<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly Report pursuant to Section 13 or 15 (d) of the Securities
Exchange Act of 1934.
For the quarterly period ended March 31, 1997
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 May 8, 1997 there were 14,276,377 shares of the registrant's common stock
outstanding.
This quarterly report on Form 10-Q contains 21
pages of which this is page number 1.
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YES! ENTERTAINMENT CORPORATION
FORM 10-Q
MARCH 31, 1997
INDEX
PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
Consolidated Statements of Operations -
Three months ended March 31, 1997
and March 31, 1996 3
Consolidated Balance Sheets -
March 31, 1997 and December 31, 1996 4
Consolidated Statements of Cash Flows -
Three months ended March 31, 1997
and March 31, 1996 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 9
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 20
SIGNATURE PAGE 21
2
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PART 1. 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
-------------------------
MARCH 31, MARCH 31,
1997 1996
--------- ---------
<S> <C> <C>
Net sales ................................................. $ 9,042 $ 8,935
Cost of sales ............................................. 5,325 4,305
--------- ---------
Gross profit .............................................. 3,717 4,630
--------- ---------
Operating expenses:
Marketing, advertising and promotion .............. 880 694
Selling, distribution and administrative .......... 6,118 4,873
--------- ---------
Total operating expenses .................................. 6,998 5,567
--------- ---------
Operating loss ............................................ (3,281) (937)
Interest income ........................................... 13 107
Interest expense .......................................... (657) (203)
Other expense, net ........................................ (52) (81)
--------- ---------
Net loss before income tax benefit ........................ (3,977) (1,114)
Income tax benefit ........................................ (795) (223)
--------- ---------
Net loss .................................................. (3,182) (891)
=========
Non-cash dividends related to discount on preferred stock . (1,550)
--------- ---------
Net loss applicable to common stockholders ................ $ (4,732)
=========
Net loss per share applicable to common stockholders ...... $ ( 0.34)
=========
Net loss per share ........................................ $ (0.07)
=========
Shares used in computing net loss per share ............... 14,044 13,527
========= =========
</TABLE>
See accompanying notes
3
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YES! ENTERTAINMENT CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1997 1996*
----------- ------------
(Unaudited)
ASSETS
------
<S> <C> <C>
Current assets:
Cash and cash equivalents .................... $ 567 $ 1,572
Accounts receivable, net ..................... 8,783 21,956
Inventories .................................. 26,166 26,194
Prepaid royalties ............................ 4,113 4,045
Prepaid expenses ............................. 1,790 1,868
Other current assets ......................... 2,901 1,671
----------- ------------
Total current assets ................................. 44,320 57,306
Property and equipment, net .......................... 3,959 3,869
Intangibles and deposits, net ........................ 227 276
----------- ------------
Total assets ......................................... $ 48,506 $ 61,451
=========== ============
LIABILITIES AND STOCKHOLDERS' EQUITY
- -------------------------------------
Current liabilities:
Loans payable ................................ 6,252 16,712
Accounts payable ............................. 3,994 12,565
Accrued royalties ............................ 658 1,018
Accrued liabilities .......................... 802 879
Capital lease obligations due within one year. 16 16
Income taxes payable ......................... - 182
----------- ------------
Total current liabilities ............................ 11,722 31,372
Capital lease obligations ............................ 10 14
Convertible debentures ............................... 1,635 -
Other liabilities .................................... 3 -
Redeemable convertible preferred stock ............... 8,886 -
Stockholders' equity:
Undesignated preferred stock ................. - -
Common stock ................................. 14 14
Additional paid-in capital ................... 83,625 82,707
Accumulated deficit .......................... (57,389) (52,656)
----------- ------------
Total stockholders' equity ........................... 26,250 30,065
----------- ------------
Total liabilities and stockholders' equity ........... $ 48,506 $ 61,451
=========== ============
*Derived from audited consolidated financial statements
</TABLE>
See accompanying notes
4
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YES! ENTERTAINMENT CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
-------------------------------
MARCH 31, 1997 MARCH 31, 1996
-------------- --------------
<S> <C> <C>
OPERATING ACTIVITIES
Net loss .............................................................................. $ (3,182) $ (891)
Adjustments to reconcile net loss to net cash
provided by operating activities:
Depreciation and amortization ......................................... 719 633
Advertising expenses funded by inventory .............................. 78 -
Debt discount and warrant amortization ................................ 270 -
Accrued interest converted to convertible debt ........................ 67 -
Employer contribution to 401(k) plan funded with common stock ......... 58 -
Changes in operating assets and liabilities:
Accounts receivable ........................................... 13,173 13,811
Inventories ................................................... 28 (3,669)
Prepaid expenses and other current assets ..................... (1,297) (2,000)
Accounts payable .............................................. (8,571) (1,286)
Accrued liabilities ........................................... (458) (1,240)
Income taxes payable .......................................... (182) -
Other long-term liabilities ................................... 3 (39)
-------------- --------------
Net cash provided by operating activities ............................................. 706 5,319
INVESTING ACTIVITIES
Acquisition of property and equipment ................................................. (801) (1,096)
Decrease in intangibles and deposits .................................................. 41 -
-------------- --------------
Net cash used in investing activities ................................................. (760) (1,096)
FINANCING ACTIVITIES
Proceeds from issuance of convertible debentures ...................................... 1,500 -
Principal payments on loans payable ................................................... (10,460) (9,914)
Principal payments on capital lease obligations ....................................... (4) (21)
Proceeds from issuance of redeemable convertible
preferred stock, net of issuance costs ........................................ 8,014 -
Proceeds from issuance of common stock, net of issuance costs ......................... - 12,943
Proceeds from shareholders' notes receivable .......................................... - 842
-------------- --------------
Net cash provided by (used in) financing activities ................................... (950) 3,850
-------------- --------------
Net increase (decrease) in cash and cash equivalents .................................. (1,004) 8,073
Cash and cash equivalents at beginning of period ...................................... 1,572 2,987
-------------- --------------
Cash and cash equivalents at end of period ............................................ $ 567 $ 11,060
============== ==============
</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. BALANCE SHEET COMPONENTS (IN THOUSANDS)
MARCH 31, DECEMBER 31,
1997 1996
--------- -----------
Inventories
Raw Materials $ 2,780 $ 2,940
Work-in-process 1,163 974
Finished goods 22,223 22,280
------- -------
$26,166 $26,194
======= =======
6
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3. SHAREHOLDER LAWSUITS
On April 15, 1997, a class action lawsuit was filed in the Superior Court of the
State of California, County of Alameda (the "California Action") against YES!
Entertainment Corporation (the "Company") and certain of its executive officers.
The California Action is purportedly brought on behalf of purchasers of the
Company's common stock between October 23, 1996 and December 12, 1996,
inclusive. It alleges violations of (i) Sections 25400 and 25500 of the
California Corporations Code, (ii) Sections 1709, 1710 and 1711 of the
California Civil Code and (iii) Section 17200 et seq. of the California Business
and Professions Code.
On April 17, 1997, a second class action lawsuit was filed against the Company
and certain of its executive officers in the United States District Court for
the Northern District of California (the "Federal Action" and together with the
California Action, the "Actions"). The Federal Action is purportedly brought on
behalf of purchasers of the Company's common stock between March 29, 1996 and
December 12, 1996, inclusive. The Federal Action alleges violation of Sections
10(b) and 20(a) of the Securities Exchange Act of 1934, as amended, 65 U.S.C.
(S)(S) 78j(b) and 78t(a), and Rule 10b-5, 17 C.F.R. (S) 240.10b-5 promulgated
thereunder by the Securities and Exchange Commission.
The Actions 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 both Actions and
intends to vigorously defend the Actions.
4. CONVERTIBLE DEBENTURES AND PREFERRED STOCK.
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.
Holders of the Series A convertible preferred stock shall be entitled to
receive, when and as declared by the Board of Directors out of legally available
funds, cumulative dividends at a rate of 6.5% per annum, payable in cash or
shares of common stock, semi-annually in arrears, but in no event later than the
date of conversion. The Series A convertible preferred stock has no voting
rights, has a liquidation preference of $100 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 the lowest of (a) $5.313, (b) the average
of the lowest per share market value for any five consecutive trading days
during the sixty trading days immediately following March 28, 1997, or (c) 82.5%
of the average per share market value for the five trading days immediately
preceding the conversion date. The Series A convertible preferred stock is
redeemable, in cash, at the option of the Company at a redemption price equal to
the sum of (i) the average per share market value for the five days immediately
preceding (1) the 20th trading day
7
<PAGE>
after the date of the redemption notice or (2) the date of payment in full by
the Company, whichever is greater, and (ii) the conversion ratio calculated on
the 20th trading day after the redemption notice. The Series A convertible
preferred stock is mandatorily redeemable on January 28, 2000 if not previously
converted or redeemed. Any redemption payments must be approved by BNY, the
financial institution with which the Company has its current accounts receivable
management agreement.
The convertible debentures earn interest at 5% per annum, are due January 28,
2000, and are convertible any time after January 28, 1998, at the option of the
holder, at a conversion price similar to that of the Series A convertible
preferred stock. The convertible debentures are subordinated to the bank
financing agreements.
In connection with the issuance of the convertible debt and preferred stock, 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.
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 A 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.
The Company is negotiating to amend certain terms of these securities.
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
ended March 31, 1997 and 1996.
8
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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."
<TABLE>
<CAPTION>
RESULTS OF OPERATIONS
- ---------------------
(Dollars in thousands) THREE MONTHS ENDED
MARCH 31,
--------------------
1997 1996
------- -------
<S> <C> <C>
Net sales $ 9,042 $ 8,935
Cost of sales 5,325 4,305
------- -------
Gross profit 3,717 4,630
Gross profit % 41% 52%
Operating expenses 6,998 5,567
------- -------
Operating expense % 77% 62%
Operating loss (3,281) (937)
Interest and other expense, net (696) (177)
------- -------
Net loss before income tax benefit (3,977) (1,114)
Income tax benefit (795) (223)
------- -------
Net loss $(3,182) $ (891)
======= =======
</TABLE>
NET SALES:
The Company's net sales for the first quarter of 1997 increased $107,000 or
approximately 1% to $9.0 million from $8.9 million in the first quarter of 1996.
International sales increased to 29% of sales in the first quarter of 1997 from
12% in the first 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 and
other returns. Sales 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.
9
<PAGE>
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 59% and 48% of net sales in the first quarters
of 1997 and 1996, respectively. The increase in cost of sales as a percentage
of net sales and in absolute dollars in the first quarter of 1997 was the result
of the increase in lower margin international sales and the sale of certain
slower moving items. In absolute dollars, cost of sales increased approximately
$1.0 million or approximately 24% to $5.3 million in the first quarter of 1997
from $4.3 million in the first quarter of 1996.
OPERATING EXPENSES:
(in thousands) THREE MONTHS ENDED
MARCH 31,
---------------------------
1997 1996
------- ------
Marketing, advertising & promotion $ 880 $ 694
Selling, distribution & administrative 6,118 4,873
------ ------
Total operating expenses $6,998 $5,567
Operating expenses increased $1.4 million or approximately 26% to $7.0 million
in the first quarter of 1997 from $5.6 million in the first quarter of 1996,
primarily as the result of higher fixed expenses required to support expected
higher sales volume in 1997. In the event higher sales volume is not achieved,
the increase in fixed expenses could result in lower profitability or a net
loss.
Marketing, Advertising and Promotion. Marketing, advertising and promotion
- ------------------------------------
expenses increased $186,000 or approximately 27% to $880,000 in the first
quarter of 1997 from $694,000 in the first quarter of 1996. The increase in the
first quarter of 1997 compared to the first quarter of 1996 was primarily due to
an increase in advertising expense. The
10
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Company expects quarterly advertising expense in the last two quarters of the
year to significantly exceed advertising expense in the first quarter of the
year to support anticipated seasonal increases in sales and the introduction of
the Company's 1997 product line.
Selling, Distribution and Administrative. Selling, distribution and
- ----------------------------------------
administrative expenses increased $1.2 million or approximately 26% to $6.1
million in the first quarter of 1997 from $4.9 million in the first quarter of
1996. The increase in expenses resulted from higher costs in operations and
sales support, product development, and general and administrative expenses
required to support expected higher sales volumes. See Dependence on 1997
------------------
Products; Increase in Fixed Expenses.
- ------------------------------------
INTEREST EXPENSE:
The following table shows interest expense and interest income for the
applicable periods:
(in thousands) THREE MONTHS ENDED
MARCH 31,
------------------
1997 1996
------ ------
Interest income $ 13 $ 107
Interest expense (657) (203)
The increase in interest expense in the quarter ended March 31, 1997 as compared
to the comparable period in 1996 is primarily the result of the non-cash
interest expense incurred in the first quarter of 1997 in connection with the
convertible debenture and prefered stock financing described under "Liquidity
and Capital Resources." 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 the higher bank borrowings during the quarter
ended March 31, 1997 as compared to the comparable period in 1996.
INCOME TAX BENEFIT:
The following table shows income tax benefit for the applicable periods:
(in thousands) THREE MONTHS ENDED
MARCH 31,
------------------
1997 1996
------ ------
Income tax benefit $(795) $(223)
The income tax benefit for the first quarter of 1997 is computed based on the
projected annualized effective tax rate of 20% applied to the pre-tax book loss
for the quarter. 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.
11
<PAGE>
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 March 31, 1997, the Company had cash and cash equivalents of approximately
$567,000, a $1.0 million decrease from approximately $1.6 million at December
31, 1996. The decrease in cash and cash equivalents was due to $950,000 used in
financing activities and $760,000 used in investing activities partially offset
by $706,000 of cash generated by operating activities. The $950,000 used in
financing activities was due to principal payments on bank debt of $10.5 million
partially offset by net proceeds from the issuance of the redeemable convertible
preferred stock ($8.0 million) and convertible debt ($1.5 million), while
investing activities used cash of $760,000 primarily due to the acquisition of
equipment. Operating activities generated cash due primarily to a decrease in
accounts receivable of $13.2 million, partially offset by the net loss, a
decrease in accounts payable and an increase in prepaid expenses and other
current assets.
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. The Company was not in compliance with a financial covenant under the
ARM Agreement at March 31, 1997, but previously had obtained a waiver from BNY
with regard to that covenant violation. 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
12
<PAGE>
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.
Holders of the Series A convertible preferred stock shall be entitled to
receive, when and as declared by the Board of Directors out of legally available
funds, cumulative dividends at a rate of 6.5% per annum, payable in cash or
shares of common stock, semi-annually in arrears, but in no event later than the
date of conversion. The Series A convertible preferred stock has no voting
rights, has a liquidation preference of $100 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 the lowest of (a) $5.313, (b) the average
of the lowest per share market value for any five consecutive trading days
during the sixty trading days immediately following March 28, 1997, or (c) 82.5%
of the average per share market value for the five trading days immediately
preceding the conversion date. The Series A convertible preferred stock is
redeemable, in cash, at the option of the Company at a redemption price equal to
the sum of (i) the average per share market value for the five days immediately
preceding (1) the 20th trading day after the date of the redemption notice or
(2) the date of payment in full by the Company, whichever is greater, and (ii)
the conversion ratio calculated on the 20th trading day after the redemption
notice. The Series A convertible preferred stock is mandatorily redeemable on
January 28, 2000 if not previously converted or redeemed. Any redemption
payments must be approved by BNY, the financial institution with which the
Company has its current accounts receivable management agreement.
The convertible debentures earn interest at 5% per annum, are due January 28,
2000, and are convertible any time after January 28, 1998, at the option of the
holder, at a conversion price similar to that of the Series A convertible
preferred stock. The convertible debentures are subordinated to the bank
financing agreements.
In connection with the issuance of the convertible debt and preferred stock, 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.
13
<PAGE>
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 A 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% equivalent of its outstanding shares of common stock in
cash.
The Company is negotiating to amend certain terms of these securities.
RECENT DEVELOPMENTS
- -------------------
Shareholder Lawsuits
- --------------------
On April 15, 1997, a class action lawsuit was filed in the Superior Court of the
State of California, County of Alameda (the "California Action") against YES!
Entertainment Corporation (the "Company") and certain of its executive officers.
The California Action is purportedly brought on behalf of purchasers of the
Company's common stock between October 23, 1996 and December 12, 1996,
inclusive. It alleges violations of (i) Sections 25400 and 25500 of the
California Corporations Code, (ii) Sections 1709, 1710 and 1711 of the
California Civil Code and (iii) Section 17200 et seq. of the California Business
and Professions Code.
On April 17, 1997, a second class action lawsuit was filed against the Company
and certain of its executive officers in the United States District Court for
the Northern District of California (the "Federal Action" and together with the
California Action, the "Actions"). The Federal Action is purportedly brought on
behalf of purchasers of the Company's common stock between March 29, 1996 and
December 12, 1996, inclusive. The Federal Action alleges violation of Sections
10(b) and 20(a) of the Securities Exchange Act of 1934, as amended, 65 U.S.C.
(S)(S) 78j(b) and 78t(a), and Rule 10b-5, 17 C.F.R. (S) 240.10b-5 promulgated
thereunder by the Securities and Exchange Commission.
The Actions 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 both Actions and
intends to vigorously defend the Actions.
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; History of Losses; Accumulated Deficit; Risk to
- --------------------------------------------------------------------------
Profitability. The Company has a short operating history, having commenced
- -------------
operations in November 1992 and shipped its first product in July 1993. Although
the Company has achieved approximately $197 million in cumulative net sales
through March 31, 1997, the Company incurred substantial operating losses in
1993 and 1994, and again in 1996, and at March 31, 1997 had an accumulated
deficit of approximately $57.4 million. 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.
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 Ice Cream Maker, Air Vectors,
YES! Extreme, and YES! PreSchool. In addition, the Company also expects to
expand its existing product lines in 1997, particularly its YES! Gear and Power
Penz 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 higher sales volumes
due in part to the Company's 1997 product lines. In the event higher sales are
not achieved, this increase in fixed expenses could result in lower
profitability or a net loss.
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, which together
--------- ----------
accounted for 83% and 58% of the Company's sales in 1996 and 1995, respectively.
The Company expects YES! Gear, and in particular the Yak Bak, and the Power Penz
--------- ------- ----------
product lines to continue to account for a substantial percentage of the
Company's business. However, there can be no assurance that the Company will be
able to sustain Yak Bak and Power Penz sales at 1996 levels. 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
15
<PAGE>
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 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
16
<PAGE>
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. Delays 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.
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.
International Business Risk. The Company in 1997 will principally rely 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
17
<PAGE>
foreign markets. 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.
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 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 1997, Hong Kong will become 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, 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, 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, including covenants concerning the
requirement that Donald Kingsborough and Sol Kershner, the Company's Chief
Executive Officer and Chief Financial Officer, respectively, remain active in
the management of the Company. 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, 1997, but previously had obtained a waiver from BNY
18
<PAGE>
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.
Potential 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, certain investors have the right to
convert the securities held by them in the face amount of approximately $10
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 the lowest of (a) $5.313, (b)
the average of the lowest per share market value for any five consecutive
trading days during the sixty trading days immediately following March 28, 1997,
or (c) 82.5% of the average per share market value for the five trading days
immediately preceding the conversion date. Because the Company's reported
common stock price dropped sharply following the completion of this financing,
the conversion of these securities could result in a significant amount of
shares of common stock being issued at a discount to prevailing market prices.
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 A 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. The Company
is negotiating to amend certain terms of these securities; however, there can be
no assurance that such negotiations will produce satisfactory amendments.
19
<PAGE>
PART II. OTHER INFORMATION
---------------------------
ITEM 1. LEGAL PROCEEDINGS
See Part I of this Quarterly Report on Form 10-Q under the heading
"Recent Developments -- Shareholder Lawsuits."
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibits
11.1 Statement Regarding Computation of Net Loss Per Share
27.1 Financial Data Schedule for the quarter ended March 31,
1997 (INCLUDED WITH EDGAR VERSION ONLY)
b) Reports on Form 8-K
In January 1997, the Company filed a Report on Form 8-K disclosing
that the Company had raised net cash of approximately $9.5 million in
a convertible debenture and warrant financing. On March 25, 1997, the
Company filed a Report on Form 8-K disclosing that the January
financing had been superseded and in its place the Company had issued
Series A Preferred Stock and Convertible Debentures in face value of
approximately $10.7 million. All exhibits filed with the above-
referenced Reports on Form 8-K are hereby incorporated by reference.
20
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
YES! Entertainment Corporation
------------------------------
Registrant
Date May 12, 1997 /s/ Donald D. Kingsborough
------------ --------------------------
Donald D. Kingsborough
Chief Executive Officer
(Principal Executive Officer)
Date May 12, 1997 /s/ Sol Kershner
------------ ----------------
Sol Kershner
Chief Financial Officer
(Principal Financial and
Accounting Officer)
21
<PAGE>
EXHIBIT 11.1
YES! ENTERTAINMENT CORPORATION
STATEMENT REGARDING COMPUTATION OF NET LOSS PER SHARE
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
----------------------------
1997 1996
------------ -------------
<S> <C> <C>
Net loss $ (3,182) $ (891)
=============
Non-cash dividends related to discount on preferred stock ($ 1,550)
------------
Net loss applicable to common stockholders $ (4,732)
============
Computation of weighted average common
and common equivalent shares outstanding:
Weighted average common shares outstanding 14,044 13,527
------------ -------------
Shares used in computing net loss per share 14,044 13,527
============ =============
Net loss per share applicable to common stockholders $ (0.34)
============
Net loss per share $ (0.07)
============
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> MAR-31-1997
<CASH> 567
<SECURITIES> 0
<RECEIVABLES> 9,268
<ALLOWANCES> 485
<INVENTORY> 26,166
<CURRENT-ASSETS> 44,320
<PP&E> 12,072
<DEPRECIATION> 8,113
<TOTAL-ASSETS> 48,506
<CURRENT-LIABILITIES> 11,722
<BONDS> 1,645
0
8,886
<COMMON> 83,639
<OTHER-SE> (57,389)
<TOTAL-LIABILITY-AND-EQUITY> 48,506
<SALES> 9,042
<TOTAL-REVENUES> 9,042
<CGS> 5,325
<TOTAL-COSTS> 5,325
<OTHER-EXPENSES> 6,998
<LOSS-PROVISION> 20
<INTEREST-EXPENSE> 657
<INCOME-PRETAX> (3,977)
<INCOME-TAX> (795)
<INCOME-CONTINUING> (3,182)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3,182)
<EPS-PRIMARY> (0.34)
<EPS-DILUTED> (0.34)
</TABLE>
