<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q/A
AMENDMENT NO. 1
(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, 1997
OR
[ ] Transition Report pursuant to Section 13 of 15 (d) of the
Securities Exchange Act of 1934.
For the transition period from to .
---------- ----------
Commission File Number 0-25916
YES! ENTERTAINMENT CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 94-3165290
-------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3875 Hopyard Road, Suite 375, Pleasanton, CA 94588
--------------------------------------------------
(Address of principal executive offices and zip code)
(510) 847-9444
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the proceeding 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
----- -----
As of July 31, 1997 there were 14,287,786 shares of the registrant's common
stock outstanding.
<PAGE>
YES! ENTERTAINMENT CORPORATION
FORM 10-Q/A
JUNE 30, 1996
INDEX
PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
Consolidated Statements of Operations -
Three months and six months ended
June 30, 1997 and June 30, 1996 3
Consolidated Balance Sheets -
June 30, 1997 and December 31, 1996 4
Consolidated Statements of Cash Flows -
Six months ended June 30, 1997
and June 30, 1996 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 10
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 20
SIGNATURE PAGE 21
2.
<PAGE>
PART I. FINANCIAL INFORMATION
-----------------------------
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
YES! ENTERTAINMENT CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
----------------------------- -----------------------------
JUNE 30, JUNE 30, JUNE 30, JUNE 30,
1997 1996 1997 1996
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net sales $ 12,616 $ 11,551 $ 21,657 $ 20,486
Cost of sales 7,615 6,887 12,940 11,192
-------- -------- -------- --------
Gross profit 5,001 4,664 8,717 9,294
-------- -------- -------- --------
Operating expenses:
Marketing, advertising and promotion 559 1,473 1,439 2,167
Selling, distribution and administrative 6,182 4,696 12,300 9,569
-------- -------- -------- --------
Total operating expenses 6,741 6,169 13,739 11,736
-------- -------- -------- --------
Operating loss (1,740) (1,505) (5,022) (2,442)
Interest income 12 105 25 212
Interest expense (444) (107) (1,101) (310)
Other expense, net (14) (11) (66) (92)
-------- -------- -------- --------
Net loss before provision for income taxes
(income tax benefit) (2,186) (1,518) (6,164) (2,632)
Provision for income taxes
(income tax benefit) 179 (304) (616) (527)
-------- -------- -------- --------
Net loss (2,365) $ (1,214) (5,548) $ (2,105)
======== ========
Non-cash dividends and discount
on preferred stock (1,049) (2,600)
-------- --------
Net loss applicable to
common stockholders $ (3,414) $ (8,148)
======== ========
Net loss per share applicable
to common stockholders $ (0.24) $ (0.58)
======== ========
Net loss per share $ (0.09) $ (0.15)
======== ========
Shares used in computing
net loss per share 14,237 13,995 14,140 13,761
======== ======== ======== ========
</TABLE>
See accompanying notes.
----------------------
3.
<PAGE>
YES! ENTERTAINMENT CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996*
------------ ------------
(Unaudited)
ASSETS
------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 1,302 $ 1,572
Accounts receivable, net 11,307 21,956
Inventories 25,621 26,194
Prepaid royalties 4,457 4,045
Prepaid expenses 1,750 1,868
Other current assets 3,222 1,671
------------ ------------
Total current assets 47,659 57,306
Property and equipment, net 4,319 3,869
Intangibles and deposits, net 215 276
------------ ------------
Total assets $ 52,193 $ 61,451
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current Liabilities:
Loans payable $ 8,164 $ 16,712
Accounts payable 7,061 12,565
Accrued royalties 1,529 1,018
Accrued liabilities 881 879
Capital lease obligations due within one year 17 16
Income taxes payable - 182
------------ ------------
Total current liabilities 17,652 31,372
Capital lease obligations 6 14
Convertible debentures 1,778 -
Other liabilities 17 -
Redeemable convertible preferred stock 8,723 -
Stockholders' equity:
Undesignated preferred stock - -
Common Stock 14 14
Additional paid-in capital 84,807 82,707
Accumulated deficit (60,804) (52,656)
------------ ------------
Total stockholders' equity 24,017 30,065
------------ ------------
Total liabilities and stockholders' equity $ 52,193 $ 61,451
============ ============
</TABLE>
*Derived from audited consolidated financial statements
See accompanying notes.
----------------------
4.
<PAGE>
YES! ENTERTAINMENT CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
-------------------------------------
JUNE 30, 1997 JUNE 30, 1997
-------------------------------------
<S> <C> <C>
OPERATING ACTIVITIES
Net loss $ (5,548) $ (2,105)
Adjustments to reconcile net loss to net cash provided by
operating activities:
Depreciation and amortization 1,494 1,208
Advertising expenses funded by inventory 118 -
Debt discount and warrant amortization 475 -
Accrued interest converted to convertible debt 67 -
Employer contribution to 401(k) plan funded with
common stock 106 -
Changes in operating assets and liabilities:
Accounts receivable 10,648 13,554
Inventories 573 (4,383)
Prepaid expenses and other current assets (1,962) (3,626)
Other assets - (307)
Accounts payable (5,504) (1,128)
Accrued royalties and liabilities 405 (1,672)
Income taxes payable (182) -
Other long-term liabilities 17 (39)
-------------- -------------
Net cash provided by operating activities 707 1,502
INVESTING ACTIVITIES
Acquisition of property and equipment (1,928) (1,709)
Decrease in intangibles and deposits 45 -
-------------- -------------
Net cash used in investing activities (1,883) (1,709)
FINANCING ACTIVITIES
Proceeds from issuance of convertible debentures 1,433 -
Principal payments on loans payable (8,548) (10,125)
Principal payments on capital lease obligations (8) (43)
Proceeds from issuance of redeemable convertible preferred
stock, net of issuance costs 8,027 -
Proceeds from issuance of common stock, net of issuance costs 2 13,770
-------------- -------------
Net cash provided by financing activities 906 3,602
-------------- -------------
Net increase (decrease) in cash and cash equivalents (270) 3,395
Cash and cash equivalents at beginning of period 1,572 2,987
-------------- -------------
Cash and cash equivalents at end of period $ 1,302 $ 6,382
============== =============
</TABLE>
See accompanying notes.
----------------------
5.
<PAGE>
YES! ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. QUARTERLY CONSOLIDATED FINANCIAL STATEMENTS
Interim Financial Statements
----------------------------
The accompanying unaudited consolidated financial statements have been
prepared in accordance with the instructions to Form 10-Q but do not
include all of the information and footnotes required by generally accepted
accounting principles for complete consolidated financial statements and
should, therefore, be read in conjunction with the Company's audited
consolidated financial statements and notes thereto for the fiscal year
ended December 31, 1996 included in the Annual Report on Form 10-K filed
with the Securities and Exchange Commission on April 15, 1997. In the
opinion of management, all adjustments (which consist only of normal
recurring accruals) have been made to present fairly the consolidated
operating results for the unaudited periods. The interim operating results
are not necessarily indicative of the results for fiscal 1997.
Basis of Presentation
---------------------
The accompanying condensed consolidated financial statements include the
accounts of the Company and its wholly owned subsidiaries. All significant
intercompany accounts and transactions have been eliminated.
Use of Estimates
----------------
The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements
and accompanying notes. Actual results could differ from those estimates.
2. INVENTORY (IN THOUSANDS)
June 30, December 31,
1997 1996
-------- ------------
Raw Materials $ 2,694 $ 2,940
Work-in-process 1,233 974
Finished goods 21,694 22,280
------- -------
$25,621 $26,194
======= =======
6.
<PAGE>
3. RECENT DEVELOPMENTS
Restructured Financing
----------------------
In July 1997, the Company entered into agreements with Infinity Investors
Limited and Fairway Capital Limited, the institutional investors who
purchased convertible debentures and Series A preferred stock in the first
quarter of 1997, restructuring the terms of the prior agreements with
respect to those securities. The transaction is deemed effective April 30,
1997.
The new terms place significant restraints on the conversion into and sale
of the common stock issuable upon conversion, including a prohibition on
conversion until the earlier of November 1, 1997 or until the price of the
Company's common stock exceeds $10 per share for twenty (20) consecutive
trading days after August 1, 1997. The new terms also generally prohibit
short sales. In addition, the conversion of the securities and sale of
common stock is restricted to amounts that vary based upon the recent price
and trading volume of the Company's common stock.
The conversion price of the securities is based on a discount to the
weighted average value of the Company's common stock near the time of
conversion. The discount increases monthly from 11.75% in November 1997 to
18.75% in April 1998. The securities are redeemable at the option of the
Company. Any amount of the securities remaining after five years will
convert at the then-prevailing conversion price.
The total face value of the new instruments is $11,727,167. The new
instruments have been issued in the place of instruments with a total value
of $9,439,104, including accrued dividends and interest through April 30,
1997. The transaction will be accounted for by recognizing (1)
approximately $647,000 in imputed interest and dividends in the second
quarter of 1997, representing the difference between the face value of the
new securities and the book value of the old instruments, including accrued
dividends and interest, and (2) approximately $2.2 million in imputed
interest expense and dividends ratably over the 12 month period beginning
May 1, 1997, representing the value of the maximum discount of 18.75% on
the face value of the new securities. Approximately $366,000 of this
amount was recognized in the quarter ended June 30, 1997.
Resignation of Director; Appointment of Executive Officer
---------------------------------------------------------
In June 1997, Gary L. Nemetz voluntarily resigned as a director of the
Company. In August 1997, the Board appointed Anthony J. Miadich to fill
the vacancy created by Mr. Nemetz's resignation. In July 1997, the Company
appointed Mike Bauer Executive Vice President, Sales.
7.
<PAGE>
4. SHAREHOLDER LAWSUITS
The Company is defending several shareholder lawsuits, as follows:
THE STATE SECURITIES CLASS ACTIONS
----------------------------------
Two class actions were filed against the Company, Donald D. Kingsborough,
Sol Kershner, and Bruce D. Bower in the California Superior Court for the
County of Alameda; Wang v. YES! Entertainment Corporation, et al., filed on
---------------------------------------------
April 15, 1997; and Miller v. YES! Entertainment Corporation et al., filed
----------------------------------------------
on July 3, 1997. In Miller, Gary L. Nemetz, a former director of the
------
Company, is also named as a defendant.
The Wang lawsuit is purportedly brought on behalf of purchasers of the
----
Company's common stock between October 23, 1996, and December 12, 1996,
inclusive. It challenges certain statements made by defendants regarding
the expected release date of the V-Link product, as well as its impact on
------
the Company's sales and profitability. The Wang lawsuit alleges that these
----
statements made by defendants violated Corporations Code Sections 25400 and
25500, which provide a remedy to California residents against persons who
make false or misleading statements while engaged in market activity;
constituted unfair competition in violation of California Business &
Professions Code Section 17200; and constituted common law fraud pursuant
to California Civil Code Sections 1709-1711.
The Miller lawsuit is based on the same facts as the Wang lawsuit, alleges
------ ----
a longer class period of March 29, 1996 to December 12, 1996, and
challenges certain additional statements made by defendants. In addition,
the Miller complaint states only one count, which is for violations of
------
(S)(S)25400 and 25500 of the California Corporations Code.
THE FEDERAL SECURITIES CLASS ACTIONS
------------------------------------
These class actions were filed against the Company and Messrs. Kingsborough
and Kershner in the United States District Court for the Northern District
of California: Harow v. YES! Entertainment Corporation, filed on April 17,
---------------------------------------
1997;
Tarkats v. YES! Entertainment Corporation, filed on June 11, 1997; and
-----------------------------------------
Siegel v. YES! Entertainment Corporation et al., filed on June 27, 1997.
----------------------------------------------
On August 6, 1997, the three Federal actions were consolidated for pretrial
proceedings and captioned In re YES! Entertainment Corp. Securities
-----------------------------------------
Litigation, Civil Action No. C-97-1388 MHP. The factual allegations in the
-----------
Federal class actions are identical to the allegations in the Miller State
------
class action.
The Federal class actions are governed by the Private Securities Litigation
Reform Act of 1995, which imposes liability on persons who make false or
misleading statements in connection with the sale or purchase of
securities.
The lawsuits have been tendered to the applicable directors and officers
insurance carriers who have responded with a reservation of rights pending
a final determination of coverage. Directors and officers insurance
coverage totals $5 million. The primary insurance policy has a $250,000
retention level. The Company believes that defense costs will be a minimum
of $250,000, and will likely substantially exceed this amount.
The Company believes that it has meritorious defenses to these State and
Federal actions and intends to vigorously defend the lawsuits.
Nevertheless, the Company believes that it will incur substantial time and
expense to defend these lawsuits, and an adverse result may have a material
effect on the Company's operating results and financial condition. The
State and Federal actions seek compensatory and punitive damages, interest,
attorneys' fees and other costs, as well as equitable relief to preserve
defendants' assets. The Company is not accruing reserves with respect to
these lawsuits.
5. FASB STATEMENT NO. 128, EARNINGS PER SHARE
In February 1997, the Financial Accounting Standards Board issued Statement
No. 128, Earnings Per Share, which is required to be adopted on
December 31, 1997. At that time, the Company will be required to change
the method currently used to compute earnings per share and to restate all
prior periods. Under the new requirements for calculating primary earnings
per share, the dilutive effect of stock options will be excluded. There
was no impact of Statement 128 on the calculation of the primary or fully
diluted loss per share for the quarters and six months ended June 30, 1997
and 1996.
8.
<PAGE>
YES! ENTERTAINMENT CORPORATION -- PART I, ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Management's Discussion and Analysis of Financial Condition and Results of
Operations includes certain forward looking statements about the Company that
are based on current expectations. Actual results may differ materially as a
result of any one or more of the risks identified in this section, as well as is
the section captioned "Business Factors."
RESULTS OF OPERATION
- --------------------
<TABLE>
<CAPTION>
(In thousands) THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30, JUNE 30, JUNE 30,
1997 1996 1997 1996
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net sales $12,616 $11,551 $21,657 $20,486
Cost of sales 7,615 6,887 12,940 11,192
------- ------- ------- -------
Gross profit 5,001 4,664 8,717 9,294
Gross profit % 40% 40% 40% 45%
Operating expenses 6,741 6,169 13,739 11,736
Operating expenses % 53% 53% 63% 57%
Operating loss (1,740) (1,505) (5,022) (2,442)
Interest and other expense, net (446) (13) (1,143) (190)
------- ------- ------- -------
Net loss before provision for income taxes (2,186) (1,518) (6,164) (2,632)
Provision for income taxes (income tax benefit) 179 (304) (616) (527)
------- ------- ------- -------
Net loss $(2,365) $(1,214) $(5,548) $(2,105)
======= ======= ======= =======
Non-cash dividends and discount on preferred stock (1,049) (2,600)
------- -------
Net loss applicable to common stockholders $(3,414) $(8,148)
======= =======
</TABLE>
NET SALES:
The Company's net sales for the second quarter of 1997 increased $1.0 million or
approximately 9% to $12.6 million from $11.6 million in the second quarter of
1996. Net sales increased $1.2 million or approximately 6% to $21.7 million for
the first six months of 1997 from $20.5 million for the first six months of
1996. International sales in the second quarter and the first six months of
1997 were higher than in the comparable periods of 1996, primarily as the result
of the Company's efforts to increase international sales. International
shipments represented 40% of shipments in the second quarter of 1997 and 26% of
shipments in the second quarter of 1996. The Company recognizes revenue upon
shipment of product and computes net sales by concurrently deducting a provision
for sales returns and allowances, including allowances for defective returns,
price protection, mark downs, stock balancing and other returns. Sales
9.
<PAGE>
allowances may vary as a percentage of gross sales due to changes in the
Company's product mix, defective product allowances or other sales allowances.
Sales of toys traditionally have been highly seasonal, with a majority of retail
sales occurring during the December holiday season. The Company expects that
its operating results will vary significantly from quarter to quarter, because
the majority of the Company's products are shipped in the quarters ending
September 30 and December 31.
The Company is dependent on a relatively small number of customers, in
particular Toys "R" Us, Inc. and Wal-Mart Stores, Inc., for a significant
percentage of its sales. Significant reductions in sales to any one or more of
the Company's largest customers would have a material adverse effect on the
Company's operating results. Because orders in the toy industry are generally
cancelable at any time without penalty, there can be no assurance that present
or future customers will not terminate their purchase agreements with the
Company or significantly change, reduce or delay the amount of products ordered
from the Company. Any such termination of a customer relationship or change,
reduction or delay in orders would have a material adverse effect on the
Company's operating results.
COST OF SALES:
Cost of sales were approximately 60% of net sales in each of the second quarters
of 1997 and 1996, and approximately 60% and 55% of net sales for the first six
months of 1997 and 1996, respectively. The increases in cost of sales as a
percentage of net sales in the first six months of 1997 from the comparable
period in 1996 was primarily the result of the increase in lower margin
international sales in the first quarter of 1997 compared to the first quarter
of 1996 and the sale of certain slower moving items. In absolute dollars, cost
of sales increased $728,000 or approximately 11% to $7.6 million in the second
quarter of 1997 from $6.9 million in the second quarter of 1996 and increased
$1.7 million or approximately 16% to $12.9 million for the first six months of
1997 from $11.2 million for the first six months of 1996.
OPERATING EXPENSES:
<TABLE>
<CAPTION>
(In thousands) THREE MONTHS ENDED SIX MONTHS ENDED
--------------------------- --------------------------
JUNE 30, JUNE 30, JUNE 30, JUNE 30,
1997 1996 1997 1996
--------- -------- -------- --------
<S> <C> <C> <C> <C>
Marketing, advertising and promotion $ 559 $1,473 $ 1,439 $ 2,167
Selling, distribution and administrative 6,182 4,696 12,300 9,569
------ ------ ------- -------
Total operating expenses $6,741 $6,169 $13,739 $11,736
====== ====== ======= =======
</TABLE>
10.
<PAGE>
Operating expenses increased $572,000 or approximately 9% to $6.7 million in the
second quarter of 1997 from $6.2 million in the second quarter of 1996, as the
result of higher variable expense associated with higher revenue and higher
fixed expenses required to support current and expected sales volumes. Operating
expenses increased $2.0 million or approximately 17% to $13.7 million for the
first six months of 1997 from $11.7 million for the first six months of 1996 for
the same reasons.
Marketing, Advertising and Promotion. Marketing, advertising and promotion
- ------------------------------------
expenses decreased $914,000 or approximately 62% to $559,000 in the second
quarter of 1997 from $1.5 million in the second quarter of 1996. Marketing,
advertising and promotion expenses decreased $728,000 or approximately 34% to
$1.4 million for the first six months of 1997 from $2.2 million for the first
six months of 1996. These decreases resulted from the increase in sales to
international customers and the sale of slower-moving items, which do not
require advertising support from the Company. The Company expects advertising
expense in the last two quarters of the year to significantly exceed advertising
expense in the first half of the year to support anticipated seasonal increases
in sales. In the event higher sales volume is not achieved, the increase in
fixed expenses could adversely affect the Company's operating results and
financial condition. See Dependence on 1997 Products; Increase in Fixed
----------------------------------------------
Expenses.
- --------
Selling, Distribution and Administrative. Selling, distribution and
- ----------------------------------------
administrative expenses increased $1.5 million or approximately 32% to $6.2
million in the second quarter of 1997 from $4.7 million in the second quarter of
1996. Selling, distribution and administrative expenses increased $2.7 million
or approximately 29% to $12.3 million for the first six months of 1997 from $9.6
million for the first six months of 1996. The increase in expenses resulted from
higher variable expense associated with higher revenues and higher costs in
operations and sales support, product development, and general and
administrative expenses required to support expected higher sales volumes.
INTEREST EXPENSE:
The following table shows interest expense and interest income for the
applicable periods:
<TABLE>
<CAPTION>
(In thousands) THREE MONTHS ENDED SIX MONTHS ENDED
---------------------------- ----------------------------
JUNE 30, JUNE 30, JUNE 30, JUNE 30,
1997 1996 1997 1996
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Interest income $ 12 $ 105 $ 25 $ 212
Interest expense $(444) $(107) $(1,101) $(310)
</TABLE>
The increase in interest expense in the quarter and six months ended June 30,
1997 as compared to the comparable periods in 1996 is primarily the result of
the non-cash interest expense recorded in connection with the convertible
debenture and preferred stock financing, and the restructuring thereof,
described under "Liquidity and Capital Resources." The non-cash interest
expenses recorded in the quarter and six months ended June 30, 1997 were
$218,000 and $558,000, respectively. The decrease in interest income and a
portion of the increase in interest expense are the result of the lower cash
balances maintained by the Company and higher bank
11.
<PAGE>
borrowings during the quarter and six months ended June 30, 1997 as compared to
the comparable periods in 1996.
PROVISION FOR INCOME TAXES (INCOME TAX BENEFIT):
The following table shows the provision for income taxes (income tax benefit)
for the applicable periods:
<TABLE>
<CAPTION>
(In thousands) THREE MONTHS ENDED SIX MONTHS ENDED
----------------------------- -----------------------------
JUNE 30, JUNE 30, JUNE 30, JUNE 30,
1997 1996 1997 1996
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Provision for income taxes
(income tax benefit) $ 179 $(304) $(616) $(527)
</TABLE>
The income tax benefit for the six months ended June 30, 1997 is computed based
on the projected annualized effective tax rate of 10% applied to the pre-tax
book loss for the period. The projected effective tax rate for the current year
is less than the federal statutory rate (34%) due to the projected benefit of
the utilization of net operating loss carryovers. The projected annualized
effective tax rate used in the quarter ended March 31, 1997 was 20% and was
reduced due to the identification of additional loss carryforwards that may be
utilized in fiscal 1997. The reduction in the projected annualized effective
tax rate resulted in a provision for income taxes in the quarter ended June 30,
1997 of $179,000.
At December 31, 1996, the Company had net operating loss carryforwards for
federal and California tax purposes of approximately $36.5 million and $17.0
million, respectively. The federal losses will expire in the years 2007 though
2011, and the state losses will expire in the years 1999 through 2001, if not
utilized. Utilization of the net operating loss carryovers may be subject to a
substantial annual limitation if it should be determined that there has been a
change in the ownership of more than 50 percent of the value of the Company's
stock, pursuant to Section 382 of the Internal Revenue Code of 1986 and similar
state provisions. The annual limitation may result in the expiration of net
operating loss carryovers before utilization.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
At June 30, 1997, the Company had cash and cash equivalents of approximately
$1.3 million, a $270,000 decrease from approximately $1.6 million at December
31, 1996. The decrease in cash and cash equivalents was due to $1.9 million used
in investing activities, partially offset by $707,000 provided by operating
activities and $906,000 provided by financing activities.
The cash generated by operating activities was due primarily to a decrease in
accounts receivable of $10.6 million, a decrease in inventory of $573,000, and
depreciation, amortization and other non-cash expenses of $2.3 million,
partially offset by the net loss, a decrease in accounts payable of $5.5 million
and an increase in prepaid expenses and other current assets of $2.0 million.
The $906,000 provided by financing activities was due to net proceeds from the
issuance of the convertible preferred stock ($8.0 million) and convertible
debentures ($1.4 million), partially
12.
<PAGE>
offset by principal payments on bank debt of $8.5 million. Investing activities
used cash of $1.9 million primarily due to the acquisition of tooling and other
equipment.
To meet seasonal working capital requirements during the balance of 1997, the
Company anticipates borrowing substantial amounts under an Accounts Receivable
Management and Security Agreement (the "ARM Agreement") entered into with BNY
Financial Corporation ("BNY") in July 1995. The terms of the ARM Agreement, as
amended, provide that BNY may advance YES! up to $30 million on the basis of the
Company's accounts receivable, inventory and product being imported on a letter
of credit basis. Loans to the Company are fully secured by all of the Company's
assets, including intellectual property, and BNY acquired ownership of all of
the Company's trade receivables. The Company is required to remain in
compliance with certain financial and other covenants under the ARM Agreement
with BNY. A ratio of earnings calculated before interest, taxes, depreciation
and amortization to total interest expense of 5:1 on a rolling four quarter
basis is required under the Loan and Security Agreement. The Company recorded a
loss before interest, taxes, depreciation and amortization for the four quarters
ended December 31, 1996, March 31, 1997, and June 30, 1997. The Company has
obtained a waiver from BNY with regard to this covenant through December 31,
1997. The ARM Agreement also restricts the ability of the Company to obtain
working capital in the form of indebtedness, other than indebtedness incurred in
the ordinary course of the Company's business, to grant security interests in
the assets of the Company or to pay dividends on the Company's securities.
The Company's actual working capital needs will depend upon numerous factors,
including the extent and timing of acceptance of the Company's products in the
market, the Company's operating results, the cost of increasing the Company's
sales and marketing activities and the status of competitive products, none of
which can be predicted with certainty. The Company has experienced severe
working capital shortfalls in the past, which have restricted the Company's
ability to conduct its business as anticipated. The Company anticipates that it
will experience periods of significant negative cash flow in 1997 as a result of
seasonality in the toy industry, the timing of new product introductions and the
Company's planned growth in new product inventory and accounts receivable. There
can be no assurance that additional financing will be available to the Company
on acceptable terms, if at all, when required by the Company. The inability to
obtain such financing would have a material adverse effect on the Company's
operating results.
During March 1997, the Company issued $1,566,667 in convertible debentures and
85,000 shares of Series A convertible preferred stock at a par value of $.001
per share for $100 per share to two investors for a total of $8,500,000 (the
"March Securities"). In April 1997, approximately $696,000 of the convertible
preferred stock, including accrued dividends, were converted. Effective April
30, 1997, the remaining March Securities plus accrued dividends and interest
were cancelled in favor of $1,956,021 in convertible debentures and 390,846
shares of Series B convertible preferred stock at a par value of $.001 per share
for $25 per share to two investors and an investment bank retained by the
Company in connection therewith for a total of $11,727,167 (the "Restructuring
Transactions").
Holders of the Series B convertible preferred stock are entitled to receive,
when and as declared by the Board of Directors out of legally available funds,
cumulative dividends at a rate of $1.28
13.
<PAGE>
per annum, payable in shares of Series B convertible preferred stock, semi-
annually, but in no event later than the date of conversion. The Series B
convertible preferred stock has no voting rights, has a liquidation preference
of $25 per share plus all accrued but unpaid dividends, subject to adjustment,
and is convertible at the option of the holder into shares of common stock at a
discount to the weighted average value of the Company's common stock near the
time of conversion. The discount increases monthly from 11.75% beginning in
November 1997 increasing to 18.75% in April 1998. The Series B convertible
preferred stock is redeemable at any time in cash, at the option of the Company.
Any redemption payments must be approved by BNY, the financial institution with
which the Company has its current accounts receivable management agreement. Any
amount of the Series B convertible preferred stock remaining after five years
will convert at the then-prevailing conversion price.
The convertible debentures earn interest at 5% per annum, are due April 30,
2002, and are convertible any time after the earlier of November 1, 1997 or
until the price of the Company's common stock exceeds a volume-weighted average
price above $10 pr share for twenty (20) consecutive trading days after August
1, 1997, at the option of the holder, at a conversion price similar to that of
the Series B convertible preferred stock. The convertible debentures are
subordinated to the bank financing agreements.
In connection with the issuance of the March Securities, the Company issued
warrants for the purchase of 300,000 shares of common stock at an exercise price
per share equal to the lesser of (a) $7.875 or (b) 125% of the average of the
lowest per share market value for any five consecutive trading days during the
sixty trading days following March 18, 1997. The warrants expire March 18,
2002. The terms of the Warrants were not modified in connection with the
Restructuring Transactions.
Because the Company is not permitted by Nasdaq rules to issue in the aggregate
more than 20% of its outstanding common stock as the result of the conversion of
the Series B convertible preferred stock and convertible debentures and the
exercise of the warrants without first obtaining stockholder approval, the
Company would be required to redeem any portion of the securities issued in
excess of 20% of its outstanding common stock in cash.
RECENT DEVELOPMENTS
- -------------------
Restructured Financing. See Note 3 to Notes to Financial Statements,
- ----------------------
Restructured Financing, and Liquidity and Capital Resources, above.
- ----------------------
Resignation of Director; Appointment of Executive Officer
- ---------------------------------------------------------
In June 1997, Gary L. Nemetz voluntarily resigned as a director of the Company.
In August 1997, the Board appointed Anthony J. Miadich to fill the vacancy
created by Mr. Nemetz's resignation. In July 1997, the Company appointed Mike
Bauer Executive Vice President, Sales.
Shareholder Lawsuits. See Note 4 to Notes to Financial Statements, Shareholder
- -------------------- -----------
Lawsuits, above.
- --------
14.
<PAGE>
BUSINESS FACTORS
- ----------------
Because of the variety and uncertainty of the factors affecting the Company's
- -----------------------------------------------------------------------------
operating results, past financial performance and historic trends may not be a
- ------------------------------------------------------------------------------
reliable indicator of future performance. These factors, as well as other
- -------------------------------------------------------------------------
factors affecting the Company's operating performance, and the fact that the
- ----------------------------------------------------------------------------
Company participates in a highly dynamic industry, may result in significant
- ----------------------------------------------------------------------------
volatility in the Company's common stock price. The Company's business is
- -------------------------------------------------------------------------
subject to a number of risks and the Company's forward looking statements should
- --------------------------------------------------------------------------------
be considered in light of the business factors set forth below.
- --------------------------------------------------------------
Limited Operating History; Risk to Profitability. The Company has a short
- ------------------------------------------------
operating history, having commenced operations in November 1992 and shipped its
first product in July 1993. Future profitability and the Company's ability to
obtain future financing on favorable terms is dependent upon the Company's
ability to successfully and timely introduce, finance and manufacture its new
products, successfully market its existing products and collect trade
receivables in a timely manner.
History of Losses; Accumulated Deficit. The Company incurred operating losses of
- --------------------------------------
$21.0, $21.9 and $12.6 million for the years ended December 31, 1993, 1994, and
1996, respectively. For the period from January 1, 1997 through June 30, 1997,
the Company had a loss of $5.5 million. At June 30, 1997, the Company had an
accumulated deficit of approximately $60.8 million. In 1996 and for the six
months ended June 30, 1997, the Company had net cash outflows of $1.4 million
and $266,000, respectively. As a result of losses, the Company has incurred
indebtedness to finance its operations. See "Dependence on Restricted Facility."
In the event the Company continues to incur operating losses and is unable to
obtain additional financing on favorable terms, or at all, in the future, its
operating results and financial condition would be materially adversely
affected.
Dependence on 1997 Products; Increase in Fixed Expenses. In 1997, the Company
- -------------------------------------------------------
has introduced and expects to commence sales of a number of new product lines in
new product categories, such as the Baskin-Robbins(R) Ice Cream Maker, Air
--------------------------------------
Vectors(TM), YES! Extreme(TM), and YES! PreSchool(TM). In addition, the Company
- ------------------------------ ------------------
also expects to expand its existing product lines in 1997, particularly its
YES! Gear, Power Penz(TM) and Mrs. Fields(TM) line of products. Manufacturing of
- ------------------------- ---------------
certain of these items in commercial quantities has not commenced or is just
commencing. The Company expects that completing the development and the
manufacture of its 1997 product lines will place great demands on management and
other Company resources. If the Company is not able to complete the development,
tooling, manufacture and successful marketing of its 1997 product lines, the
Company's operating results and financial condition would be materially
adversely affected. In addition, the Company has increased its fixed expenses
in anticipation of the introduction of the Company's 1997 product lines. In the
event expected sales volumes are not achieved, this increase in fixed expenses
could adversely affect the Company's operating results and financial condition.
Dependence on YES! Gear and Power Penz. The majority of the Company's current
- --------------------------------------
product lines are sold under the YES! Gear and Power Penz brands. The YES! Gear
--------- ---------- ---------
brand accounted for 55%
15.
<PAGE>
and 60.7% of the Company's sales in 1995 and 1996, respectively. The Power Penz
----------
brand accounted for 3.1% and 22.0% of the Company's sales in 1995 and 1996,
respectively. The Company expects YES! Gear, and in particular the Yak Bak(R),
--------- ----------
and the Power Penz product lines to continue to account for a substantial
----------
percentage of the Company's business, but there can be no assurance that the
Company will be able to sustain Yak Bak and Power Penz sales at 1996 levels or
------- ----------
such level as may be necessary to maintain its overall sales and revenues. See
Short Product Cycles. In addition, the Company is aware that a number of toy
- --------------------
manufacturers have attempted to duplicate the Company's success in this area of
product by introducing similar lines of products in 1996 and for 1997. While the
Company believes it will compete favorably with these new products on the basis
of styling, quality, product depth and promotional support, there can be no
assurance that the sale of these competitive products will not impact the sale
of the YES! Gear or Power Penz product lines, particularly on the basis of
--------- ----------
price.
Just in Time Inventory; Compressed Sales Cycles. Most of the Company's
- -----------------------------------------------
significant customers have adopted inventory management systems to track sales
of particular products and rely on reorders being filled rapidly by suppliers,
rather than maintaining large on-hand inventories to meet consumer demand. While
these systems reduce a retailer's investment in inventory, they increase
pressure on suppliers like the Company to fill orders promptly and shift a
significant portion of inventory risk to the supplier, and may limit the
Company's ability to accurately forecast reorders creating potential volatility
in the Company's operating results. The limited inventory carried by the
Company's customers may also reduce or delay consumer sell-through which in turn
could impair the Company's ability to obtain reorders of its product in
quantities necessary to permit the Company to achieve planned sales and income
growth. In addition, the Company may be required to incur substantial additional
expense to fill late reorders in order to ensure the product is available at
retail locations prior to the peak holiday buying season; these may include
drop-shipment expenses and higher advertising allowances which would otherwise
be born by the Company's customers. In the event that anticipated reorders do
not materialize, the Company's operating results will be adversely affected and
the Company may incur increased inventory carrying costs.
Changes in 1997 Product Line. The Company constantly evaluates the toy markets
- ----------------------------
and its development and manufacturing schedules. As the year progresses, the
Company may elect to reduce the number of products it currently plans on
shipping in 1997 for a variety of reasons, which include but are not limited to
more accurate evaluation of demand, supply and manufacturing difficulties, or
competitive considerations. Similarly, the Company may add products to its 1997
line either by accelerating development schedules or strategic acquisitions of
current product lines. Reducing or adding products from and to the Company's
line may have an impact on the Company's financial performance depending on,
among other things, the price points, advertising and promotional support for
and development, tooling and manufacturing costs of such products, relative to
products they replace or are replaced by, as the case may be, if at all. The
Company has made adjustments to its 1997 product line to date and expects to
make further adjustments as the year progresses.
Sales Concentration Risk. The Company's ten largest customers accounted for
- ------------------------
approximately 85%, 87% and 68% of sales for the years ending December 31, 1996,
1995 and 1994, respectively. For the year ended December 31, 1996, the Company's
two largest customers, TRU
16.
<PAGE>
and Wal-Mart, accounted for 21% and 20% of net sales, respectively. For the year
ended December 31, 1995, the same two customers each accounted for approximately
27% of net sales and for the year ended December 31, 1994, TRU and Wal-Mart
accounted for 14% and 21% of net sales, respectively. While the Company intends
to expand distribution to new accounts, the Company expects to continue to
depend on a relatively small number of customers for a significant percentage of
its sales. Significant reductions in sales to any one or more of the Company's
largest customers would have a material adverse effect on the Company's
operating results. Because orders in the toy industry are generally cancelable
at any time without penalty, there can be no assurance that present or future
customers will not terminate their purchase arrangements with the Company or
significantly change, reduce or delay the amount of products ordered from the
Company. Any such termination of a significant customer relationship or change,
reduction or delay in significant orders could have a material adverse effect on
the Company's operating results.
Price Protection; Stock Balancing; Reliance on Timely Payment. In connection
- -------------------------------------------------------------
with the introduction of new products, many companies in the toy industry
discount prices of existing products, provide for certain advertising allowances
and credits or give other sales incentives to their customers, particularly
their most significant customers. In addition, in order to address working
capital requirements, sales of inventory, changes in marketing trends and other
issues, many companies in the toy industry allow retailers to return slow-moving
products for credit, or if the manufacturer lowers the prices of its products,
to provide price adjustments for inventories on hand at the time the price
change occurs. The Company has made such accommodations in the past, and expects
to make accommodations such as stock balancing, returns, other allowances or
price protection adjustments in 1997. Any significant change in such
accommodations by the Company in the future could have a material adverse effect
on the Company's operating results. In addition, in the past certain of the
Company's retail customers have delayed payment beyond the date such payment is
due and have claimed deductions to which, upon investigation, they may not be
entitled or which may be overstated. Delays or unanticipated reductions in
payments from retail customers in the future could materially impact the
Company's anticipated cash flow to the detriment of the Company's business.
Delays or reductions in payment have, in the past, increased the Company's
reliance on other sources of capital, including bank lines of credit, which has
increased the Company's interest expense and, in the case of payment reductions,
reduced profitability, or increased loss, by an amount equivalent to such
reductions. Delays or reductions in payment in the future would have the same or
similar effect.
Seasonality. Sales of toys traditionally have been highly seasonal, with
-----------
a majority of retail sales occurring during the December holiday season.
Accordingly, the Company expects that its operating results will vary
significantly from quarter to quarter, particularly in the third and fourth
quarters, when the majority of products are shipped, and the first quarter, when
a disproportionate amount of receivables are collected and trade credits are
negotiated. In addition, although indications of interest are provided by
retailers early in the year for product shipments for the December holiday
season, committed orders are not placed until later in the year and, even when
placed, such orders generally are cancelable at any time without penalty.
Accordingly, the Company generally must enter into tooling, manufacturing, media
and advertising commitments prior to having firm orders. As a result, there can
be no assurance that the Company can maintain sufficient flexibility with
respect to its working capital needs or its
17.
<PAGE>
ability to manufacture products and obtain supplies of raw materials, tools and
components to be able to minimize the adverse effects of an unanticipated
shortfall or increase in demand.
Short Product Cycles. Consumer preferences in the toy industry are continuously
- --------------------
changing and are difficult to predict. Few products achieve market acceptance,
and even when they do achieve commercial success, products typically have short
life cycles. There can be no assurance that (i) new products introduced by the
Company will achieve any significant degree of market acceptance, (ii)
acceptance, if achieved, will be sustained for any significant amount of time,
or (iii) such products' life cycles will be sufficient to permit the Company to
recover development, manufacturing, marketing and other costs associated
therewith. In addition, sales of the Company's existing product lines are
expected to decline over time, and may decline faster than expected unless
existing products are enhanced or new product lines are introduced. Failure of
new or existing product lines to achieve or sustain market acceptance can create
excess inventory, reduce average selling prices and/or require that the Company
provide retailers with financial incentives, any one or all of which results
would have a material adverse effect on the Company's operating results and
financial condition. Any or all products within the YES! Gear and Power Penz
--------- ----------
categories, which categories account for a majority of the Company's overall
product sales, will experience relatively short life cycles.
Litigation. The Company and certain of its current and former executive
- ----------
officers are defendants in certain shareholder lawsuits that have been filed in
federal and California state court. These lawsuits seek compensatory and
punitive damages, interest, attorneys' fees and other costs, as well as
equitable relief to preserve defendants' assets. The Company believes that it
has meritorious defenses to these lawsuits and intends to vigorously defend
them. Nevertheless, the Company believes that it will incur substantial time and
expense to defend these lawsuits, and an adverse result in any of the lawsuits
may have a material effect on the Company's operating results and financial
condition.
International Business Risk. The Company principally relies on foreign
- ---------------------------
distributors to market and sell the Company's products outside the United
States. Although the Company's international sales personnel work closely with
its foreign distributors, the Company cannot directly control such entities'
sales and marketing activities and, accordingly, cannot directly manage the
Company's product sales in foreign markets. The percentage of total sales
constituting foreign sales for 1994, 1995, 1996 and for the six months ended
June 30, 1997 are 29%, 7%, 21% and 36%, respectively. In addition, the Company's
international sales may be disrupted by currency fluctuations or other events
beyond the Company's control, including political or regulatory changes.
To date, substantially all of the Company's international sales have been
denominated in U.S. dollars and therefore the Company has not to date
experienced any adverse impact from currency fluctuations. To the extent future
sales are not denominated in U.S. dollars, currency exchange fluctuations in the
countries where the Company does business could materially adversely affect the
Company's business, financial condition and results of operations.
Competition. The toy industry is highly competitive. Among the Company's
- -----------
competitors are toy companies, divisions of large diversified companies, and
producers of consumer electronics products, many of which have greater assets
and resources than those of the Company, as well as smaller domestic and foreign
toy and entertainment products manufacturers, importers and
18.
<PAGE>
marketers. The Company's principal competitors include Mattel, Inc., Hasbro,
Inc., and, particularly in the Yak Bak and Power Penz categories, Tiger
------- ----------
Electronics, Inc. These competitors may impede the Company's ability to
maintain market share and pricing goals in its existing categories, and may
prevent the Company from successfully launching new products in categories
served by these competitors.
Dependence on Manufacturing Facilities Based in People's Republic of China. The
- --------------------------------------------------------------------------
Company contracts for the manufacture of substantially all of its products with
entities based in Hong Kong whose manufacturing facilities are located in the
People's Republic of China. In June 1997, Hong Kong became a sovereign territory
of the People's Republic of China. While the People's Republic of China has
provided assurances that Hong Kong will be allowed to maintain critical economic
and tax policies, and while the transition to date has not adversely impacted
the Company's business, there can be no assurance that political or social
tensions will not develop in Hong Kong that would disrupt this process. In
addition, recent tensions between the Peoples Republic of China and the Republic
of China (Taiwan), and the United States' involvement therein, and recent debate
regarding the extension of the Peoples Republic of China most favored nation
trading status, could result either in a disruption in manufacturing in the
China mainland or in the imposition of tariffs or duties on Chinese manufactured
goods. Either event would have an adverse impact on the Company's ability to
obtain its products or on the cost of these products, respectively, such that
its operating results and financial condition would be materially adversely
affected.
Dependence on Restrictive Facility. The Company is dependent on the ARM
- ----------------------------------
Agreement with BNY Financial Corporation to meet its financial needs during
1997, due in large part to the seasonality of the Company's business whereby the
Company is required to finance the manufacture of a substantial portion of its
products in the summer and autumn but does not collect on the sale of these
products until the fourth quarter of that year and the first quarter of the
following year. Under the terms of the ARM Agreement, BNY Financial Corporation
has taken a first priority security interest in substantially all of the
Company's assets, including its intellectual property. The ARM Agreement also
contains a number of restrictive covenants and events of default, including a
provision specifying that it shall be an event of default if either Donald
Kingsborough or Sol Kershner, the Company's Chief Executive Office and Chief
Financial Officer, respectively, is not active in the management of the Company
and is not replaced within ninety (90) days with a suitable individual of
comparable experience and capability. The Company is required to remain in
compliance with certain financial and other covenants under the ARM Agreement
with BNY. The Company was not in compliance with a financial covenant under the
ARM Agreement at March 31 and June 30, 1997, but previously had obtained a
waiver from BNY with regard to that covenant violation. In the event the
Company falls out of compliance with the ARM Agreement, and BNY Financial
Corporation does not provide financing, the Company would not be able to finance
its operations as contemplated, and its operating results and financial
condition would be materially adversely affected.
Dilution from Convertible Securities; Obligation to Redeem in Cash. Under the
- ------------------------------------------------------------------
terms of a preferred stock and convertible debenture financing completed in the
first quarter of 1997 and restructured in the second quarter of 1997, certain
investors have the right to convert the
19.
<PAGE>
securities held by them in the face amount of approximately $11.7 million, plus
dividends and interest accrued, into Company common stock at a discount to the
prevailing market price. The conversion price at which such securities may be
converted into common stock is at a discount of 11.25% beginning in November
1997 increasing to 18.75% in April 1998 of a weighted average value of the
Company's common stock, depending principally on the date on which such
securities are converted. Because the Company is not permitted by Nasdaq rules
to issue in the aggregate more than 20% of its outstanding common stock as the
result of the conversion of the Series B convertible preferred stock and
convertible debentures and the exercise of the warrants without first obtaining
stockholder approval, the Company would be required to redeem any portion of the
securities issued in excess of 20% of its outstanding common stock in cash.
Dependence on Key Personnel. The Company's future success will depend to a
- ---------------------------
significant extent on the efforts of the key management personnel, including
Donald D. Kingsborough, the Company's Chairman and Chief Executive Officer, and
other key employees. The loss of one or more of these employees could have a
material adverse effect on the Company's business. In addition, the Company
believes that its future success will depend in large part on its ability to
attract and retain highly qualified management, operations and sales personnel.
There can be no assurance that the Company will be able to attract and retain
the employees it needs to in order to ensure its success.
20.
<PAGE>
PART II. OTHER INFORMATION
---------------------------
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibits
4.1 (1) Form of Amended and Restated Registration Rights Agreement dated July
25, 1997
11.1 (1) Statement Regarding Computation of Net Loss Per Share
27.1 (1) Financial Data Schedules for the quarter ended June 30, 1997.
b) Reports on Form 8-K
A current report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 was filed by the Company on August 4, 1997. Such
report on Form 8-K disclosed the consummation of the restructured
convertible debenture and preferred stock financing and included copies
of the purchase agreement and securities as exhibits.
- -----------------------------
(1) Previously filed.
21.
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, as
amended, the registrant has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
YES! Entertainment Corporation
Registrant
Date October 24, 1997 /s/ Donald D. Kingsborough
-----------------------------
Donald D. Kingsborough
Chief Executive Officer
(Principal Executive Officer)
Date October 24, 1997 /s/ Mark C. Shepherd
-----------------------------
Mark C. Shepherd
Chief Financial Officer
(Principal Financial and
Accounting Officer)
22.
