U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB/A-2
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission File Number O-25030
PLAY CO. TOYS & ENTERTAINMENT CORP.
-----------------------------------
(Exact Name of Small Business Issuer as Specified in its Charter)
Delaware 95-3024222
(State or Other Jurisdiction of (IRS Employer Identification No.)
Incorporation or Organization)
550 Rancheros Drive, San Marcos, California 92069
(Address of Principal Executive Offices)
(760) 471-4505
(Issuer's Telephone Number, Including Area Code)
N/A
-----------------------------------------------------
(Former Name, Former Address, and Former Fiscal Year,
if Changed Since Last Report)
Check whether the Issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12
months (or for such shorter period that registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days. Yes [X] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS
State the number of shares of each of the issuer's classes of common equity
outstanding as of the latest practicable date: Common Stock, $0.01 par value:
5,548,857 shares outstanding as of August 12, 1999.
Transitional Small Business Disclosure Format (check one): Yes [ ] No [X]
<PAGE>
PLAY CO. TOYS & ENTERTAINMENT CORP.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION Page Number
Item 1. FINANCIAL STATEMENTS
<S> <C> <C> <C>
Condensed Balance Sheets as of June 30, 1999 (unaudited) 3
and March 31, 1999.
Condensed Statements of Operations and Comprehensive Net Loss for the Three Months
Ended June 30, 1999 and 1998 (unaudited). 4
Condensed Statements of Cash Flows for the Three Months Ended June 30, 1999 and 1998
(unaudited). 5
Notes to Condensed Financial Statements 6-12
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
13-21
PART II. OTHER INFORMATION
22
Item 1. LEGAL PROCEEDINGS
Item 2. CHANGES IN SECURITIES AND USE OF PROCEEDS 22
Item 3. DEFAULTS UPON SENIOR SECURITIES 22
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 22
Item 5. OTHER INFORMATION 22
Item 6. EXHIBITS AND REPORTS ON FORM 8-K 22
Signatures 23
</TABLE>
See accompanying notes to condensed financial statements
5
<PAGE>
PLAY CO. TOYS & ENTERTAINMENT CORP.
(A SUBSIDIARY OF UNITED TEXTILES & TOYS CORP.)
CONDENSED BALANCE SHEETS
<TABLE>
<CAPTION>
ASSETS June 30,1999 March 31, 1999
Restated (Note 5) Restated (Note 5)
(Unaudited)
----------------------- ----------------------
Current
<S> <C> <C>
Cash $ 392,745 $ 125,967
Accounts receivable 131,836 98,276
Merchandise inventories 12,247,019 11,506,284
Other current assets 1,320,550 1,591,629
--------- ---------
Total current assets 14,092,150 13,322,156
Property and Equipment, net of accumulated
depreciation and amortization of $4,283,071
and $4,058,603, respectively 5,583,035 5,348,175
Deposits and other assets 2,922,838 2,411,427
--------- ---------
$ 22,598,023 $ 21,081,758
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
June 30, 1999 March 31, 1999
Restated (Note 5) Restated (Note 5)
Unaudited
--------------------- ----------------------
Current
Accounts payable $ 7,931,269 $ 5,611,442
Accrued expenses and other liabilities 327,025 595,008
Current portion of notes payable and capital leases 1,212,088 1,352,197
--------- ---------
Total current liabilities 9,470,382 7,558,647
Borrowings under financing agreement 8,263,713 7,814,666
Notes payable, and capital leases, net of current portion 572,838 585,681
Deferred rent liability 129,534 126,769
--------- ---------
Total liabilities 18,436,467 16,085,763
--------- ---------
Stockholders' equity
Series E convertible preferred stock, $1 par value
10,000,000 shares authorized;
5,883,903 shares outstanding 6,239,074 5,761,101
Series F convertible preferred stock, $.01 par value,
5,500,000 shares authorized; 750,000 and 0
shares outstanding, respectively (Note 3) 107,143 -
Common stock, $.01 par value, 40,000,000 shares
authorized; 5,548,857 and 5,503,519 shares
Outstanding, respectively 55,488 55,035
Additional paid-in-capital 16,619,319 15,906,172
Accumulated deficit (18,859,468) (16,726,313)
--------- ---------
Total stockholders' equity 4,161,556 4,995,995
--------- ---------
$ 22,598,023 $ 21,081,758
============ ============
</TABLE>
<PAGE>
PLAY CO. TOYS & ENTERTAINMENT CORP.
(A SUBSIDIARY OF UNITED TEXTILES & TOYS CORP.)
CONDENSED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE NET LOSS
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended June 30,
1999 1998
Restated (Note 5)
-------------
<S> <C> <C>
Net sales $6,508,565 $6,357,395
Cost of sales 3,763,214 3,706,331
--------- ---------
Gross profit 2,745,351 2,651,064
--------- ---------
Operating expenses:
Operating expenses 3,753,528 2,483,771
Depreciation and amortization 224,468 188,417
--------- ---------
Total operating expenses 3,977,996 2,672,188
--------- ---------
Operating loss (1,232,645) (21,124)
--------- ---------
Interest expense:
Interest and finance charges 284,664 138,452
Amortization of debt issuance costs 30,730 27,200
Effective non-cash interest expense from
beneficial 650,000 -
--------- ---------
conversion feature
Total interest expense 965,394 165,652
--------- ---------
Net loss before extraordinary gain (2,198,039) (186,776)
Extraordinary gain on modification of debt terms (Note 4) 650,000 -
--------- ---------
Net loss (1,548,039) (186,776)
Other comprehensive loss - -
--------- ---------
Comprehensive net loss $(1,548,039) $(186,776)
============ =========
Calculation of Basic and Diluted Loss Per Share:
Net loss (1,548,039) (186,776)
Effect of non-cash dividends on
preferred stock (585,116) (273,806)
--------- ---------
Net loss applicable to common shares $ (2,133,155) $(460,582)
============ =========
Basic and diluted loss per common
Share and share equivalents $ (0.39) $ (0.11)
============ =========
Weighted average number of common
Shares and share equivalents
outstanding 5,525,936 4,103,525
============ =========
</TABLE>
<PAGE>
PLAY CO. TOYS & ENTERTAINMENT CORP.
(A SUBSIDIARY OF UNITED TEXTILES & TOYS CORP.)
CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended June 30,
1999 1998
Restated (Note 5)
----------------------- ---------------
CASH FLOWS FROM OPERATING ACTIVITIES:
<S> <C> <C>
Net loss $(1,548,039) $ (186,776)
Adjustments used to reconcile net loss to net cash used for operating
activities:
Depreciation and amortization 224,468 188,417
Deferred rent 2,764 4,552
Stock compensation 56,100 10,938
Extraordinary gain (Note 4) (650,000) -
Effective interest for beneficial conversion (Note 4) 650,000 -
Increase (decrease) from changes in:
Accounts receivable (33,560) 26,618
Merchandise inventories (740,735) (1,503,233)
Other current assets 271,079 (127,228)
Deposits and other assets (511,410) (93,072)
Accounts payable 2,319,827 1,249,369
Accrued expenses and other liabilities (267,983) (527,702)
-------- --------
Net cash used for operating activities (227,489) (958,117)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (196,653) (377,028)
-------- --------
Net cash used for investing activities (196,653) (377,028)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of preferred stock 657,500 -
Borrowings under financing agreements 8,561,047 8,099,497
Repayments under financing agreements (8,112,000) (7,023,000)
Borrowings under notes payable 200,000 -
Repayments of notes payable and capital leases (615,627) (100,883)
-------- --------
Net cash provided by financing activities 690,920 975,614
-------- --------
Net increase (decrease) in cash 266,778 (359,531)
Cash at beginning of period 125,967 648,986
-------- --------
Cash at end of period $ 392,745 $ 289,455
========= =========
</TABLE>
<PAGE>
Note 1. General
The interim accompanying unaudited condensed financial statements have been
prepared in accordance with generally accepted accounting principles ("GAAP")
for interim financial information and with the instructions to Form 10-QSB.
Accordingly, they do not include all of the information and footnotes required
by GAAP for complete financial statements. In the opinion of management, all
adjustments (consisting of normal recurring accruals) considered necessary for a
fair presentation have been included. For further information, management
suggests that the reader refer to the audited financial statements, as restated
(Note 6), for the year ended March 31, 1999 included in its Annual Report on
Form 10-KSB. Operating results for the three-month period ended June 30, 1999
are not necessarily indicative of the results of operations that may be expected
for the year ending March 31, 2000.
Note 2. Capital Leases
During the three-month period ended June 30, 1999, the Company entered into
several capital leases and loans to help finance the cost of opening its new
stores. The leases are for an aggregate principal amount of $262,675. They
generally carry terms of five years and bear interest at rates between 13.3% and
18.0%.
Note 3. Series F Private Placement
On May 27, 1999, pursuant to a Securities Purchase Agreement entered into by and
between the Company and several unaffiliated investors, the Company sold 750,000
unregistered shares of Series F Preferred Stock ("Series F Stock") in a private
transaction. As part of the Securities Purchase Agreement, the Company undertook
to register the Common Stock underlying the Series F Stock through the filing of
a registration statement with the Securities and Exchange Commission. Each share
of Series F Stock is convertible into two shares of Common Stock, at the option
of the holder, at any time following the effective date of the registration
statement, expected to occur in January, 2000. Each share of Series F Stock
shall convert automatically on the occurrence of the earlier of either of the
following events, without action on the part of the holder thereof: (i) two
years from issuance or (ii) in the event the closing price per share of Common
Stock has been at least $5.00 for a consecutive 30 day period. The Company
received net proceeds of $657,500 after deduction of all investment banking and
legal and administrative fees.
<PAGE>
Note 3. Series F Private Placement (continued)
As part of the Private Placement, the Company granted an option to the Placement
Agent and its assignees to purchase an aggregate 350,000 shares of Common Stock,
with an exercise price of $3.00 per share for a period of four years from the
date of closing of the Private Placement. Utilizing the Black-Scholes valuation
model, the options were valued at $507,000, or $1.45 per option. The model
utilized several variables to determine the value including the current price of
the stock and its expected volatility, and the risk-free interest rate for the
expected term. The current stock price was $1.69 on the May 27, 1999 closing
date. Based on an analysis of the stock price over the previous twenty months,
the volatility factor utilized was 155%. Additionally, the model used a
risk-free interest rate of 6.0%.
Additionally, as commission, the Placement Agent received a 10% fee, or $75,000
and a 1% fee, or $7,500 to cover administrative expenses. The Private Placement
closed on May 27, 1999, providing net cash proceeds of $667,500 to the Company
before legal and other administrative expenses.
Due to the beneficial conversion feature of the Series F Stock, the proceeds
have been recorded initially as additional paid - in capital, which will be
amortized over a 7-month period in the form of a non-cash dividend. The time
period corresponds with the expected length of time in order to register the
securities.
Note 4. Extraordinary Gain
In May 1999, the Company and these two creditors, EACF and Frampton, agreed to
modify certain terms of their convertible debentures. The debentures originally
contained a 50% discount factor to the market price of the Series E Preferred
Stock. The amended debenture was changed to eliminate the discount based on the
market price on the date of the original agreement. This changed the conversion
price from $.10 per share to $.20 per share; i.e., for every $100,000 converted,
the holder would receive only 500,000 shares instead of 1,000,000 as a result of
the modification in terms. The Company had previously recognized a $650,000
non-cash effective interest expense for the year ended March 31, 1999. The
Company has subsequently applied the provisions of EITF 96-19 to recognize this
modification of debt terms as an extinguishment of debt since the modifications
significantly changed the terms of the debt instrument. The extinguishment was
recorded as an extraordinary gain of $650,000 was subsequently recognized in the
quarter ended June 30, 1999. However, since the agreement was revised in May
1999, the revised agreement is treated as a new arrangement for accounting
purposes. At the date of the amended agreement, the $.20 conversion price was
substantially lower than the approximate $2.00 per share closing market price
for the Series E Preferred Stock. As such, the modified agreement contains a
beneficial conversion feature, the amount of which is limited to the proceeds of
$650,000 under Topic D-60 of the EITF. Therefore, the Company also subsequently
recognized $650,000 in non-cash effective interest expense for the beneficial
conversion feature in the quarter ended June 30, 1999 since the revised
agreement was treated as a new debt instrument.
<PAGE>
Note 5. Restatement of Amounts Previously Reported
The March 31, 1999 and June 30, 1999 financial statements contain certain
restatements of amounts previously reported. The restatements were the result of
inquiries made by the SEC regarding the accounting treatment for transactions
revolving around the Company's debt and equity securities, including grants of
options/stock, convertible debentures, and convertible preferred stock. As a
result, the Company has restated several amounts, which are described below. The
table below identifies significant changes to balances in the financial
statements.
The revision for the grant of options relates to the Company recognizing a
prepaid expense for the fair value of options at the time it entered into two
agreements to issue options, the related services for which were never
performed. Therefore, the Company reversed the accounting for these
transactions. See Items 1 and 4 below for the impact on the balance sheet and
Item 2 below for the impact on the statement of operations and comprehensive net
income (loss). This reduction of other current assets is less than the amount of
the adjustment to additional paid-in capital in Item 4 because of the reversal
of the amortization of the prepaid expense recorded during the year ended March
31, 1999.
The revision for the Series E Preferred Stock was to record the issuance of
shares to officers for which the Company did not previously recognize
compensation expense during the year ending March 31, 1999. See Item 2 below for
the impact on the balance sheet, and Item 1 below for the impact on the
consolidated statement of operations and comprehensive net income (loss).
The revision in Item 3 below is to reflect accounting necessary for a beneficial
conversion feature included in $650,000 of debentures convertible into shares of
Series E Preferred Stock at a discount from the trading price of the Series E
Preferred Stock.
<PAGE>
Note 5. Restatement of Amounts Previously Reported (continued)
The following is a summary of the impact of the restatements on the
March 31, 1999 consolidated balance sheet.
<TABLE>
<CAPTION>
<S> <C> <C>
1. Reduction of other current assets for options not ultimately
issued (CRG for $35,000 and Typhoon for $44,000, net of
amortization expense of $10,366) $ (68,634)
2. Increase in Series E Preferred Stock for issuance of shares to officers 79,000
3. Increase in additional paid-in capital for beneficial conversion feature
of convertible debentures 650,000
4. Reduction in additional paid-in capital for the options never issued to
CRG and Typhoon (79,000)
5. Additional net loss in accumulated deficit (from above items) 718,634
The following is a summary of the impact of the restatements on the
March 31, 1999 consolidated statement of operations and comprehensive
net income (loss).
1. Increase in operating expenses from recognition of compensation
expense from issuance of Series E Preferred Stock to officers $ 79,000
2. Reduction in operating expenses from reversing amortization for options
not ultimately issued (10,366)
3. Additional effective non-cash interest expense attributable to the
beneficial conversion feature of convertible debentures 650,000
---------------
Decrease in March 31, 1999 net income $ 718,634
===============
</TABLE>
<PAGE>
Note 5. Restatement of Amounts Previously Reported (continued)
The effects on the Company's previously issued March 31, 1999 financial
statements are summarized as follows.
<TABLE>
<CAPTION>
Previously Increase
Reported (Decrease) Restated
--------------- ---------------- ---------------
Consolidated Balance Sheet:
<S> <C> <C> <C>
Other current assets $ 1,310,263 $ (68,634) $ 1,241,629
Total assets $ 21,150,392 $ (68,634) $ 21,081,758
=============== ================ ===============
Series E convertible preferred stock $ 5,682,101 $ 79,000 $ 5,761,101
Additional paid-in capital 15,335,172 571,000 15,906,172
Accumulated deficit (16,007,679) 718,634 (16,726,313)
Total liabilities and stockholders' equity $ 21,150,392 $ (68,634) $ 21,081,758
=============== ================ ===============
Consolidated Statement of Operations and
Comprehensive Income (Loss):
Operating expenses $ 12,658,376 $ 68,634 $ 12,727,010
Effective interest for beneficial
conversion feature - 650,000 650,000
Net income (loss) and comprehensive
net loss $ 140,868 $ (718,634) $ (577,766)
=============== ================ ===============
Net income (loss) applicable to
common shares $ (1,566,857) $ (718,634) $ (2,285,491)
=============== ================ ===============
Basic and diluted income (loss) per
common share and share equivalents $ (.34) $ (.16) $ (.50)
============== ============== ==============
</TABLE>
<PAGE>
Note 5. Restatement of Amounts Previously Reported (continued)
The following is a summary of the impact of the restatements on the June 30,
1999 consolidated financial statements which include the cumulative effects of
the restatements made to the March 31, 1999 financial statements as detailed
above.
<TABLE>
<CAPTION>
Balance Sheet
<S> <C>
1. Reduction of other current assets for options not ultimately issued,
net of previously recorded amortization $ (67,072)
2. Increase in Series E Preferred Stock for issuance of shares 79,000
3. Increase in additional paid-in capital for beneficial conversion feature
of convertible debentures 650,000
4. Reduction in additional paid-in capital for extraordinary gain from
modification of debt terms, which was considered a debt extinguishment
from significant modification in the terms under EITF 96-19. (650,000)
5. Increase in additional paid-in capital for beneficial conversion
feature of revised convertible debentures treated as new debt instruments
(Note 4) 650,000
6. Reduction in additional paid-in capital for cancellation of options (79,000)
7. Increase in Series F Preferred Stock to reflect change in amortization
period for beneficial conversion feature. The amortization for the
dividend associated with the beneficial conversion feature of the
securities was initially to be recognized over the two-year hold period.
The amortization period was changed to seven months to correspond
to the expected timeframe to bring the Series F Stock registration statement
effective, since this is the first instance when the Series F Stock is
able to be converted. 44,643
8. Additional net loss and non-cash dividend in accumulated deficit.
The increase in the accumulated deficit is attributable to a cumulative
increase of $718,634 for the year ended March 31, 1999 (see previous
table outlining changes in the March 31, 1999 balance sheet), less
$1,562 in operating expenses attributed to the reversal of amortization
expense of prepaid stock options that were not issued, plus an additional
non-cash dividend of $44,643 related to the change in the
amortization period of the beneficial conversion feature, as noted
in 7. above. 761,715
9. Net reduction in stockholders' equity (67,072)
</TABLE>
<PAGE>
Note 5. Restatement of Amounts Previously Reported (continued)
Statement of Operations and Comprehensive Net Income (Loss)
<TABLE>
<CAPTION>
<S> <C>
1. Net decrease in operating expenses from reversal of amortization of
stock options not issued $ (1,562)
2. Additional effective non-cash interest expense attributable to the
beneficial conversion feature of revised convertible debentures
treated as new debt instruments (Note 4) 650,000
3. Extraordinary gain from modification of debt terms, since such
modifications were significant to be considered a debt extinguishment
under EITF 96-19 650,000
Decrease in net loss for the three months ending June 30, 1999 $ (1,562)
================
</TABLE>
The effects on the Company's previously submitted June 30, 1999 financial
statements are summarized as follows.
<TABLE>
<CAPTION>
Previously Increase
Reported (Decrease) Restated
--------------- ---------------- ---------------
Consolidated balance sheet:
<S> <C> <C> <C>
Other current assets $ 1,387,622 $ (67,072) $ 1,320,550
Total assets $ 22,665,095 $ (67,072) $ 22,598,023
=============== ================ ===============
Series E convertible preferred stock $ 6,160,074 $ 79,000 $ 6,239,074
Additional paid-in capital 16,048,319 571,000 16,619,319
Total liabilities and stockholders' equity $ 22,665,095 $ (67,072) $ 22,598,023
=============== ================ ===============
Consolidated statement of operations and comprehensive loss:
Operating expenses $ 3,755,090 $ (1,562) $ 3,753,528
Effective interest for beneficial
conversion feature - 650,000 650,000
Extraordinary gain on extinguishment
of debt - 650,000 650,000
Net income(loss) $ (1,549,601) $ 1,562 $ (1,548,039)
=============== ================ ===============
Non-cash dividends on preferred stock (540,473) 44,643 (585,116)
Net income(loss) applicable to
common shares $ (2,090,074) $ 43,081 $ (2,133,155)
=============== ================ ===============
Basic and diluted income(loss) per
common share and share equivalents $ (.39) $ - $ (.39)
============== ================ ==============
</TABLE>
<PAGE>
Note 6. Subsequent Events
On July 15, 1999, Tudor Technologies, Inc. ("Tudor") - an entity of which Mr.
Moses Mika (a director of the Company) is a shareholder - as the assignee of an
option to acquire 25% of the outstanding shares of the common stock of the
Company's subsidiary, Toys International.COM, Inc. ("Toys"), which shares were
then owned by the Company and which option price was set at Toys' book value on
the date of election to exercise the option, elected to exercise its right to
purchase the stock and requested that the exercise price be amended to reflect
the book value of Toys at the most recent fiscal quarter, June 30, 1999. The
Company agreed to Tudor's request. As the book value of Toys as of June 30, 1999
is not yet determined, the Company has not yet provided Tudor with the basis for
the option exercise and, as a result, Tudor has not yet provided the Company
with the appropriate consideration. The Company anticipates that it will provide
Tudor the June 30, 1999 book value determination by the end of August 1999.
This option arose out of the June 30, 1998 conversion, by ABC Fund, Inc. ("ABC,"
an affiliate of the Company), of a $1.5 million debenture into Series E
Preferred Stock ("Series E Stock") as of June 30, 1998. Pursuant to the terms of
the debenture, in September 1998, ABC assigned its right to purchase the Toys
common stock to Tudor.
On July 20, 1999, Toys completed a placement of its Common Stock to two
investors for $2.8 million in gross proceeds in a private transaction. The new
shares issued represented a 6.6% interest in Toys. The investors were an
unaffiliated investment banking firm and CDMI Capital Corporation ("CDMI"), a
British Virgin Islands corporation. Mr. Mika is a shareholder of CDMI. Each
party invested $1.4 million in the transaction.
The Company accounted for this as a capital transaction, and therefore did not
recognize any gain or loss on the transaction. The Company followed the
guidelines established by the SEC under Staff Accounting Bulletin Topic 5 -
Miscellaneous Accounting, "Accounting for Sales of Stock in a Subsidiary", since
Toys sold shares of its own stock. Management of the Company does not believe
recognizing a gain or loss would be appropriate due to the fact that the sale
was "part of a broader corporate reorganization contemplated or planned by the
registrant". This "broader corporate reorganization" is a foreign public
offering of the subsidiary's stock, which Toys is in the process of completing.
In these instances, the Staff Accounting Bulletin indicates that recognition of
a gain is not appropriate.
On August 4, 1999, the Company entered into a sixth amendment to its Loan and
Security Agreement with FINOVA Capital Corporation ("FINOVA"). As a result of
this amendment, the Company's aggregate credit facility with FINOVA increased
from $8.3 million to $11.3 million.
The amendment also (1) increased the minimum net worth financial covenant from
$750,000 to $2.9 million as of June 30, 1999 with the $2.9 million threshold
increasing by 60% of any equity raised by the Company and by 60% of any annual
profits generated by the Company; (2) allows the Company to sell a minority
equity interest (up to 49%) in its Toys subsidiary; and (3) increased the
maximum levels of capital expenditures, capital leases and unsecured debt
allowed under the Financing Agreement.
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Results of Operations
Statements contained in this report which are not historical facts may be
considered forward looking information with respect to plans, projections, or
future performance of the Company as defined under the Private Securities
Litigation Reform Act of 1995. These forward-looking statements are subject to
risks and uncertainties which could cause actual results to differ materially
from those projected.
At June 30, 1999, the Company's operations were influenced to a significant
degree by United Textiles & Toys Corp. ("UTTC") and Breaking Waves, Inc.
("Breaking Waves") which owned 44.9% and 22.9%, respectively, of the then issued
and outstanding shares of the Company's Common Stock (then totaling 5,548,857).
By virtue of Breaking Wave's status as a wholly-owned subsidiary of Shopnet.com,
Inc. ("Shopnet"), a Delaware public company, Shopnet may be deemed the
beneficial owner of the shares of Common Stock owned by Breaking Waves.
For the three months ended June 30, 1999 compared to the three months ended June
30, 1998
The Company generated net sales of $6,508,565 in the three months ended June 30,
1999. This represented an increase of $151,170, or 2.4%, from net sales of
$6,357,395 in the three months ended June 30, 1998. All of this sales growth
came from the Company's new stores as same store sales declined by 27% for the
period.
The Company believes that its same store sales showed a decline after a period
of two years of continuous increases because in the three months ended June 30,
1999, the flow of allocated or "hot" selling merchandise is being spread over
25% more stores. This shortfall in allocated or "hot" selling inventory is a
result of the current credit lines that the Company has with some of its
vendors. The Company is working to increase its lines of credit with its vendors
to more adequately address not only the past growth but its expected future
growth as well.
In addition, the Company held back a substantial amount of critical inventory
from its existing stores for the openings of its Toys International stores
located in the Venetian Resort and Casino (the "Venetian") in Las Vegas and in
Pier 39 in San Francisco. The Venetian store opened in mid-June, a full two
months late, and due to major site construction delays, the Company currently
expects to open Pier 39 in early September, four months late.
<PAGE>
The Company posted a gross profit of $2,745,351 in the three months ended June
30, 1999, reflecting an increase of $94,287, or 3.6%, from the gross profit of
$2,651,064 in the three months ended June 30, 1998. This increase was due to the
above noted growth in sales and to an increase in the Company's gross margin.
The gross margin of 42.2% in the June 1999 period was 0.5% higher than the
Company's gross margin of 41.7% in the June 1998 period. This gross margin
improvement was the result of the continuing change in the company's
merchandising mix to augment its historical product base of lower margin
traditional toys with educational and specialty toys which generally produce
better margins than traditional toys. This change in merchandising mix has been
the centerpiece of the Company's business plan for approximately the past three
business years.
Operating expenses (excluding depreciation and amortization expenses) for the
three months ended June 30, 1999 were $3,753,528. This represented a $1,269,757,
or 51.1%, increase over the Company's operating expenses of $2,483,771 in the
three months ended June 30, 1998. The primary reasons for the operating expense
increase were an increase in payroll and related expenses of $436,000 and an
increase in rent expense of $548,000. The payroll expense increase was due to
the addition of several middle managers and employees at the Company's new
stores. The growth of rent expense was the result of adding additional stores.
During the three months ended June 30, 1999, the Company recorded non-cash
depreciation and amortization expense of $224,468, a $36,051, or 19.1%, increase
from $188,417 in the period ended June 30, 1998. Total operating expenses
(operating expenses combined with depreciation and amortization) in the June
1999 period were $3,977,996, representing a $1,305,808, or 48.9%, increase from
total operating expenses of $2,672,188 in the June 1998 period.
As a result of the $94,287 increase in gross profit less the $1,305,808 increase
in total operating expenses, the Company's operating loss increased by
$1,211,521 from $(21,124) during the three months ended June 30, 1998 to
$(1,232,645) during the three months ended June 30, 1999.
Interest expense totaled $965,394 for the three months ended June 30, 1999. This
represented a $799,742, or 482.8%, increase from interest expense of $165,652
for the three months ended June 30, 1999. The primary reason for the increased
level of interest expense was the recognition of $650,000 in non-cash effective
interest expense, which was allocable to the proceeds of the beneficial
conversion feature of the amended Frampton and EACF convertible debentures
during the three months ended June 30, 1999, which were treated as new debt
instruments due to the significant changes in the terms. The effective interest
expense represents a non-cash item that is effectively offset dollar for dollar
in stockholders' equity by an increase in additional paid-in capital.
The Company also recorded an extraordinary gain of $650,000 as the result of the
modification of terms for the Frampton and EACF convertible debentures, since
the modification was treated as an extinguishment of debt under EITF 96-19.
<PAGE>
As a result of the above-mentioned factors, the Company recorded a net loss of
$(1,548,039) for the three months ended June 30, 1999. This represented a
$1,361,263 increase over the net loss of $(186,776) recorded in the three months
ended June 30, 1998.
For the three months ended June 30, 1999, the net loss of $(1,548,039) was
increased by non-cash dividends of $585,116 in order to determine the net loss
applicable to common shares. This compares with $273,806 of non-cash dividends
recorded in the three month period ended June 30, 1998. The non-cash dividends
represent amortization of the discount recorded upon issuance of the Series E
Preferred Stock ("Series E Stock") and Series F Preferred Stock ("Series F
Stock") with a beneficial conversion feature.
The basic and diluted loss per share for the three months ended June 30, 1999
was $(0.39) compared to basic and diluted loss per share of $(0.11) for the
three months ended June 30, 1998. The weighted average number of common shares
outstanding increased from 4,103,525 in the June 1998 period to 5,525,936 in the
June 1998 period.
Liquidity and Capital Resources
At June 30, 1999, the Company had a working capital position of $4,621,768
compared to a working capital position of $5,763,509 at March 31, 1999. The
primary factors in the $1,141,741 decrease in working capital were a $1,579,092
reduction in the Company's net investment in inventories (increase in
inventories less increase in accounts payable).
The Company believes that its same store sales showed a decline after a period
of two years of continuous increases because in the three months ended June 30,
1999, the flow of allocated or "hot" selling merchandise is being spread over
25% more stores. This shortfall in allocated or "hot" selling inventory is a
result of the current credit lines that the Company has with some of its
vendors. The Company is working to increase its lines of credit with its vendors
to more adequately address not only the past growth but its expected future
growth as well.
The Company has generated operating losses for the past several years and has
historically financed those losses and its working capital requirements through
loans and sales of the Company's equity securities, primarily through the sale
of the Company's Series E Stock. There can be no assurance, however, that the
Company will be able to generate sufficient revenues or have sufficient control
over expenses and other charges to achieve profitability.
During the three-month period ended June 30, 1999, the Company used $227,489 of
cash in its operations compared to $958,117 used in operations in the
three-month period ended June 30, 1998. The Company's net loss was $1,548,039
and $186,776, respectively, in those periods. The primary reason the Company
used a far lower level of cash in its operating activities than its loss was due
to a decrease in its net investment (increase in inventories less increase in
accounts payable) in inventories of $1,579,092.
<PAGE>
The Company used $196,653 of cash in its investing activities during the
three-month period ended June 30, 1999 compared to $377,028 in the three-month
period ended June 30, 1998. Investing activity consisted of the purchase of
equipment and fixtures for new stores.
The Company generated $690,920 of cash from its financing activities in the
three-month period ended June 30, 1999 compared to the generation of $975,614
from financing activities in the three-month period ended June 30, 1998. The
primary contributors to the Company's financing activities in the 1999 period
were $657,500 in proceeds from the sale of Series F Stock and net borrowings on
the Company's line of credit. Those proceeds were used to finance the Company's
working capital requirements and capital expenditures during the three-month
period ended June 30, 1999. The primary factor in the prior period was
$1,076,497 in net borrowings on the Company's line of credit.
As a result of the above factors, the Company had a net increase in cash of
$266,778 in the three-month period ended June 30, 1999 compared to a net
decrease in cash of $359,531 in the three-month period ended June 30, 1998.
In November 1998, the Company entered into an agreement with ZD Group, L.L.C.
("ZD"), a related party, to secure additional financing. ZD is a New York trust,
the beneficiary of which is a member of the family of the Company's chairman.
Pursuant to the ZD agreement, ZD issued a $700,000 irrevocable standby letter of
credit ("L/C") in favor of FINOVA. FINOVA then loaned a matching $700,000 to the
Company in the form of a term loan. The term loan expires on August 3, 2000 and
bears interest at prime plus one percent. As consideration for its issuance of
the L/C, ZD will receive a one-third profit percentage after application of
corporate overhead beginning April 1, 1999 from three of the Company's stores
(Woodfield Mall in Schaumburg, Illinois now scheduled to open in the late fall
of 1999; Auburn Hills, Michigan; and Gurnee, Illinois). As those stores did not
generate a profit after application of corporate overhead in the three-month
period ended June 30, 1999, no payments were accrued or made to ZD during the
June period.
Planned new store openings remain a significant capital commitment of the
Company. The Company entered into leases to open eight new stores by the end of
calendar year 1999. The Company expects that the costs of building those new
stores, net of landlord tenant improvement contributions and of inventory
requirements, will be approximately $2.8 million. The Company plans to finance
the costs of opening those new stores through a combination of capital lease
financing, use of the Company's working capital, and the sale of additional
equity.
The first of those stores opened in June in the Venetian in Las Vegas, Nevada.
The costs of opening that store (excluding inventory) were approximately
$825,000. This store was projected to be the most capital intensive of all the
stores scheduled to be opened this fiscal year.
<PAGE>
As of June 30, 1999, the Company is a defendant in a lawsuit with a former
landlord of a retail site the Company vacated in August 1997. The plaintiff
seeks damages ranging to $300,000. The Company has accrued $41,000 at June 30,
1999 as an approximate settlement amount based on management's assessment of the
matters that the landlord allowed the retail mix of the mall site to change from
a contractually agreed minimum percentage level of retail tenants. As this
action is in the discovery phase at June 30, 1999, the actual outcome could
differ from management's estimate. A trial date has been set for September 1999.
The following transactions entered into after April 1, 1999 were equity and debt
transactions structured to help the Company with the cost of the capital
expenditures associated with opening the total of eight new stores in 1999.
The Company received approximately $240,000 in lease financing in the three
month period ended June 30, 1999 period. The Company continues to seek
additional capital lease financing.
In May 1999, pursuant to ss.506 of Regulation D, the Company sold 750,000 shares
of Series F Stock, at a purchase price of $1.00 per share, through Robb Peck
McCooey Clearing Corporation as placement agent. The Company received $657,500
in net proceeds from the sale. Each share of Series F Stock is convertible, at
the holder's option, into two fully paid and non-assessable shares of Common
Stock, at any time commencing on the date the registration statement registering
the Common Stock underlying same is declared effective by the Securities and
Exchange Commission. Each share of Series F Stock shall convert automatically on
the occurrence of the earlier of either of the following events, without action
on the part of the holder thereof: (i) two years from issuance or (ii) in the
event the closing price per share of Common Stock has been at least $5.00 for a
consecutive 30 day period. The Company received net proceeds of $657,500 after
deduction of all investment banking and legal and administrative fees.
Due to the beneficial conversion feature of the Series F Stock, the proceeds
have initially been recorded as additional paid-in capital, which will amortize
over a 7-month period in the form of a non-cash dividend. The seven month period
is the expected time frame until the shares are convertible upon the effective
date of a registration statement.
In connection with the Private Placement of the Series F Stock, the Company
granted options to the Placement Agent to purchase 350,000 shares of Common
Stock at an exercise price of $3.00 per share for a period of four years from
the date of closing of the Private Placement. The Company has valued these
options at approximately $507,000 using the Black-Scholes option valuation
model. As the options were granted in connection with the Private Placement, the
compensation effect of these was effectively offset against the proceeds into
additional paid-in capital with no net effect on the Company's stockholders'
equity or result of operations. The Placement Agent also received a 10%
commission, or $75,000, and a 1% allowance, or $7,500, to cover administrative
expenses. The Private Placement closed on May 27, 1999.
<PAGE>
On July 15, 1999, Tudor Technologies, Inc. ("Tudor") - an entity of which Mr.
Moses Mika (a director of the Company) is a shareholder - as the assignee of an
option to acquire 25% of the outstanding shares of the common stock of the
Company's subsidiary, Toys International.COM, Inc. ("Toys"), which shares were
then owned by the Company and which option price was set at Toys' book value on
the date of election to exercise the option, elected to exercise its right to
purchase the stock and requested that the exercise price be amended to reflect
the book value of Toys at the most recent fiscal quarter, June 30, 1999. The
Company agreed to Tudor's request. As the book value of Toys as of June 30, 1999
is not yet determined, the Company has not yet provided Tudor with the basis for
the option exercise and, as a result, Tudor has not yet provided the Company
with the appropriate consideration. The Company anticipates that it will provide
Tudor the June 30, 1999 book value determination by the end of August 1999.
This option arose out of the June 30, 1998 conversion, by ABC Fund, Inc. ("ABC,"
an affiliate of the Company through common control), of a $1.5 million debenture
into Series E Preferred Stock ("Series E Stock") as of June 30, 1998. Pursuant
to the amended terms of the debenture, in September 1998, ABC assigned its right
to purchase the Toys common stock to Tudor.
On July 20, 1999, the Company's subsidiary, Toys, sold a 6.6% interest in Toys
to two investors for $2.8 million in gross proceeds in a private transaction.
The investors were an unaffiliated investment banking firm and CDMI Capital
Corporation ("CDMI"), a British Virgin Islands corporation. Mr. Mika is a
shareholder of CDMI. Each party invested $1.4 million in the transaction.
Toys accounted for this as a capital transaction, and therefore did not
recognize any gain or loss on the transaction. Management followed the
guidelines established by the SEC under Staff Accounting Bulletin Topic 5 -
Miscellaneous Accounting, "Accounting for Sales of Stock in a Subsidiary".
Management does not believe recognizing a gain or loss would be appropriate due
to the fact that the sale was "part of a broader corporate reorganization
contemplated or planned by the registrant", the foreign public offering of Toy's
stock, which currently is in process of being completed. In these instances, the
Staff Accounting Bulletin indicates that recognition of a gain is not
appropriate.
On August 4, 1999, the Company entered into a sixth amendment to its Loan and
Security Agreement with FINOVA Capital Corporation ("FINOVA"). As a result of
this amendment, the Company's aggregate credit facility with FINOVA increased
from $8.3 million to $11.3 million.
The amendment also (1) increased the minimum net worth financial covenant from
$750,000 to $2.9 million as of June 30, 1999 with the $2.9 million threshold
increasing by 60% of any equity raised by the Company and by 60% of any annual
profits generated by the Company; (2) allows the Company to sell a minority
equity interest (up to 49%) in its Toys subsidiary; and (3) increased the
maximum levels of capital expenditures, capital leases and unsecured debt
allowed under the Financing Agreement.
<PAGE>
Electronic commerce represents another area that may result in significant
capital expenditures for the Company in fiscal 2000. It is also a major focus
for management. In April 1999, The Company debuted the first of three dedicated
electronic commerce websites. This site, www.ToysWhyPayRetail.com, represents a
new trade name for the Company and allows consumers to purchase, at near
wholesale prices, overstocks, special buys, and overruns on mostly name-brand
toys purchased by the Company out of season. The Company plans to offer
approximately 1000 items for sale on the website.
The second and third electronic commerce websites are currently being developed
to a state-of-the-art standard in conjunction with two Internet consulting
firms. These sites will offer collectible and imported specialty merchandise
such as die-cast cars, dolls, plush toys, trains, and collectible action figures
and are expected to open in the late fall of 1999. In conjunction with the
website launch, the Company plans to place computer kiosks in several of its
retail locations in order to permit customers to place orders on the website for
goods otherwise not sold in such store.
The Company has entered into a letter of intent with an investment banking firm
to raise additional equity in the approximate amount of $20-25 million through
the public sale of a minority interest in the Company's Toys subsidiary. This
public offering currently is expected to close in 1999. This investment banking
firm also participated in the $2.8 million private placement in July 1999.
The Company is pursuing this opportunity and is continuing to seek additional
lease financing. There can be no assurance that the Company will be able to
obtain sufficient financing to successfully open the planned new stores.
Additionally, the Company has incurred significant capital expenditures over the
past twelve months. To date, the Company has deployed its working capital to
cover a significant portion of these capital expenditures. As a result, the
Company is also seeking additional working capital from the above-mentioned
equity offerings. Should the Company be unable to raise sufficient working
capital, it may be unable to purchase product directly from factories at
advantageous pricing, thereby resulting in a negative impact on gross margins
and results of operations.
<PAGE>
Year 2000
In 1998, the Company developed a plan to upgrade its existing management
information system and computer hardware and to become year 2000 compliant. The
Company has completed the hardware upgrade and has installed a year 2000
compliant upgrade to its accounting software. The Company expects to finish the
year 2000 compliance work in the September quarter of 1999. To finance the cost
of the new hardware in the computer upgrade project, the Company entered into a
lease in the amount of $82,472 bearing an interest rate of 10.8%. The total cost
of the hardware and software purchased for the project was approximately
$100,000.
Beyond the above noted internal year 2000 system issue, the Company has no
current knowledge of any outside third party year 2000 issues that would result
in a material negative impact on its operations. Management has reviewed its
significant vendors' (i.e., Mattel, Inc. and Hasbro, Inc.) and financing arm's
(FINOVA) recent SEC filings vis-a-vis year 2000 risks and uncertainties and, on
the basis thereof, is confident that the steps the Company has taken to become
year 2000 compliant are sufficient. In continuation of this review, the Company
shall continue to monitor or otherwise obtain confirmation from the aforesaid
entities - and such other entities as management deems appropriate - as to their
respective degrees of preparedness. To date, nothing has come to the attention
of the Company that would lead it to believe that its significant vendors and/or
service providers will not be year 2000 ready.
Year 2000 readiness is a priority of the Company, and the Company believes that
it is taking such reasonable and prudent steps as are necessary to mitigate the
risks associated with potential year 2000 difficulties. The effect, if any, of
year 2000 problems on the Company's results of operations if the Company's or
its customers, vendors, or service providers are not fully compliant cannot be
estimated with any degree of certainty. It is nonetheless possible that year
2000 problems could have a material adverse effect in that holiday 1999
purchases may be stunted due to consumer uncertainty and that the overall
business environment may be disrupted in the Company's fourth fiscal quarter.
Trends Affecting Liquidity, Capital Resources and Operations
The Company believes that its same store sales showed a decline after a period
of two years of continuous increases because the flow of allocated or "hot"
selling merchandise is being spread over 25% more stores. This shortfall in
allocated or "hot" selling inventory is a result of the current credit lines
that the Company has with some of its vendors. The Company is working to
increase its lines of credit with its vendors to more adequately address not
only the past growth but its expected future growth as well. As noted above, the
Company has significantly strengthened its balance sheet by raising
approximately $3.5 million in additional equity over the past three months,
which should result in expanded lines of credit with its trade vendors.
The Company believes that its growth and the availability of "hot" or allocated
merchandise within certain sectors of its core business - such as action
figures, video games, and collector plush - could have an impact on continuing
store sales in the future. The Company is working diligently to address this
issue.
<PAGE>
The Company's future financial performance will depend upon continued demand for
toys and the Company's ability to choose locations for new stores, the Company's
ability to purchase product at favorable prices and on favorable terms, and the
effects of increased competition and changes in consumer preferences.
The toy and hobby retail industry faces a number of potentially adverse business
conditions including price and gross margin pressures and market consolidation.
The Company competes with a variety of mass merchandisers, superstores, and
other toy retailers, including Toys R Us and Kay Bee Toy Stores. Competitors
that emphasize specialty and educational toys include Disney Stores, Warner
Bros. Stores, Learning Smith, Lake Shore, Zainy Brainy, and Noodle Kidoodle. The
Company also competes both through its electronic commerce operations and
through its stores against Internet oriented toy retailers such as eToys, Inc.
There can be no assurance that the Company's business strategy will enable it to
compete effectively in the toy industry.
Seasonality
The Company's operations are highly seasonal with approximately 30-40% of its
net sales falling within the Company's third quarter, which coincides with the
Christmas selling season. The Company intends to open new stores throughout the
year, but generally before the Christmas selling season, which will make the
Company's third quarter sales an even greater percentage of the total year's
sales.
Impact of Inflation
The impact of inflation on the Company's results of operations has not been
significant. The Company attempts to pass on increased costs by increasing
product prices over time.
<PAGE>
PART II
Item 1. Legal Proceedings
In October 1997, in the Superior Court of the State of California, County of San
Bernardino, Foothill Marketplace commenced suit against the Company and its
former guarantor for breach of contract pertaining to premises leased by the
Company in Rialto, California. The lease for the premises has a term from
February 1987 through November 2003. The Company vacated the premises in August
1997. Under California State law and the provisions of the lease, plaintiff has
a duty to mitigate its damages. Plaintiff seeks damages, of a continuing nature,
for unpaid rent, proximate damages, costs, and attorneys' fees, in the
approximate amount of $300,000. The Company is engaged in settlement
negotiations with plaintiff with respect to this action; in the event no
settlement is reached, however, trial has been scheduled by the court for
September 1999.
Neither the Company's officers, directors, affiliates, nor owners of record or
beneficially of more than five percent of any class of the Company's Common
Stock is a party to any material proceeding adverse to the Company or has a
material interest in any such proceeding adverse to the Company.
Item 2. Changes in Securities and Use of Proceeds: None
Item 3. Defaults Upon Senior Securities: None
Item 4. Submission of Matters to a Vote of Security Holders: None
Item 5. Other Information: None
Item 6. Exhibits and Reports on Form 8-K
(a) The following exhibits are filed herewith:
(b) During the quarter ended June 30, 1999, no reports on Form 8-K were filed
with the Securities and Exchange Commission.
<TABLE>
<CAPTION>
<S> <C>
10.131 ABC Fund, Inc. Assignment of Debenture to Tudor Technologies, Inc. dated September 15, 1998
10.132 Tudor Technologies, Inc. Election to Exercise dated July 15, 1999
10.133 Sixth Amendment to Loan and Security Agreement by and between the Company and FINOVA Capital
Corporation, dated August 1999
10.134 Fixture Financing Agreement with Longwater Capital Corporation
27.1 Financial Data Schedule
</TABLE>
<PAGE>
SIGNATURES
In accordance with the requirements of the Exchange Act, the Registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized, this day of 2000.
PLAY CO. TOYS & ENTERTAINMENT CORP.
By: /s/ Richard L. Brady
Richard L. Brady
President and Chief Executive Officer
By: /s/ James B. Frakes
James B. Frakes
Chief Financial Officer
