising in the normal course of business,
including product liability insurance with respect to all of its products, there
can be no assurance that insurance coverage will be sufficient to cover one or
more large claims or that the applicable insurer will be solvent at the time of
any covered loss. Further, there can be no assurance that the Company will be
able to obtain insurance coverage at acceptable levels and cost in the future.
Successful assertion against the Company of one or a series of large uninsured
claims, or of one or a series of claims exceeding any insurance coverage, could
have a material and adverse effect on the Company's results of operations and
financial condition.
Trademarks and Proprietary Rights. There are risks inherent in the
design and development of new products and product enhancements, including those
associated with patent issues and marketability. Potential liability from patent
and other intellectual property infringements can have a material and adverse
effect on the Company's business, financial condition, results of operations or
cash flows.
More specifically, in March 1998, the Company was served with two
lawsuits entitled: (i) Mark C. Carter and International E-Z Up, Inc. v.
Variflex, Inc. and Service Merchandise Co., Inc. (Case No. 98-0167 WJR (RNBx))
in the United States District Court for the Central District of California in
Los Angeles and (ii) James P. Lynch and KD Kanopy, Inc. v. Variflex, Inc. (Civil
Action No. 98-D-477) in the United States District Court of Colorado. The first
Complaint (a) alleges, among other things, that the Company's Quik Shade(R)
product infringes a patent owned by the plaintiff and used in a competing
instant set-up, collapsible canopy product, and infringes plaintiff's trade
dress, and (b) prays for unspecified monetary damages, treble damages, punitive
damages, costs and attorney's fees, an injunction and the destruction of all
allegedly infringing products. The second Complaint (a) alleges that the
Company's Quik Shade(R) product infringes two patents owned by the plaintiff and
(b) prays for an accounting, general damages, treble damages, an injunction and
costs and attorney's fees. The Company has filed an answer in both lawsuits
denying the allegations of the Complaints and has filed counterclaims in both
lawsuits seeking declarations of patent invalidity and non-infringement as to
the plaintiffs' patents, as well as damages against the plaintiffs for alleged
antitrust violations and restitution for unfair competition violations.
On September 8, 1999 the Court allowed plaintiffs Carter and E-Z Up to
amend their Complaint to state an additional claim against the Company for
alleged infringement of an additional patent. The Company has answered this
amended Complaint, denying its material allegations, and pleading an amended
counterclaim for similar alleged wrongs as previously pleaded in its
counterclaim.
In September 1998, the Company received a demand for defense and
indemnification of Service Merchandise Company, Inc. in that action entitled
Mark C. Carter, et. al. v. Service Merchandise Company, Inc., (Case No. C98-
03274 DLJ ENB) in the United States District Court for the Northern District of
California. The Complaint in this action is virtually identical to the Complaint
on behalf of Service Merchandise in the above-referenced action by Carter in the
Central District of California in Los Angeles. The Company has agreed to
indemnify and defend Service Merchandise (which is a retailer of the Company's
product) in this action. Service Merchandise filed an answer to the Complaint in
the Central District of California (Los Angeles) action. Thereafter, the
plaintiff dismissed without prejudice the Northern District of California
action, and the claim proceeded in the Los Angeles action. Thereafter, Service
Merchandise filed a Chapter 11 bankruptcy petition, so the case is now stayed as
to that defendant only. No party has taken any action to obtain an order for
relief from the automatic stay as to defendant Service Merchandise.
18
<PAGE>
The Los Angeles action has had extensive discovery taken, with a trial
date set for February 8, 2000. Recently the Denver action was ordered
transferred to the federal court in Los Angeles, with a recommendation for
consolidation with the previously pending Los Angeles action. The Los Angeles
court has not yet acted to consolidate the two actions. The transfer of the
Denver action to Los Angeles and the addition of the new patent in suit probably
will result in a 60 to 75 day continuance of the existing trial date by
agreement of the parties, subject to the approval of the Court.
In the Carter action, SAFECO Insurance Company of America has agreed
to provide a defense with a reservation of rights. SAFECO denies coverage for
the patent claims and reserves rights as to trade dress and advertising injury
claims, asserting numerous defenses to coverage. On September 28, 1999 SAFECO
filed, and on October 11, 1999 caused to be served on the Company, a Complaint
for Declaratory Relief entitled SAFECO Insurance Company of America vs.
Variflex, Inc., et al., (Case No. BC217286) in the Superior Court of the State
of California for the County of Los Angeles ("the Coverage Action"). The
Coverage Action asserts a single cause of action for declaratory relief by which
SAFECO seeks a declaration concerning seven different theories of defense to
coverage liability in the underlying Carter action. The Company has not yet
answered the Coverage Action, but it will do so on or before November 10, 1999.
The Company intends vigorously to defend the coverage action. Further, based on
a recent judicial decision, the Company also will tender to SAFECO the defense
of the Lynch action referenced above.
The Company believes it has meritorious defenses to the claims alleged
in the Carter and Lynch Complaints and intends to conduct a vigorous defense.
The Company also intends to vigorously pursue its counterclaims. An unfavorable
outcome in the above matters could have a material and adverse effect on the
Company's business prospects and financial condition.
In addition, even if the ultimate outcome in both cases is resolved in
favor of the Company, the defense of such litigation may involve considerable
costs, which could be material, and could divert the efforts of management,
which could have a material and adverse effect on the Company's business and
results of operations.
With respect to the Company's own patents, service marks, trademarks,
trade secrets and similar intellectual property, the Company considers such
proprietary rights as critical to its success, and relies on patent and
trademark law, trade secret protection and confidentiality and/or license
agreements with its employees, customers, partners and others to protect its
proprietary rights. The Company holds or has pending certain design patents and
utility patents and employs various trademarks, trade names, including its own
logos, in the packaging and advertising of its products. The Company has
registered the Variflex(R), Static(R), Quik Shade(R) and Airzone(TM) trademarks
in the United States, and has secured a worldwide watch to alert the Company to
any unauthorized use in any other parts of the world. Registration of various
other trademarks of the Company's products are pending.
However, effective patent, trademark, service mark and trade secret
protection may not be available in every country in which the Company's products
and services are made available. There can be no assurance that the steps taken
by the Company to protect its proprietary rights will be adequate or that third
parties will not infringe or misappropriate the Company's patents, trademarks
and similar proprietary rights. In addition, there can be no assurance that
other parties will not assert infringement claims against the Company. The
Company has been subject to claims and expects to be subject to legal
proceedings and claims from time to time in the ordinary course of its business,
including claims of alleged infringement of the trademarks and other
intellectual property rights of third parties by the Company. Such claims, even
if not meritorious, could result in the expenditure of significant financial and
managerial resources.
Year 2000. Many computer programs were designed and developed
utilizing only two digits in date fields, thereby creating the inability to
recognize the Year 2000 or years thereafter. Beginning in the Year 2000, these
date codes will need to accept four digit entries to distinguish 21st century
dates from 20th century dates. This Year 2000 issue creates risks for the
Company from unforeseen or unanticipated problems in its internal computer
systems as well as from computer systems of third parties on which the Company's
systems and operations rely. Failures to address the Year 2000 issue could
result in system failures and the generation of erroneous data.
State of Readiness. The Company has been working to resolve the
potential impact of the Year 2000 on the processing of date-sensitive
information by the Company's computerized information systems. The Company has
been assured by its outside information systems consultant that the Company's
primary information management hardware and software systems--the mainframe
systems from which the Company generates its significant third party and
business information processing as a distributor and wholesaler--have been
tested and confirmed to be Year 2000 compliant. The Company's secondary personal
computer based information systems--hardware and software utilized for financial
and operational spreadsheets and word processing--have been tested and confirmed
to be Year 2000 compliant. The Company believes that it does not have any
significant non-information technology embedded systems that require Year 2000
remediation.
19
<PAGE>
The Company's operations are also dependent on the Year 2000 readiness
of third parties who do business with the Company. As a distributor and
wholesaler, the Company is dependent upon independent contractors for supply of
its products and upon major retailers, such as mass merchandisers, catalog
houses, home improvement chains and sporting goods chains, for the sale of its
products. The Company has sent questionnaires to its primary vendors, suppliers,
customers and other third party providers of significant services to determine
that they have a program in place to address Year 2000 issues and that they
expect to be Year 2000 compliant. Over 90% of the third parties with whom the
Company has a material relationship have provided written assurances that they
will be Year 2000 compliant.
Costs. The Company has utilized both internal and external resources
to reprogram or replace, test, and implement the software and operating
equipment for Year 2000 modifications. The total cost of the project was
approximately $50,000 and was funded by the Company's cash flow.
Risks. The Company believes it has an effective program in place to
resolve the Year 2000 issue in a timely manner. As noted above, the Company is
dependent upon third party independent contractors for supply of its products
and upon major retailers for the sale of its products. In the event that a major
supplier is not able to make its systems Year 2000 compliant, it could adversely
limit the Company's ability to receive new products to be shipped. In the event
that a major retailer is not able to make its systems Year 2000 compliant, it
could adversely limit the Company's ability to ship its products and receive
collection of receivables. If third parties are not able to make their systems
Year 2000 compliant in a timely manner, it could have a material and adverse
effect on the Company's business, results of operations and financial condition.
In addition, disruptions in the economy generally resulting from Year 2000
issues could also materially and adversely affect the Company.
Contingency Plans. The Company has manual workaround contingency plans
for certain critical applications and other systems. The Company currently has
contingency plans in place to have on hand sufficient additional inventory if
significant third party suppliers are not Year 2000 compliant on time.
Risks Associated With Entry Into New Business Areas. The Company may
choose to expand its operations by developing and promoting new or complementary
products, expanding the breadth and depth of products and services offered or
expanding the acquisition of new or complementary businesses, products or
technologies, although it has no present understandings, commitments or
agreements with respect to any material acquisitions or investments. There can
be no assurance that the Company would be able to expand its efforts and
operations in a cost-effective or timely manner or that any such efforts would
increase overall market acceptance. Furthermore, any new business or product
line launched by the Company that is not favorably received by consumers could
damage the Company's reputation or the Variflex(R) brand. Expansion of the
Company's operations in this manner would also require significant additional
development and operations expenses and would strain the Company's management,
financial and operational resources. The lack of market acceptance of such
efforts or the Company's inability to generate satisfactory revenues from such
expanded businesses or products to offset their cost could have a material and
adverse effect on the Company's business, prospects, financial condition and
results of operations.
Dependence on Key Personnel. The Company's performance is
substantially dependent on the continued services and on the performance of its
senior management and other key personnel, particularly Raymond (Jay) H. Losi
II, who has entered into an employment agreement with the Company. The loss of
Mr. Losi II could have a material and adverse effect on the Company. Although
the Company carries a $5,000,000 life insurance policy on Mr. Losi II, no
assurance can be given that the proceeds will be sufficient to protect against
such a loss. The Company's performance also depends on the Company's ability to
retain and motivate its other officers and key employees. The loss of the
services of any of its executive officers or other key employees could have a
material and adverse effect on the Company's business, prospects, financial
condition and results of operations. Other than the aforementioned exceptions,
the Company has long-term employment agreements with only a few of its key
personnel. The Company's future success also depends on its ability to identify,
attract, hire, train, retain and motivate other highly skilled technical,
managerial, merchandising, marketing and customer service personnel. Competition
for such personnel is intense, and there can be no assurance that the Company
will be able to successfully attract, assimilate or retain sufficiently
qualified personnel. The failure to retain and attract the necessary technical,
managerial, merchandising, marketing and customer service personnel could have a
material and adverse effect on the Company's business, prospects, financial
condition and results of operations.
20
<PAGE>
Consumer Regulation of Company Products. Certain of the Company's
products are subject to regulation by the Federal Consumer Products Safety
Commission (the "CPSC"), and may therefore be subject to recall request by the
CPSC. Although the Company is not aware of any current proceeding by the CPSC
which would result in the recall of the Company's products, any such proceeding
could have a material and adverse effect on the Company's business, prospects,
financial condition and results of operations.
Item 8. Financial Statements and Supplementary Data.
Item 14. The financial statements and schedules included herein are listed in
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
Not applicable.
21
<PAGE>
REPORT OF INDEPENDENT AUDITORS
The Board of Directors
Variflex, Inc.
We have audited the accompanying consolidated balance sheets of Variflex, Inc.
(the Company) as of July 31, 1999 and 1998, and the related consolidated
statements of operations, stockholders' equity and cash flows for each of the
three years in the period ended July 31, 1999. Our audits also included the
financial statement schedule listed in the Index at Item 14. These financial
statements and schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Variflex, Inc. at
July 31, 1999 and 1998, and the consolidated results of its operations and its
cash flows for each of the three years in the period ended July 31, 1999, in
conformity with generally accepted accounting principles. Also, in our opinion,
the related financial statement schedule, when considered in relation to the
basic financial statements taken as a whole, presents fairly in all material
respects the information set forth therein.
/s/ Ernst & Young LLP
Woodland Hills, California
September 24, 1999
22
<PAGE>
VARIFLEX, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
<TABLE>
<CAPTION>
July 31
-------------------------------
1999 1998
---------- ----------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 5,343 $ 7,522
Marketable securities available for sale 19,892 20,147
Trade accounts receivable, less allowances of $430 and
$413 as of July 31, 1999 and 1998, respectively 6,900 8,205
Inventory 5,748 6,483
Deferred income taxes 604 -
Prepaid expenses and other current assets 641 1,809
---------- ----------
Total current assets 39,128 44,166
Property and equipment, net 283 501
Other assets 1,206 88
---------- ----------
Total assets $ 40,617 $ 44,755
========== ==========
Liabilities and stockholders' equity
Current liabilities:
Trade acceptances payable $ 133 $ 384
Accounts payable 466 371
Accrued warranty 844 450
Accrued salaries and related liabilities 410 234
Accrued co-op advertising 1,612 2,481
Accrued returns and allowances 429 150
Accrued product liability claims 267 120
Income taxes payable 272 -
Other accrued expenses 623 693
---------- ----------
Total current liabilities 5,056 4,883
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.001 par value:
Authorized shares - 5,000,000
Issued and outstanding shares - none - -
Common stock, $.001 par value:
Authorized shares - 40,000,000
Issued shares - 6,025,397 as of
July 31, 1999 and 1998 9 9
Common stock warrants 702 702
Additional paid-in capital 21,023 21,023
Retained earnings 19,333 18,530
Accumulated other comprehensive loss (2,432) (392)
Treasury stock, at cost, 512,979 shares as of
July 31, 1999 (3,074) -
---------- ----------
Total stockholders' equity 35,561 39,872
---------- ----------
Total liabilities and stockholders' equity $ 40,617 $ 44,755
========== ==========
</TABLE>
See accompanying notes.
23
<PAGE>
VARIFLEX, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
<TABLE>
<CAPTION>
Year Ended July 31
---------------------------------
1999 1998 1997
--------- --------- ---------
<S> <C> <C> <C>
Net sales $ 37,370 $ 43,148 $ 51,661
Cost of goods sold 29,872 36,531 44,944
--------- --------- ---------
Gross profit 7,498 6,617 6,717
--------- --------- ---------
Operating expenses:
Selling and marketing 4,118 4,880 6,344
General and administrative 4,495 4,905 4,255
Impairment write-off - 995 -
--------- --------- ---------
Total operating expenses 8,613 10,780 10,599
--------- --------- ---------
Loss from operations (1,115) (4,163) (3,882)
--------- --------- ---------
Other income (expense):
Interest expense - - (39)
Interest income and other 2,098 1,459 838
--------- --------- ---------
Total other income (expense) 2,098 1,459 799
--------- --------- ---------
Income (loss) before income taxes 983 (2,704) (3,083)
(Benefit from) provision for income taxes 180 784 (1,278)
--------- --------- ---------
Net income (loss) $ 803 $ (3,488) $ (1,805)
========= ========= =========
Net income (loss) per share of common stock:
Basic $ 0.14 $ (0.58) $ (0.30)
========= ========= =========
Diluted $ 0.14 $ (0.58) $ (0.30)
========= ========= =========
Weighted average shares outstanding:
Basic 5,817 6,025 6,025
========= ========= =========
Diluted 5,860 6,025 6,025
========= ========= =========
</TABLE>
See accompanying notes.
24
<PAGE>
VARIFLEX, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands, except share data)
<TABLE>
<CAPTION>
Accumulated
Common Additional Other
Common Stock Stock Paid-In Retained Comprehensive
------------
Shares Amounts Warrants Capital Earnings Income (Loss)
--------- ------- -------- --------- -------- -------------
<S> <C> <C> <C> <C> <C> <C>
Balance at July 31, 1996 6,025,397 $ 9 $ - $ 21,023 $ 23,823 $ (43)
Comprehensive loss:
Net unrealized holding gains on
debt securities available for sale - - - - - 93
Net loss - - - - (1,805) -
Total comprehensive loss
--------- ------- -------- --------- -------- -------------
Balance at July 31, 1997 6,025,397 9 - 21,023 22,018 50
Comprehensive loss:
Net unrealized holding losses on
debt securities available for sale - - - - - (442)
Net loss - - - - (3,488) -
Total comprehensive loss
Issuance of common stock
warrants - 702 - - -
--------- ------- -------- --------- -------- -------------
Balance at July 31, 1998 6,025,397 9 702 21,023 18,530 (392)
Comprehensive Loss:
Net unrealized holding losses on
debt securities available for sale - - - - - (2,040)
Net income - - - - 803 -
Total comprehensive loss
Purchase of treasury shares - - - - - -
--------- ------- -------- ---------- -------- -------------
Balance at July 31, 1999 6,025,397 $ 9 $ 702 $ 21,023 $ 19,333 $ (2,432)
========= ======= ======== ========== ======== =============
<CAPTION>
Treasury Stock
--------------
Shares Amount Total
------- ------ --------
<S> <C> <C> <C>
Balance at July 31, 1996 - $ - $ 44,812
Comprehensive loss:
Net unrealized holding gains on
debt securities available for sale - - 93
- - (1,805)
Net loss --------
Total comprehensive loss (1,712)
------- -------- --------
Balance at July 31, 1997 - - 43,100
Comprehensive loss:
Net unrealized holding losses on
debt securities available for sale - - (442)
Net loss - - (3,488)
------- -------- --------
Total comprehensive loss (3,930)
Issuance of common stock
warrants - - 702
------- -------- --------
Balance at July 31, 1998 39,872
Comprehensive Loss:
Net unrealized holding losses on
debt securities available for sale - - (2,040)
Net income - - 803
--------
Total comprehensive loss (1,237)
Purchase of treasury shares 512,979 (3,074) (3,074)
------- -------- --------
Balance at July 31, 1999 512,979 $ (3,074) $ 35,561
======= ======== ========
</TABLE>
See accompanying notes.
25
<PAGE>
VARIFLEX, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
Year Ended July 31
------------------------------------------
1999 1998 1997
---------- ---------- ----------
<S> <C> <C> <C>
Operating activities
Net income (loss) $ 803 $ (3,488) $ (1,805)
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Depreciation and amortization 368 805 1,437
Deferred income taxes (604) 784 (32)
(Gain) loss on sale of marketable securities 1 (27) 63
(Gain) loss on disposal of fixed assets 2 (38) -
Impairment write-off - 995 -
Common stock warrants issued - 702 -
Changes in operating assets and liabilities:
Trade accounts receivable 1,305 1,395 2,447
Inventory 735 3,223 3,626
Prepaid expenses and other current assets 1,168 783 1,326
Accounts payable 95 (306) 257
Other current liabilities 329 582 (540)
Trade acceptances payable (251) (186) 482
---------- ---------- ----------
Net cash provided by operating activities 3,951 5,224 7,261
---------- ---------- ----------
Investing activities
Purchases of property and equipment (110) (308) (888)
Proceeds from sale of assets - 325 -
Gross purchases of available-for-sale securities (1,788) (26,026) (5,544)
Gross sales of available-for-sale securities 2 20,348 3,636
Other assets (1,160) 136 7
---------- ---------- ----------
Net cash (used in) investing activities (3,056) (5,525) (2,789)
---------- ---------- ----------
Financing activities
Purchase of treasury shares (3,074) - -
---------- ---------- ----------
Net cash (used in) financing activities (3,074) - -
---------- ---------- ----------
Net increase (decrease) in cash (2,179) (301) 4,472
Cash and cash equivalents beginning of period 7,522 7,823 3,351
---------- ---------- ----------
Cash and cash equivalents at end of period $ 5,343 $ 7,522 $ 7,823
========== ========== ==========
Cash paid during the period for:
Interest $ - $ - $ 39
Income taxes $ 512 $ - $ -
</TABLE>
Supplemental disclosure of non-cash financing and investing activities:
In November 1997, the Company issued stock warrants and recorded therewith a
non-cash expense of $702,000 as compensation in connection with certain
consulting agreements entered into as further described in Note 11.
See accompanying notes.
26
<PAGE>
VARIFLEX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
July 31, 1999
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation and Basis of Presentation
The consolidated financial statements include the accounts of Variflex, Inc., a
Delaware corporation, and its two wholly owned subsidiaries, Oketa Limited
(Oketa), a Hong Kong corporation, and Static Snowboards, Inc., a Delaware
corporation (collectively, the Company). The Company markets and distributes in-
line skates, skateboards, recreational safety helmets, athletic protective
equipment (such as knee pads, elbow pads and wrist guards), portable instant
canopies, trampolines, yo-yo's, snowboards and other products. The Company
designs and develops these products which are then manufactured to the Company's
specifications by independent contractors. The Company's products are sold
primarily to retailers, with some sales to wholesalers and distributors. All
significant intercompany accounts and transactions have been eliminated in
consolidation.
Use of Estimates
Financial statements prepared in accordance with generally accepted accounting
principles require management to make estimates and judgments that affect
amounts and disclosures reported in the financial statements. Actual results
could differ from those estimates.
Revenue Recognition and Warranty
The Company recognizes revenue from product sales upon shipment. The Company has
established programs with its customers which enable them to receive credit for
defective merchandise covered under its warranty policy. The Company's products
are under warranty against defects in material and workmanship for varying
periods from date of purchase. The amount of potential credits is estimated and
provided for in the period of sale.
Concentration of Risk
The Company performs periodic evaluation of the credit worthiness of its
customers and generally does not require collateral. Credit losses relating to
the Company's customers, mainly mass merchant retailers, have consistently been
within management's expectations and are provided for in the financial
statements.
The Company operates within one industry segment where certain customers
represent a significant portion of the Company's business. Sales to the
Company's largest customers which have each individually accounted for more than
10% of the Company's sales as a percentage of consolidated gross sales, were 40%
and 19% for fiscal 1999; 31%, 21% and 10% for fiscal 1998; 26%, 21% and 15% for
fiscal 1997. Receivables from these customers as a percentage of the Company's
total trade accounts receivable were 47% and 9% at July 31, 1999.
With the exception of snowboards, which were manufactured domestically at the
Company's factory during 1998 (see Note 12), and yo-yo's, which are manufactured
by independent contractors located domestically and in Asia, all of the
Company's products are manufactured by independent contractors located in Asia.
The Company presently knows of no circumstances that would materially affect its
supply or costs of goods; however, there can be no assurances with respect to
events which may arise in the future.
27
<PAGE>
Cash Equivalents
Short-term investments and money market funds with original maturities of three
months or less are classified as cash equivalents. The carrying value of cash
equivalents approximates market value.
Marketable Securities
The Company accounts for investments in marketable securities in accordance with
Statement of Financial Accounting Standard No. 115, "Accounting for Certain
Investments in Debt and Equity Securities." Management has determined all
investments should be classified as available-for-sale.
Available-for-sale securities are carried at fair value, with the unrealized
gains and losses, net of tax, reported as accumulated other comprehensive income
(loss). The amortized cost of debt securities in this category is adjusted for
amortization of premiums and accretion of discounts to maturity. Such
amortization is included in investment income. Realized gains, losses and
declines in value judged to be other-than-temporary on available-for-sale
securities are included in interest income. The cost of securities is based on
the specific identification method. Interest and dividends on securities
classified as available-for-sale are included in interest income.
Inventory
Inventory is stated at the lower of cost (first-in, first-out method) or market
and consists of the following:
<TABLE>
<CAPTION>
July 31
--------------------------
1999 1998
-------- --------
(In thousands)
<S> <C> <C>
Raw material and work-in-process $ 554 $ 585
Finished goods 5,194 5,898
------- -------
$ 5,748 $ 6,483
======= =======
</TABLE>
Long Lived Assets
In accordance with FASB Statement No. 121, Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, the Company
records impairment losses on long-lived assets (including goodwill) used in
operations when events and circumstances indicate that the assets might be
impaired and the undiscounted cash flows estimated to be generated by those
assets are less than the carrying amounts of those assets. The impairment loss
is measured by comparing the fair value of the asset to its carrying amount.
See Note 12.
Property and Equipment
Property and equipment are stated at cost. Depreciation is provided using the
straight-line method over the estimated useful lives of the related assets or,
for leasehold improvements, over the terms of the related leases, if shorter.
See Note 12 for discussion of write-down of property and equipment.
Intangible Assets
Goodwill arising from acquisitions is amortized on a straight-line basis over a
period of 15 years. As discussed in Note 12, unamortized goodwill of $495,000
was written down during fiscal 1998.
License agreement assets described in Note 9 are amortized on a straight-line
basis over a period of 8 years and are included net of amortization as a
component of other assets in 1999. Accumulated amortization of license
agreements as of July 31, 1999 and 1998 amounted to $42,000 and $0,
respectively.
28
<PAGE>
Earnings (Loss) Per Share
Basic earnings (loss) per share is computed based on the weighted average number
of shares of common stock outstanding during the period. Dilutive earnings
(loss) per share is based on the weighted average number of shares of common
stock outstanding, and common stock equivalents, when dilutive. Common stock
equivalents represent the dilutive effect of the assumed exercise of certain
outstanding options and warrants. For the year ended July 31, 1999 the number of
shares used in the calculation of diluted earnings per share included 42,778
shares issuable under stock options and warrants using the treasury stock
method. Common stock equivalents are excluded from the computation for the year
ended July 31, 1998 and 1997 because their effect is antidilutive.
Advertising Costs
Advertising costs are expensed as incurred. Advertising costs for the years
ended July 31, 1999, 1998 and 1997 amounted to $1,988,000, $2,490,000, and
$3,845,000, respectively.
Stock-Based Compensation
Statement of Financial Accounting Standard No. 123, "Accounting for Stock-Based
Compensation," encourages but does not require companies to record compensation
expenses for stock options at fair value. The Company has chosen to continue to
account for stock options using the intrinsic value method prescribed in
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees," and related interpretations. Accordingly, the Company has computed
the pro forma disclosures of the earnings per share as determined under the
provision of SFAS No. 123.
Comprehensive Income
As of January 1, 1998, the Company adopted Statement 130, "Reporting
Comprehensive Income." Statement 130 establishes new rules for the reporting
and display of comprehensive income and its components; however, the adoption of
this statement had no impact on the Company's net income or stockholders'
equity. Statement 130 requires unrealized gains or losses on the Company's
available-for-sale securities, which prior to adoption were reported separately
in stockholders' equity, to be included in other comprehensive income. Prior
year financial statements have been reclassified to conform to the requirements
of Statement 130.
Other comprehensive income consists of unrealized gains or losses on securities
for the years ended July 31, 1999, 1998 and 1997 as follows:
<TABLE>
<CAPTION>
1999 1998 1997
----------- ------------ -----------
(In thousands)
<S> <C> <C> <C>
Unrealized holding gains (losses) arising during period,
net of taxes of zero in each period $ (2,041) $ (415) $ 30
Reclassification adjustments for (gains) losses realized in net income 1 (27) 63
----------- ------------ -----------
Net unrealized gains (losses) on securities $ (2,040) $ (442) $ 93
=========== ============ ===========
</TABLE>
The deferred tax benefit arising from the unrealized holding losses is offset by
the valuation allowance.
Segment Reporting
In June 1997, the FASB issued SFAS No. 131, "Disclosures About Segments of an
Enterprise and Related Information" ("SFAS 131"). SFAS 131 establishes
standards for the way that public business enterprises report information about
operating segments in annual financial statements and requires that those
enterprises report selected information about operating segments in interim
financial reports. It also establishes standards for related disclosures about
products and services, geographic areas, and major customers. The Company has
determined, based on its internal system of management reporting and since it
assesses performance as a single operating unit, that in the years ended July
31, 1999, 1998 and 1997, it operated in only one segment.
29
<PAGE>
Gross sales of similar products for that segment are as follows:
<TABLE>
<CAPTION>
1999 1998 1997
------------- ------------- -------------
(In thousands)
<S> <C> <C> <C>
In-line Skates $19,876 $24,924 $36,758
Skateboards 5,389 6,376 8,298
Canopies 7,084 4,071 441
Other 6,529 8,913 8,005
------------- ------------- -------------
Total gross sales 38,878 44,284 53,502
Returns and allowances (1,508) (1,136) (1,841)
------------- ------------- -------------
Total net sales $37,370 $43,148 $51,661
============= ============= =============
</TABLE>
Reclassifications
Certain reclassifications have been made to the 1998 and 1997 financial
statements to conform with the 1999 presentation.
2. INVESTMENTS
Available-for-sale securities consist of the following:
<TABLE>
<CAPTION>
Available-for-Sale Securities
--------------------------------------------------------------------
Gross Gross Estimated
Unrealized Unrealized Fair
Cost Gains Losses Value
------------- --------------- -------------- -------------
<S> <C> <C> <C> <C>
(In thousands)
July 31, 1999
Corporate and high-yield bond mutual funds $ 22,324 $ - $ 2,432 $ 19,892
============= =============== ============== =============
July 31, 1998:
Corporate and high-yield bond mutual funds $ 20,539 $ - $ 392 $ 20,147
============= =============== ============== =============
</TABLE>
The Company experienced a net realized gain of $1,000, a net realized gain of
$27,000 and a net realized loss of $63,000 on sales of available-for-sale
securities during the fiscal years ended July 31, 1999, 1998 and 1997
respectively. The net adjustments to unrealized holding losses on available-for-
sale securities as of July 31, 1999 and 1998 are reflected in accumulated other
comprehensive loss. The Company's investments consist of bond mutual funds and
are subject to risks associated with changes in the various financial markets,
changes in interest rates, and the condition of the United States and world
economies and many other factors.
3. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
<TABLE>
<CAPTION>
July 31
-----------------------------
1999 1998
------------ ------------
(In thousands)
<S> <C> <C>
Computer equipment $ 419 $ 460
Trade show assets 159 162
Machinery and equipment 227 227
Furniture and fixtures 197 191
Leasehold improvements 166 154
Transportation equipment 28 54
Molds, dies and tooling equipment 3,734 3,665
------------ ------------
4,930 4,913
Less accumulated depreciation and amortization (4,647) (4,412)
------------ ------------
$ 283 $ 501
============ ============
</TABLE>
30
<PAGE>
4. REVOLVING LINE OF CREDIT
The Company has a $6,500,000 revolving line of credit with a major bank for the
issuance of commercial letters of credit. The credit line matures on December
31, 1999. The agreement requires the Company to comply with certain financial
ratios and covenants.
As of July 31, 1999, letters of credit in the amount of $849,619 were open for
the receipt of future merchandise. Of this amount, $716,722 has not been
reflected on these financial statements since title to the merchandise has not
yet passed to the Company.
5. COMMITMENTS AND CONTINGENCIES
Lease Commitments
The Company leases warehouse and office facilities under an operating lease that
requires minimum monthly payments of $35,000, and also provides for the lessee
to pay property taxes, insurance, repairs and maintenance and utilities. The
lease expires on December 31, 2000. The Company also subleases additional
warehouse and office space in an adjacent building under a separate operating
lease requiring minimum monthly payments of $8,000, which amount includes
property taxes and utilities, but which provides for the Company to pay
insurance and repairs and maintenance costs. This agreement expires June 30,
2000. The Company's subsidiary, Static Snowboards, Inc., leases office and
manufacturing facilities under an operating lease that requires monthly payments
of $13,000 and expires in September 2000. The Company has entered into a
sublease agreement with a third party for this facility. The agreement provides
monthly receipts of $13,000 and expires in September 2000.
The Company has no capital leases as of July 31, 1999. Annual future minimum
lease payments under existing operating leases are as follows:
<TABLE>
<CAPTION>
Operating
Leases
---------------
(In thousands)
<S> <C>
Years ending July 31:
2000 $ 563
2001 233
2002 39
2003 -
2004 and thereafter -
---------------
Total minimum lease payments $ 835
===============
</TABLE>
Total rent expense was $508,000, $775,000 and $687,000 for the fiscal years
ended July 31, 1999, 1998 and 1997, respectively.
Litigation
The Company is involved in various claims arising primarily from sales of
products in the normal course of business. Management has recorded a $267,000
allowance for product liability losses at July 31, 1999 ($120,000 at July 31,
1998). In addition, the Company carries product liability insurance on its
products. In the opinion of management, any additional liability to the Company
arising under any pending product liability litigation would not materially
affect its financial position, cash flow or results of operations.
In March 1998, the Company was served with two lawsuits alleging that the
Company's Quik Shade(R) product infringes on patents owned by the plaintiffs.
The Company has filed counterclaims in both lawsuits. In September 1998, the
Company received a demand for defense and indemnification which is virtually
identical to one of the March 1998 lawsuits. The Company believes it has
meritorious defenses for all of these actions, intends to conduct a vigorous
defense and vigorously pursue its counterclaims. The Company currently believes
the outcome of these matters would not have a materially adverse effect on its
financial position or cash flow, but the defense of such litigation may involve
considerable costs which could have a material adverse effect on the Company's
results of operations. However, there can be no assurance that an adverse
outcome of these matters will not have a material adverse effect on the
Company's business prospects and financial condition.
31
<PAGE>
Employment Agreements
The Company has employment and consulting agreements in effect with certain of
its employees. The agreements provide for varying terms of employment
aggregating $701,000 and $142,000 in base compensation during the fiscal years
ended July 31, 2000 and 2001, respectively.
6. PENSION PLAN
During fiscal 1997 the Company had a defined benefit pension plan (the Pension
Plan) covering substantially all of its employees. The benefits were based on
years of service and the employee's compensation during the last five years of
employment. The Company's funding policy was generally to contribute annually
the minimum amount that could be deducted for federal income tax purposes.
Contributions were intended to provide not only for benefits attributed to
service to date but also for those expected to be earned in the future. During
1997 the Company amended the Pension Plan to provide for its termination
effective July 31, 1997. Accordingly, included in net periodic pension expense
for the year ended July 31, 1997 is a curtailment gain of $219,000 resulting
from the reduction of the projected benefit obligation due to the termination of
the Pension Plan. The assets of the Pension Plan were used to settle the pension
obligation in fiscal 1998.
Net pension cost for the fiscal year ended July 31, 1997 included the following
components:
<TABLE>
<CAPTION>
1997
---------------
(In thousands)
<S> <C>
Service costs - benefits earned during the period $ 262
Interest cost on projected benefit obligations 191
Actual return on plan assets (720)
Net amortization and deferral 505
Curtailment gain (219)
---------------
Net periodic pension cost $ 19
===============
</TABLE>
The weighted-average discount rate and the rate of increase in future
compensation levels used in determining the actuarial present value of the
projected benefit obligations was 6 percent and zero percent in 1997. The
expected long-term rate of return on assets and the increase in cost of living
assumption used in computing the periodic pension cost was zero percent and zero
percent, respectively, for 1997, due to the termination of the plan as
previously discussed.
Effective August 1, 1997, the Company established a defined contribution pension
plan covering substantially all of its employees. Company contributions are
determined at the discretion of the Company. Contributions for fiscal 1999 and
fiscal 1998 were zero and approximately $40,000, respectively. Effective August
1, 1999, the Company amended and restated this plan as a 401(k) profit sharing
plan, with company matching contributions determined at the discretion of the
Company.
7. INCOME TAXES
The (benefit from) provision for income taxes for the fiscal years ended July
31, 1999, 1998 and 1997 is as follows:
<TABLE>
<CAPTION>
1999 1998 1997
------------ ------------ ------------
(In thousands)
<S> <C> <C> <C>
Current (benefit) provision:
Federal $ 731 $ - $ (1,246)
State 53 - -
------------ ------------ ------------
Total current (benefit) provision 784 - (1,246)
Deferred provision (benefit):
Federal (352) (750) (29)
State (56) (3) (3)
------------ ------------ ------------
Total deferred provision (benefit) (408) (753) (32)
------------ ------------ ------------
Valuation allowance (196) 1,537 -
------------ ------------ ------------
$ 180 $ 784 $ (1,278)
============ ============ ============
</TABLE>
32
<PAGE>
Deferred income taxes consist of the tax effect of timing differences related to
the following components:
<TABLE>
<CAPTION>
1999 1998
--------------- --------------
(In thousands)
<S> <C> <C>
Deferred tax assets:
Unrealized loss on marketable securities $ 962 $ 155
Inventory valuation allowances 464 304
Inventory 369 286
Warranty allowances 334 183
Allowances for losses on receivables 274 574
Sales return allowances 170 61
Product liability 106 49
Other 612 398
----------- -----------
Total deferred tax assets 3,291 2,010
Deferred tax liabilities:
Depreciation (168) (96)
Unremitted earnings of Oketa (115) (143)
Prepaid Insurance (80) (78)
Other (21) (1)
----------- -----------
Total deferred tax liabilities (384) (318)
----------- -----------
Net deferred tax assets 2,907 1,692
Valuation allowance (2,303) (1,692)
----------- -----------
$ 604 $ -
=========== ===========
</TABLE>
During fiscal 1999, due to the net operating losses for the fiscal years ended
July 31, 1998 and 1997, the Company established a valuation allowance against
the fiscal 1997 deferred tax asset of $784,000 and the fiscal 1998 net deferred
tax benefit of $753,000 in accordance with Statement of Financial Accounting
Standard No. 109 "Accounting for Income Taxes." The deferred tax benefit and
related valuation allowance on the unrealized loss on marketable securities is
reflected in equity.
A reconciliation of the statutory federal income tax rate to the effective tax
rate, as a percentage of income before taxes based on income, follows:
<TABLE>
<CAPTION>
1999 1998 1997
---------- ---------- ----------
<S> <C> <C> <C>
Statutory federal income tax rate 34% (35%) (35%)
Valuation allowance (18) 56 -
Tax exempt interest income - (6) (7)
Non-deductible stock warrants - 9 -
Other non-deductible expenses 2 5 1
------ ------ ------
18% 29% (41%)
====== ====== ======
</TABLE>
Pretax income (loss) earned by Oketa amounted to $(32,000), $431,000 and
$215,000 in fiscal 1999, 1998 and 1997, respectively, and is not subject to Hong
Kong tax as provided under that country's taxation requirements. The Company
provides deferred taxes on Oketa's income until such income is repatriated to
the United States.
8. Stock Option Plans
In April 1993, the Company established a non-qualified stock option plan (the
Plan) to grant stock options to one of its officers. Under the Plan, stock
options were granted each April through April 1997, and each grant shall vest
cumulatively at 20% per year over five years. The options are exercisable over
ten years at an exercise price of $0.0004 per share. The number of shares
granted at each grant date will have an aggregate fair market value of $20,000
as of such grant date. In sum the Company has granted options to purchase a
total of 20,129 shares of the Company's common stock under the Plan. The Company
has recorded compensation expense related to these options.
33
<PAGE>
On April 1, 1994, the stockholders of the Company approved the 1994 Variflex
Stock Plan (the 1994 Stock Plan) which became effective at the initial public
offering date of June 17, 1994. Under the 1994 Stock Plan, options, stock
appreciation rights (SARS) and bonus stock may be granted for the purpose of
attracting and motivating deserving employees and directors of the Company. The
exercise price of the options is to be not less than the market price of the
common stock at the time of grant with respect to incentive stock options, and
not less than 85% of the market price of the common stock at the time of grant
with respect to non-qualified options. The maximum number of shares reserved for
issuance under the 1994 Stock Plan is 600,000. At July 31, 1999, 318,750 shares
are available for grant under the 1994 Stock Plan.
In June 1997, the Company terminated certain incentive stock option plans and
stock options granted in April 1994 for the purchase of 280,000 shares of common
stock at $15.50 per share. In connection with the termination of these stock
options and stock option plans the Company granted to certain officers and
employees of the Company incentive stock options, under the 1994 Stock Plan, for
the purchase of an aggregated amount of 145,000 shares of the Company's common
stock. The options vest over the next two to five years, carry exercise prices
ranging from $5.00 to $5.50 per share and are exercisable over 10 years from the
date of grant.
On March 16, 1998, the Company established the 1998 Stock Option Plan for Non-
Employee Directors (The 1998 Stock Plan) for the purpose of attracting and
retaining experienced and knowledgeable non-employee directors of the Company.
Under the 1998 Stock Plan, each non-employee director receives an option to
purchase 4,000 shares of common stock of the Company upon being appointed or
elected as a director, and an option to purchase 2,000 shares as an annual
retainer upon being re-appointed or re-elected as a director. The exercise price
of the options is to be not less than the market price of the common stock at
the time of grant. The options vest on the first business day prior to the first
anniversary of the date of grant and are exercisable over 10 years from the date
of grant. The maximum number of shares reserved for issuance under the 1998
Stock Plan is 250,000. At July 31, 1999, 238,000 shares are available for grant
under the 1998 Stock Plan.
There were no options exercised in the years ended July 31, 1999, 1998 and 1997.
A summary of stock option activity and data is as follows:
<TABLE>
<CAPTION>
Options Outstanding
-------------------------------------------
Number Weighted
of Shares Average Price
---------------- -------------------
<S> <C> <C>
Balance at July 31, 1996 296,178 $ 14.6534
Granted 148,951 5.1695
Canceled (280,000) -
-------------
Balance at July 31, 1997 165,129 4.6631
Granted 33,000 5.3788
Canceled (12,500) 5.0000
-------------
Balance at July 31, 1998 185,629 4.7676
Granted 134,000 4.6567
Canceled (6,250) 5.0000
-------------
Balance at July 31, 1999 313,379 4.7156
=============
</TABLE>
34
<PAGE>
Information regarding stock options outstanding as of July 31, 1999 is as
follows:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
- -------------------------------------------------------------------------------------- ---------------------------------------
Weighted
Average
Remaining Weighted Weighted
Number Contractual Average Number Average Exercise
Price Range of Shares Life Exercise Price of Shares Price
- -------------------------------------------------------------------------------------- --------------------------------------
<S> <C> <C> <C> <C> <C>
$ 0.0004 20,129 5 years $0.0004 16,415 $0.0004
$4.625 to $5.50 293,250 9 years $5.0392 85,250 $5.2405
</TABLE>
Fair Value Disclosures
The weighted average exercise prices and fair market value of stock options and
warrants (see Note 11) using the Black-Scholes option valuation model were as
follows:
<TABLE>
<CAPTION>
1999 1998
-------------------------------- --------------------------
Fair Exercise Fair Exercise
Value Price Value Price
------------- ------------- ------------ ------------
<S> <C> <C> <C> <C>
Exercise price equals market value of stock at date of grant $1.75 $4.66 $1.95 $5.38
Exercise price exceeds market value of stock at date of grant - - 1.55 5.10
</TABLE>
The weighted average fair values of 1999 and 1998 stock option and warrant
grants were estimated at the date of grant using the Black-Scholes option
valuation model and the following average actuarial assumptions:
<TABLE>
<CAPTION>
1999 1998
-------------------------- ---------------------------------------------
Options Warrants Options
------- -------- -------
<S> <C> <C> <C>
Risk-free interest range 5.5 7.5 5.5
Expected life 5.0 7.0 4.0
Expected volatility .301 .271 .337
Expected dividend yield None None None
</TABLE>
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options. The Company's employee stock options have
characteristics significantly different from those of traded options such as
vesting restrictions and extremely limited transferability. In addition, the
assumptions used in option valuation models (see above) are highly subjective,
particularly the expected stock price volatility of the underlying stock.
Because changes in these subjective input assumptions can materially affect the
fair value estimate, in management's opinion, the existing models do not provide
a reliable single measure of the fair value of its employee stock options.
For purposes of the pro forma disclosure of net income (loss), the estimated
fair value of the stock options and warrants granted in 1997, 1998 and 1999 is
amortized as compensation expense over the options' vesting period. Pro forma
net income (loss) and pro forma diluted income (loss) per share for fiscal 1999,
1998 and 1997 would have been $693,000, $(3,243,000) and $(1,790,000) and $0.12,
$(0.54) and $(0.30), respectively. However, the pro forma effect on net income
for 1999 and 1998 is not representative of the pro forma effect on net income in
future years because it does not take into consideration pro forma compensation
expense related to grants prior to 1998. Pro forma information in future years
may reflect the amortization of a larger number of stock options granted in
several succeeding years.
9. LICENSE AGREEMENTS
In December 1998, the Company entered into an exclusive license agreement with
another company to manufacture and market a "springless" trampoline. The Company
paid $1,000,000 in cash upon execution of the agreement, $500,000 of which will
be applied towards royalties otherwise payable by the Company. An additional
$500,000 will be paid by the Company when a U.S. patent pending on this
technology is issued. Total royalties and amortization of the license agreement
were $43,000 during the year ended July 31, 1999.
35
<PAGE>
10. TREASURY STOCK
In January 1999, the Company purchased 371,279 shares of its common stock, which
were tendered as a result of a self-tender offer, pursuant to a modified Dutch
auction. The shares were purchased at a price of $6.00 per share. In June 1999,
the Company, in a private sale transaction, purchased an aggregate of 141,700
shares of its common stock at a price of $5.50 per share pursuant to an
unsolicited offer to sell received by the Company. Treasury stock is recorded at
cost, including all applicable fees and expenses.
11. STOCK WARRANTS
In November 1997, in connection with the acquisition of approximately 28% of the
Company's outstanding common stock from existing shareholders by REMY Capital
Partners IV, L.P., a private investment partnership ("Remy"), the Company
entered into consultation agreements with Remy and Raymond H. Losi, the
Company's co-founder and former Chairman of the Board. As compensation under
those agreements, Remy and Mr. Losi received warrants to purchase 400,000 and
200,000 shares respectively, of the Company's common stock for $5.10 per share,
all of which are currently exercisable until November 2004. The Company
recognized in general and administrative expenses non-cash consulting expenses
of $702,000 in connection with the issuance of those stock warrants. The amount
of consulting expense was determined in accordance with FASB Statement No. 123,
"Accounting for Stock-Based Compensation," and the Company recognized the entire
amount of the expense immediately.
Also in connection with the Remy common stock acquisition, Raymond H. Losi, II,
the Company's Chief Executive Officer, received warrants to purchase 100,000
shares of the Company's common stock for $5.10 per share, all of which are
currently exercisable until November 2004.
12. IMPAIRMENT AND SALE OF CERTAIN ASSETS
During the quarter ended January 31, 1998, as required by FASB Statement No.
121, "Accounting for the Impairment of Long-Lived Assets," the Company
considered the operating losses of its wholly-owned subsidiary, Static
Snowboards, Inc., and the continuing challenges facing the snowboard industry in
general and concluded that impairment of the subsidiary's assets had occurred.
Accordingly, an impairment loss totaling $995,000, representing the excess of
the carrying value over the estimated fair market value of assets, was
recognized for write-downs of fixed assets and write-off of the remaining
unamortized balance of goodwill relating to such subsidiary.
In May 1998, the Company entered into a Purchase and Sale Agreement to sell
certain assets of Static Snowboards, Inc. resulting in no significant gain or
loss. The Company closed its manufacturing factory in California, with the
intention of sourcing snowboards from independent contractors located in Asia.
13. RELATED PARTY TRANSACTIONS
The Company purchases certain inventories from an entity affiliated with an
officer and stockholder of the Company. Total inventory purchases made from the
related party were approximately $1,530,000, $0 and $0 during the years ended
July 31, 1999, 1998 and 1997, respectively. Amounts due to the related party are
recorded in accounts payable and paid under normal terms. Amounts recorded in
accounts payable at July 31, 1999 and 1998 were $6,000 and $0, respectively.
36
<PAGE>
14. QUARTERLY OPERATING DATA (UNAUDITED)
The following is a summary of unaudited quarterly results of operations:
<TABLE>
<CAPTION>
First Second Third Fourth
--------- ----------- ---------- -----------
(In thousands, except per share data)
<S> <C> <C> <C> <C>
Year ended July 31, 1999:
Net sales $ 8,876 $10,626 $10,395 $7,473
Gross profit 1,654 2,739 2,398 707
Net income 108 131 318 246
Net income per share:
Basic .02 .02 .06 .04
Diluted .02 .02 .06 .04
Year ended July 31, 1998:
Net sales $13,659 $10,645 $10,558 $8,286
Gross profit 2,161 1,757 2,042 657
Net income (loss) (21) (2,788) * 20 (699)
Net income (loss) per share:
Basic - (.46) * - (.12)
Diluted - (.46) - (.12)
</TABLE>
* Includes $702,000 for non-cash consulting expenses in connection with issuance
of stock warrants per note 11 and $995,000 impairment loss per note 12.
37
<PAGE>
VARIFLEX, INC.
VALUATION AND QUALIFYING ACCOUNTS
Three years ended July 31, 1999
<TABLE>
<CAPTION>
Additions
Balance at Charged Write-offs Balance
Beginning to Charged to At End
of Period Expense Allowance of Period
------------- ------------ -------------- -------------
<S> <C> <C> <C> <C>
Year ended July 31, 1999:
Reserves and allowances deducted from asset accounts:
Allowance for uncollectable accounts $413,000 $ 95,000 $ 78,000 $430,000
Year ended July 31, 1998:
Reserves and allowances deducted from asset accounts:
Allowance for uncollectable accounts $549,000 $(24,000) $112,000 $413,000
Year ended July 31, 1997:
Reserves and allowances deducted from asset accounts:
Allowance for uncollectable accounts $555,000 $100,000 $106,000 $549,000
</TABLE>
38
<PAGE>
PART III
Item 10. Directors and Executive Officers of the Registrant.
Item 11. Executive Compensation.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
Item 13. Certain Relationships and Related Transactions.
Except as noted in the following paragraph, the information required by
Items 10, 11, 12 and 13 is included in the Company's definitive Proxy Statement
to be filed pursuant to Regulation 14(A) not later than 120 days after the close
of fiscal 1999 in connection with the Company's 1999 Annual Meeting of
Stockholders, and is therefore incorporated herein by reference.
The information called for by Item 10 with respect to executive
officers of the Registrant appears following Item 4 under Part I of this Report
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
Financial Statements
The following financial statements are included in Part II, Item 8 of
this Annual Report on Form 10-K:
Independent Auditors' Report on Consolidated Financial Statements and
Schedules
Consolidated Balance Sheets as of July 31, 1999 and 1998
Consolidated Statements of Operations for the years ended July 31, 1999,
1998 and 1997
Consolidated Statements of Stockholders' Equity for the years ended July
31, 1999, 1998 and 1997
Consolidated Statements of Cash Flows for the years ended July 31, 1999,
1998 and 1997
Notes to Consolidated Financial Statements
Financial Statement Schedules
The following schedules are included in Part II, Item 8 of this Annual
Report on Form 10-K:
Schedule II. Valuation and Qualifying Accounts
Schedules I and III through V are omitted for the reason that they are
not applicable, not required or the information is presented in the
consolidated financial statements or related notes.
Reports on Form 8-K
None
39
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit No. Description Note No.
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
3.1 Certificate of Incorporation of the Company (1)
3.2 By-laws of the Company (1)
9.1 Voting Agreement dated November 18, 1997, by and among Raymond H. Losi, Raymond H. Losi, II, (4)
Raymond H. Losi, as Trustee of the 1989 Raymond H. Losi Revocable Trust under Declaration of Trust
dated January 23, 1989, Losi Enterprises Limited Partnership, Raymond H. Losi, II and Kathy Losi,
as Co-Trustees of the Jay and Kathy Losi Revocable Trust dated January 1, 1989, EML Enterprises,
L.P., Eileen Losi, as Trustee of the Eileen Losi Revocable Trust under Declaration of Trust dated
October 13, 1993, Barbara Losi, as Trustee of the 1989 Barbara Losi Revocable Trust under
Declaration of Trust dated January 31, 1989, The BL 1995 Limited Partnership, Raymond H. Losi, as
Trustee of the Diane K. Losi Trust and Remy Capital Partners IV, L.P.
10.1 Lease for property located at 5152 North Commerce Avenue, Moorpark, California, (1)
dated June 8, 1992
10.2 First Amendment, dated March 20, 1995, to the June 8, 1992 lease for property located (3)
at 5152 North Commerce Avenue, Moorpark, California
10.3 Second Amendment, dated November 18, 1996, to the June 8, 1992 lease for property located (3)
at 5152 North Commerce Avenue, Moorpark, California
*10.4 Employment agreement dated April 1, 1994 with Raymond H. Losi II (1)
*10.5 Employment agreement dated April 1, 1994 with Warren Marr (1)
*10.6 Employment agreement dated April 1, 1994 with Paula Coffman (formerly Paula Montez) (1)
*10.7 Employment agreement dated May 11, 1998 with Roger M. Wasserman (5)
*10.8 Employment agreement dated August 24, 1998 with Steven Muellner (5)
*10.9 Consulting Agreement dated November 18, 1997, by and between Variflex, Inc. and Remy Capital (4)
Partners IV, L.P.
10.10 Consulting Agreement dated November 18, 1997, by and between Variflex, Inc. and Raymond H. Losi (4)
10.11 Indemnification agreement dated April 1, 1994 with Raymond H. Losi (1)
10.12 Indemnification agreement dated April 1, 1994 with Raymond H. Losi II (1)
10.13 Indemnification agreement dated April 1, 1994 with Loren Hildebrand (1)
10.14 Indemnification agreement dated September 17, 1998 with Mark S. Siegel (5)
10.15 Indemnification agreement dated September 17, 1998 with Michael T. Carr (5)
10.16 Indemnification agreement dated September 17, 1998 with Steven Muellner (5)
10.17 Indemnification agreement dated September 17, 1998 with Roger M. Wasserman (5)
10.18 License Agreement with Rollerblade, Inc. dated September 1, 1993 (1)
10.19 1994 Variflex Stock Plan dated April 1, 1994 (1)
10.20 Business Loan Agreement dated January 23, 1998, between Bank of America National Trust and Savings (5)
Association and Variflex, Inc.
10.21 Amendment No. 1, dated October 6, 1998, to the January 23, 1998 Business Loan Agreement with Bank (6)
of America National Trust and Savings Association
10.22 Amendment No. 2, dated December 8, 1998, to the January 23, 1998 Business Loan Agreement with Bank (6)
of America National Trust and Savings Association
10.23 Amendment No. 3, dated March 29, 1999, to the January 23, 1998 Business Loan Agreement with Bank of (6)
America National Trust and Savings Association
- ---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
40
<PAGE>
<TABLE>
<CAPTION>
Exhibit No. Description Note No.
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
10.24 Stock Purchase Agreement dated November 18, 1997, by and between Remy Capital Partners IV, L.P., (4)
The RHL Limited Partnership, EML Enterprises, L.P. and The BL 1995 Limited Partnership
10.25 Registration Rights Agreement dated November 18, 1997, by and among Variflex, Inc., Remy Capital (4)
Partners IV, L.P. and Raymond H. Losi, II
10.26 Warrant to purchase Variflex, Inc. Common Stock issued to Remy Capital Partners IV, L.P. (4)
10.27 Warrant to purchase Variflex, Inc. Common Stock issued to Raymond H. Losi (4)
10.28 Warrant to purchase Variflex, Inc. Common Stock issued to Raymond H. Losi, II (4)
10.29 1994 Stock Option Plan, as amended (5)
10.30 Non-Employee Directors Compensation Plan (5)
21.1 Subsidiaries of the registrant (2)
27.1 Financial Data Schedule (6)
- ---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Previously filed together with the Company's Registration Statement on Form
S-1, Reg. No. 33-77362.
(2) Previously filed together with the Company's annual report on Form 10-K
(file no.: 0-24338) on October 24, 1995.
(3) Previously filed together with the Company's annual report on Form 10-K
(file no.: 0-24338) on November 4, 1997.
(4) Previously filed together with the Company's report on Form 8-K (file no.:0-
24338) on November 26, 1997.
(5) Previously filed together with the Company's annual report on Form 10-K
(file no.: 0-24338) on October 29, 1998.
(6) Filed herewith the Company's annual report on Form 10-K (file no.:0-24338)
on October 20, 1999.
* Management contract, compensatory plan or arrangement.
41
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
VARIFLEX, INC.
October 20, 1999 By /s/ RAYMOND H. LOSI II
--------------------------------
Raymond H. Losi II
Chief Executive Officer (Principal
Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
October 20, 1999 /s/ MARK S. SIEGEL
-----------------------------------
Mark S. Siegel
Chairman of the Board
October 20, 1999 /s/ RAYMOND H. LOSI II
-----------------------------------
Raymond H. Losi II
Chief Executive Officer (Principal
Executive Officer) and Director
October 20, 1999 /s/ STEVEN L. MUELLNER
-----------------------------------
Steven L. Muellner
President
October 20, 1999 /s/ ROGER M. WASSERMAN
-----------------------------------
Roger M. Wasserman
Chief Financial Officer (Principal
Financial and Accounting Officer)
October 20, 1999 /s/ KENNETH N. BERNS
-----------------------------------
Kenneth N. Berns
Director
October 20, 1999 /s/ MICHAEL T. CARR
-----------------------------------
Michael T. Carr
Director
October 20, 1999 /s/ LOREN HILDEBRAND
-----------------------------------
Loren Hildebrand
Director
October 20, 1999 /s/ RAYMOND H. LOSI
-----------------------------------
Raymond H. Losi
Director
42
<PAGE>
Exhibit 10.21
Bank of America
Amendment to Documents
AMENDMENT NO. 1 TO BUSINESS LOAN AGREEMENT
This Amendment No. 1 (the "Amendment") dated as of 10/6, 1998 is between
----
Bank of America National Trust and Savings Association (the "Bank") and
Variflex, Inc. (the "Borrower").
RECITALS
--------
A. The Bank and the Borrower entered into a certain Business Loan Agreement
dated as of January 23, 1998 (the "Agreement").
B. The Bank and the Borrower desire to amend the Agreement.
AGREEMENT
---------
1. Definitions. Capitalized terms used but not defined in this Amendment
------------
shall have the meaning given to them in the Agreement.
2. Amendments. The Agreement is hereby amended as follows:
-----------
2.1 The first sentence in Paragraph 6.4 of the Agreement is amended
in its entirety to read as follows:
"To maintain tangible net worth equal to at least the amounts
indicated for each period specified below:
Period Amount
------ ------
For the period ending
October 31, 1998 $35,000,000
3. Effect of Amendment. Except as provided in this Amendment, all of the
--------------------
terms and conditions of the Agreement shall remain in full force and effect.
This Amendment is executed as of the date stated at the beginning of
this Amendment.
Bank of America
National Trust and Savings Association Variflex. Inc.
/s/ Timothy J. Egan /s/ Roger M. Wasserman
-------------------- -----------------------
By: Timothy J. Egan By: Roger M. Wasserman
Title: Vice President Title: Chief Financial Officer
-1-
<PAGE>
Exhibit 10.22
Bank of America
Amendment to Documents
AMENDMENT NO. 2 TO BUSINESS LOAN AGREEMENT
This Amendment No. 2 (the "Amendment") dated as of December 8, 1998, is
---------- ----
between Bank of America National Trust and Savings Association (the "Bank") and
Variflex, Inc. (the "Borrower").
RECITALS
--------
A. The Bank and the Borrower entered into a certain Business Loan Agreement
dated as of January 23, 1998, (the "Agreement").
B. The Bank and the Borrower desire to amend the Agreement.
AGREEMENT
---------
1. Definitions. Capitalized terms used but not defined in this Amendment
------------
shall have the meaning given to them in the Agreement.
2. Amendments. The Agreement is hereby amended as follows:
-----------
2.1 In Paragraph 1 .2 of the Agreement, the date "March 31, 1999" is
substituted for the date "December 31, 1998."
3. Representations and Warranties. When the Borrower signs this Amendment,
------------------------------
the Borrower represents and warrants to the Bank that: (a) there is no event
which is, or with notice or lapse of time or both would be, a default under the
Agreement except those events, if any, that have been disclosed in writing to
Bank or waived in writing by the Bank, (b) the representations and warranties in
the Agreement are true as of the date of this Amendment as if made on the date
of this Amendment, (c) this Amendment is within the Borrower's powers, has been
duly authorized, and does not conflict with any of the Borrower's organizational
papers, and (d) this Amendment does not conflict with any law, agreement, or
obligation by which the Borrower is bound.
4. Effect of Amendment. Except as provided in this Amendment, all of the
--------------------
terms and conditions of the Agreement shall remain in full force and effect.
This Amendment is executed as of the date stated at the beginning of this
Amendment.
Bank of America Variflex, Inc.
National Trust and Savings
Association
X /s/ Timothy J. Egan X /s/ Roger M. Wasserman
------------------- ----------------------
By: Timothy J. Egan, Vice President By: Roger M. Wasserman, CFO
-1-
<PAGE>
Exhibit 10.23
Bank of America
Amendment to Documents
AMENDMENT NO. 3 TO BUSINESS LOAN AGREEMENT
This Amendment No. 3 (the "Amendment") dated as of 3/29, 1999, is between
---- ----
Bank of America National Trust and Savings Association (the "Bank") and
Variflex, Inc. (the "Borrower").
RECITALS
--------
A. The Bank and the Borrower entered into a certain Business Loan Agreement
dated as of January 23, 1998, as previously amended (the "Agreement)
B. The Bank and the Borrower desire to further amend the Agreement.
AGREEMENT
---------
1. Definitions. Capitalized terms used but not defined in this Amendment
------------
shall have the meaning given to them in the Agreement.
2. Amendments. The Agreement is hereby amended as follows:
-----------
2.1 In Paragraph 1.1(a) of the Agreement, the amount "Six Million Five
Hundred Thousand Dollars ($6,500,000)" is substituted for the amount
"Seven Million Five Hundred Thousand Dollars ($7,500,000)."
2.2 In Paragraph 1.2 of the Agreement, the date "December 31, 1999" is
substituted for the date "March 31, 1999."
2.3 In Paragraph 1.3 of the Agreement, the phrase "120 days beyond the
Expiration Date" is substituted for the phrase "90 days beyond the
Expiration Date."
2.4 Paragraph 6.2 of the Agreement is amended to read in its entirety as
follows:
"6.2 Use of Proceeds - Ineligible Securities. Not to use any portion
of the proceeds of the credit to purchase during the underwriting
period, or for thirty days thereafter, Ineligible Securities
underwritten by NationsBanc Montgomery Securities LLC. NationsBanc
Montgomery Securities LLC is a wholly-owned subsidiary of BankAmerica
Corporation, and is a registered broker-dealer which is permitted to
underwrite and deal in certain Ineligible Securities. 'Ineligible
Securities' means securities which may not be underwritten or dealt in
by member banks of the Federal Reserve System under Section 16 of the
Banking Act of 1933 (12 U.S.C. (S) 24, Seventh), as amended. The
restrictions of this paragraph shall also cover Ineligible Securities
underwritten by any other present or future subsidiary of BankAmerica
Corporation which underwrites Ineligible Securities."
2.5 In Paragraph 6.3(d) of the Agreement, "month end" is substituted for
"quarter end."
2.6 Paragraph 6.4 of the Agreement is amended to read in its entirety as
follows:
"6.4 Tangible Net Worth. To maintain tangible net worth equal to at
least Twenty Five Million Dollars ($25,000,000). 'Tangible Net Worth'
means the gross book value of the Borrower's assets (excluding
goodwill not generated by an acquisition, patents, trademarks, trade
names, organization expense, treasury stock, unamortized debt discount
and expense, capitalized or deferred research and development costs,
deferred marketing expenses, deferred receivables, and other like
intangibles not generated by an acquisition) less total liabilities,
including but not limited to accrued and deferred income taxes, and
any reserves against assets."
2.7 In Paragraph 6.6 of the Agreement, "Thirteen Million Dollars
($13,000,000) is substituted for "Ten Million Dollars ($10,000,000)."
3. Representations and Warranties. When the Borrower signs this Amendment,
-------------------------------
the Borrower represents and warrants to the Bank that: (a) there is no event
which is, or with notice or lapse of time or both would be, a default under the
Agreement except those events, if any, that have been disclosed in writing to
the Bank or waived in writing by the Bank, (b) the representations and
warranties in the Agreement are true as of the date of this Amendment as if made
on the date of this Amendment, (c) this Amendment is within the Borrower's
powers, has been duly authorized, and does not conflict with any of the
Borrowers organizational papers, and (d) this Amendment does not conflict with
any law, agreement, or obligation by which the Borrower is bound.
-1-
<PAGE>
4. Effect of Amendment. Except as provided in this Amendment, all of the
-------------------
terms and conditions of the Agreement shall remain in full force and effect.
This Amendment is executed as of the date stated at the beginning of this
Amendment.
Bank of America Variflex, Inc.
National Trust and Savings Association
/s/ Timothy J. Egan /s/ Roger M. Wasserman
------------------- ----------------------
By: Timothy J. Egan, Vice President By: Roger M. Wasserman
Chief Financial Officer
-2-
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEETS AND CONSOLIDATED STATEMENTS OF INCOME AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> JUL-31-1999
<PERIOD-START> AUG-01-1998
<PERIOD-END> JUL-31-1999
<CASH> 5,343
<SECURITIES> 19,892
<RECEIVABLES> 7,330
<ALLOWANCES> 430
<INVENTORY> 5,748
<CURRENT-ASSETS> 39,128
<PP&E> 4,930
<DEPRECIATION> 4,647
<TOTAL-ASSETS> 40,617
<CURRENT-LIABILITIES> 5,056
<BONDS> 0
0
0
<COMMON> 9
<OTHER-SE> 35,552
<TOTAL-LIABILITY-AND-EQUITY> 40,617
<SALES> 37,370
<TOTAL-REVENUES> 37,370
<CGS> 29,872
<TOTAL-COSTS> 29,872
<OTHER-EXPENSES> 8,613
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 983
<INCOME-TAX> 180
<INCOME-CONTINUING> 803
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 803
<EPS-BASIC> .14
<EPS-DILUTED> .14
</TABLE>
