<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 June 30, 1998
-------------
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
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3875 Hopyard Road, Suite 375, Pleasanton, CA 94588
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(Address of principal executive offices and zip code)
(925) 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 June 30, 1998, there were 16,671,259 shares of the registrant's common
stock outstanding.
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YES! ENTERTAINMENT CORPORATION
INDEX
Page
----
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of
June 30, 1998 and December 31, 1997 3
Consolidated Statements of Operations 4
for the three months and six months ended
June 30, 1998 and June 30, 1997
Consolidated Statements of Cash Flows 5
for the six months ended June 30, 1998
and June 30, 1997
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of 10
Financial Condition and Results of Operations
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 22
Item 5. Other Information 22
Item 6. Exhibits and Reports on Form 8-K 22
SIGNATURES 23
2
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ITEM 1. FINANCIAL STATEMENTS
YES! ENTERTAINMENT CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1998 1997
------------ -----------------
(UNAUDITED) (AUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 368 $ 624
Accounts receivable, net of allowance for doubtful accounts of $236,000
on June 30, 1998 and $137,000 on December 31, 1997 4,929 8,659
Inventories 9,065 13,513
Prepaid royalties 651 955
Prepaid expenses 1,184 1,254
Other current assets 2,502 1,989
-------- --------
Total current assets 18,699 26,994
Property and equipment, net 4,493 5,345
Intangibles and deposits, net 165 156
-------- --------
Total assets $ 23,357 $ 32,495
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Loans payable $ 6,736 $ 10,709
Accounts payable 8,023 11,716
Accrued royalties 1,734 2,406
Accrued liabilities 614 2,178
Deferred royalty income 300 --
Dividends payable 114 123
Capital lease obligations 2 5
-------- --------
Total current liabilities 17,523 27,137
Convertible debentures 1,743 1,741
Stockholders' equity :
Series B convertible preferred stock, $0.001 par value:
Authorized shares 2,000,000
Issued and outstanding shares of 361,896 on June 30, 1998 and 387,770
on December 31,1997 (aggregate liquidation preference of $8,981,100) 7,989 8,500
Common stock,$.001 par value:
Authorized shares 48,000,000 at June 30, 1998
Issued and outstanding shares - 16,671,259 on June 30,1998 and 17 16
15,537,159 on December 31,1997
Additional paid-in capital 92,191 90,434
Deferred compensation (521) (606)
Accumulated deficit (95,585) (94,727)
-------- --------
Total stockholders' equity 4,091 3,617
-------- --------
Total liabilities and stockholders' equity $ 23,357 $ 32,495
======== ========
</TABLE>
See accompanying notes.
3
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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
1998 1997 1998 1997
------- ------- ------- -------
<S> <C> <C> <C> <C>
Net sales $ 5,834 $12,616 $17,703 $21,657
Cost of sales 3,148 7,615 10,349 12,940
-------
Gross profit 2,686 5,001 7,354 8,717
------- ------- ------- -------
Operating expenses:
Marketing, advertising and promotion 1,046 559 1,970 1,439
Selling, distribution and administrative 4,973 6,182 10,571 12,300
Total operating expenses 6,020 6,741 12,541 13,739
------- ------- ------- -------
Operating (loss) (3,334) (1,740) (5,186) (5,022)
Interest income - 12 3 25
Interest expense (247) (444) (647) (1,101)
Other expense, net (20) (14) (60) (66)
Gain on sale of assets 90 --- 6,003 ---
------- ------- ------- -------
Income (loss) before provision for income taxes (3,511) (2,186) 113 (6,164)
Provision for income taxes (income tax benefit) --- 179 --- (616)
Net income (loss) $(3,511) $(2,365) $ 113 $(5,548)
Non-cash dividends and discount on preferred stock (331) (1,049) (954) (2,600)
------- ------- ------- -------
Net income (loss) applicable to common stockholders $(3,842) $(3,414) $ (841) $(8,148)
======= ======= ======= =======
Basic earnings (loss) per share applicable to common stockholders $ (0.23) $ (0.24) $ (0.05) $ (0.58)
======= ======= ======= =======
Shares used in computing basic earnings (loss) per share 16,520 14,237 16,252 14,140
======= ======= ======= =======
</TABLE>
See accompanying notes.
4
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YES! ENTERTAINMENT CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30
1998 1997
------- --------
<S> <C> <C>
OPERATING ACTIVITIES
Net income (loss) $ 113 $ (5,548)
Adjustments to reconcile net income (loss) to net cash provided by
operating activities:
Gain on Sale of Product Lines (6,003) --
Depreciation and amortization 1,425 1,494
Advertising expenses funded by inventory 118
Debt discount and warrant amortization 172 475
Accrued interest converted to convertible debt 48 67
Employer contribution to 401(k) plan funded with common stock 58 106
Deferred compensation 84 --
Changes in operating assets and liabilities:
Accounts receivable 3,729 10,648
Inventories 1,728 573
Prepaid royalties, expenses and other current assets (400) (1,962)
Accounts payable (4,231) (5,504)
Accrued royalties and liabilities (2,414) 405
Income taxes payable -- (182)
Other long-term liabilities -- 17
------- --------
Net cash (used in) provided by operating activities (5,691) 707
INVESTING ACTIVITIES
Proceeds from Sale of product lines 10,207 --
Acquisition of property and equipment (787) (1,928)
(Increase) decrease in intangibles and deposits (8) 45
------- --------
Net cash (used in) provided by investing activities 9,412 (1,883)
FINANCING ACTIVITIES
Proceeds from issuance of convertible debentures -- 1,433
Principal payments on loans payable (3,974) (8,548)
Principal payments on capital lease obligations (3) (8)
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
------- --------
Net cash (used in) provided by financing activities (3,977) 916
------- --------
Net increase (decrease) in cash and cash equivalents (256) (270)
Cash and cash equivalents at beginning of period 624 1,572
------- --------
Cash and cash equivalents at end of period $ 368 $ 1,302
======= ========
</TABLE>
See accompanying notes.
5
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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, 1997 included in the Annual Report on Form 10-K, as
amended filed with the Securities and Exchange Commission on April 15,
1998. 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
1998.
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,
1998 1997
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Raw Materials $ 759 $ 496
Work-in-process 92 600
Finished goods 8,214 12,417
------ -------
$9,065 $13,513
====== =======
6
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3. SHAREHOLDER LAWSUITS
As of July 30, 1998, the Company was defending several class action
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 of the
County of Alameda: Wang v. YES! Entertainment Corporation et al., filed on
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April 15, 1997; and Miller v. YES! Entertainment Corporation et al., filed
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on July 3, 1997. In Miller, Gary L. Nemetz, a director of the Company, is
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also named as a defendant.
The Wang lawsuit was purportedly brought on behalf of purchasers of the
----
Company's common stock between October 23, 1996 and December 12, 1996,
inclusive. It challenged certain statements made by defendants regarding
the Company's V-Link product, as well as its impact on the Company's sales
and profitability. The Wang lawsuit alleged that these statements violated
----
Corporations Code Section 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
Section 1709- 1711.
The Miller lawsuit was based on the same facts as the Wang lawsuit, but
------ ----
alleged a longer class period of March 29, 1996 to December 12, 1996, and
challenged certain additional statements made by defendants. The Miller
------
first amended complaint stated only one count for violation of Sections
25400 and 25500 of the California Corporations Code.
In July 1997 a demurrer filed by defendants in the Wang action was
------
sustained with leave to amend. Plaintiffs filed an amended complaint on
September 29, 1997. On January 8, 1998, the court sustained without leave
to amend defendants' demurrer to the causes of action for violations of
Sections 25400 and 25500 of the California Corporations Code, and Section
17200 of the Business and Professions Code in the amended complaint. On
January 19, 1998, the plaintiff filed a second amended complaint alleging
only one count for violation of California Civil Code sections, 1709, 1711
and 1717. Defendants filed a demurrer to the second amended complaint
which was sustained with ten days leave to amend on March
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31, 1998. One May 8, 1998, plaintiff filed a third amended complaint.
Defendants' response to the third complaint is due on November 2, 1998.
On January 7, 1998, the defendants' demurrer to the first amended complaint
of the Miller action was sustained with leave to amend. On January 19,
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1998, plaintiff filed a second amended complaint. Defendants filed a
demurrer to the second amended complaint which is scheduled to be heard on
October 2, 1998. In addition, the plaintiffs served on the Company two
separate requests for production of documents and noticed the deposition of
Donald D. Kingsborough with a request for the production of documents. As
of July 30, 1998, a date for the deposition and production of documents had
not yet been agreed upon.
The Federal Securities Class Actions
------------------------------------
Three class actions were filed against the Company and Messrs. Kingsborough
and Kershner in the United States District Court for the Northern District
of California: Harrow v. YES! Entertainment Corporation et al., filed on
-----------------------------------------------
April 17, 1997; Takats v. YES! Entertainment Corporation et al., filed on
-----------------------------------------------
June 11, 1997; and Siegel v. YES! Entertainment Corporation et al., filed
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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.
-----------------------------------------
On December 4, 1997, the action was referred to the Honorable Charles
Breyer of the Northern District of California. On August 18, 1997, all
defendants filed a motion to dismiss the consolidated action. In response,
on November 8, 1997, plaintiffs filed a first amended consolidated
compliant for violation of the Securities Exchange Act of 1934. Defendants
filed a motion to dismiss the consolidated complaint on January 5, 1998.
One May 15, 1998, the Court granted defendants' motion to dismiss without
prejudice. Plaintiffs filed a second amended complaint on July 9, 1998.
The Federal class actions were based upon claims under federal securities
laws which impose liability on persons who make false or misleading
statements in connection with the purchase or sales of securities.
The Company maintained, and continues to maintain, that the allegations
contained in each of the class actions lawsuits were without merit.
Nonetheless, the Company concluded that further conduct of the class action
lawsuits would be protracted and expensive, and that it would be desirable
and beneficial to the Company to settle the lawsuits. Accordingly, on July
8, 1998, the Company entered into an agreement that settles all the class
action securities lawsuits. The settlement calls for
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payment to the plaintiff class of $2.25 million, which is being funded
under the Company's insurance policies. Judge Breyer preliminarily approved
the settlement on July 10, 1998, and the settlement funds were placed in
escrow on August 3, 1998. The hearing for final approval of the settlement
is scheduled for September 18, 1998 at 10:00 a.m. Upon final Court
approval, all claims against the Company and its executive officers and
directors in these federal actions will be dismissed with prejudice.
The Company is involved from time to time in other litigation matters
incidental to its business.
4. SALE OF PRODUCT LINES
In March 1998, the Company entered into a definitive agreement with Wham-O,
Inc. to purchase the assets of YES!'s Food and Girls Activity product
lines. The total purchase price includes approximately $9.8 million in
cash for the purchase of the lines and related inventories, a $2.5 million
contingency payment to be earned based upon certain performance criteria
for the Food line in the first year, and royalties of up to $5.5 million
over a seven year period.
Sales from these product lines were $15.7 million, $5.1 million and $0 for
1997, 1996 and 1995. Gross margin from these product lines were $9.5
million, $2.8 million and $0 for 1997, 1996 and 1995.
5. FASB STATEMENT NO. 130, REPORTING COMPREHENSIVE INCOME
As of January 1, 1998 the Company adopted Statement 130, Reporting
Comprehensive Income. Statement 130 establishes new rules for the
reporting and display of comprehensive income and its components; however,
the adoption of the Statement had no impact on the Company's net income or
shareholders' equity.
During the second quarter of 1998 and 1997, total comprehensive income
(loss) amounted to $(3,511) and $(2,365).
6. APPOINTMENT TO THE BOARD OF DIRECTORS
In April of 1998, the Board of Directors appointed Gary L. Nemetz to fill a
vacancy on the Board.
9
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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 in
the section captioned "Business Risk Factors."
<TABLE>
<CAPTION>
RESULTS OF OPERATIONS
- ---------------------
(Dollars in thousands)
Three months ended Six months ended
June 30 June 30
------------------------------------------------------------
1998 1997 1998 1997
------------------------- ------- -------
<S> <C> <C> <C> <C>
Net Sales 5,834 12,616 17,703 21,657
Cost of sales 3,148 7,615 10,349 12,940
Gross profit 2,686 5,001 7,354 8,717
Gross profit % 46% 40% 41% 40%
Operating Expenses 6,020 6,741 12,541 13,739
Operating Expense % 103% 53% 71% 66%
Operating (loss) (3,334) (1,740) (5,186) (5,022)
Gain on Sale of Assets 90 ----- 6,003 -----
Interest and other expense, net (267) (446) (704) (1,143)
Income (loss) before provision (3,511) (2,186) 113 (6,164)
for income taxes
Provision for income taxes 0 179 0 (616)
Net income (loss) (3,511) (2,365) 113 (5,548)
Non-cash dividends and discount
on preferred stock (331) (1,049) (954) (2,600)
Net income (loss) applicable to
common stockholders (3,842) (3,414) (841) (8,148)
</TABLE>
10
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NET SALES
The Company's net sales for the second quarter of 1998 decreased $6.8 million, a
decline of approximately 54% to $5.8 million from $12.6 million in the second
quarter of 1997. Net sales in the second quarter of 1998 included approximately
$ 1.6 million in sales of lower margin close-out goods pertaining to V-Link and
Comes to Life Players. International sales in the second quarter of 1998
represented approximately 34% of total sales as compared to 40% in the second
quarter of 1997. For the first six months of 1998 net revenues declined by $4.0
million or 18% to $17.7 million as compared to $21.7 million in the first six
months of 1997. International sale represented 33% for the for the six month
period ending June 30,1998 as compared to 36% for the comparable period in 1997.
The decrease in net sales in the second quarter of 1998 was due primarily to
reduced volume in YES! Gear and Power Penz, and the sale of the Food lines in
March 1998 (see Note 4 to the Financial Statements). This decrease was partially
offset by the introduction of W3 Speed Loader. As a result of the sale of the
Food lines, to the extent the loss of net sales of these lines are not replaced
by increased net sales of current or future products, the Company's net sales
and operating results will be materially and adversely affected.
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.
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.
11
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COST OF SALES
Cost of sales were approximately 54% and 60% of net sales in the second
quarters of 1998 and 1997, respectively. The decrease in cost of sales as a
percentage of net sales in the second quarter of 1998 as compared to the second
quarter of 1997 was primarily the result of a decreased percentage of lower
margin product sales. For the six month period ending June 30, 1998 cost of
sales as a percentage of total sales were approximately 59% as compared to
approximately 60% in the comparable period of 1997. In absolute dollars, cost
of sales decreased by approximately $4.5 million for the second quarter of 1998
to $3.2 million, compared to $7.6 million in the second quarter of 1997. For the
six month period ended June 30,1998 cost of sales decreased by approximately
$2.6 million to $10.4 million as compared to approximately $12.9 million in the
comparable period in 1997.
<TABLE>
<CAPTION>
OPERATING EXPENSES
(in thousands) Three months ended Six months ended
June 30 June 30
------------------------ --------------------
1998 1997 1998 1997
-------- ------- -------- --------
<S> <C> <C> <C> <C>
Marketing, advertising & promotion $1,046 $ 559 $ 1,970 $ 1,439
Selling, distribution & administrative 4,973 6,182 10,571 12,300
------ ------ ------- -------
Total operating expenses $6,020 $6,741 $12,541 $13,739
====== ====== ======= =======
</TABLE>
Marketing, Advertising and Promotion. Marketing, advertising and promotion
expenses increased by approximately $487,000. As a percentage of net sales,
marketing, advertising and promotion expenses were 17.9% in the second quarter
of 1998 as compared to 4.4% in the second quarter of 1997. For the six month
period ending June 30, 1998 marketing, advertising, and promotion expenses
increased by $531,000 and were 11.1% of net revenues as compared to 6.6% of net
revenues for the comparable period in 1997. The increase for the second quarter
and year to date expenditures are related to promotion of the W3 Speed Loader
and Air Vectors. 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.
Selling, Distribution and Administrative. Selling, distribution and
administrative expenses decreased by $1.2 million, or approximately 19.5%, to
$5.0 million in the second quarter of 1998 as compared to $6.2 million in the
second quarter of 1997. For the six month period ended June 30, 1998 selling,
distribution, and administrative expenses were reduced by $1.7 million or 14% to
$10.6 million as compared to $12.3 million in the prior
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year period. Net reductions in this expense category were the result of cost
control measures implemented by the Company.
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
--------------------------------------------------------
1998 1997 1998 1997
----- ----- ------ -------
<S> <C> <C> <C> <C>
Interest income $ -- $ 12 $ 3 $ 25
Interest expense (247) (444) (647) (1,101)
</TABLE>
The decrease in interest expense in the quarter ended June 30, 1998 as compared
to the comparable period in 1997 is the result of lower bank borrowings and non-
cash interest expense recorded in connection with the convertible debenture and
preferred stock financing, and the restructuring thereof, described in detail in
the Company's Annual Report on Form 10-K for the year ended December 31, 1997.
The non-cash interest expense recorded in the quarter ended June 30, 1998 was
$88,000. Non-cash interest expense for the six months ended June 30,1998 was
$236,000. The decrease in interest income is the result of the lower cash
balances maintained by the Company during the quarter and six months ended June
30, 1998 as compared to the comparable periods in 1997.
PROVISION FOR INCOME TAXES (INCOME TAX BENEFIT):
No income tax provision has been computed for the three and six months ended
June 30, 1998 as the Company did not have net income during such periods. The
Company does not expect to earn a profit during 1998.
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 1998, the Company had cash and cash equivalents of approximately
$368,000, a $256,000 decrease from approximately $624,000 at December 31, 1997.
The decrease in cash and cash equivalents was due to $9.4 million provided by
investing activities, primarily offset by $3.1 million used in financing
activities and $5.7 million used in operating activities.
The cash used by operating activities was due primarily to the Company's net
income which includes a $6.0 million gain from the sale of two product lines, a
decrease in accounts receivable of $3.7 million, a decrease in inventories of
$1.7 million offset by a decrease in accounts payable of approximately $4.2
million.
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The $9.4 million provided by investing activities related primarily to proceeds
from the sale of two product lines.
Since its inception, the Company's internally generated cash flow has not been
sufficient to finance trade receivables, inventory, capital equipment
requirements and new product development, or to support operations. The Company
has met its capital requirements to date primarily through the initial public
offering of the Company, which generated net proceeds to the Company of
approximately $10.9 million, the exercise of IPO Warrants which generated
approximately $19.7 million, the private sales of approximately $50.0 million of
equity securities, borrowings of $2.0 million of long-term convertible
subordinated notes (now repaid), borrowings under short term loans from certain
stockholders, borrowings under bank loans guaranteed by certain shareholders,
borrowings under a factoring agreement with a group of banks, borrowings under a
Loan and Security Agreement with Congress Financial Corporation Western (now
repaid), and borrowings under an Accounts Receivable Management and Security
Agreement entered into with BNY Financial Corporation in July 1995, as amended
(the "ARM Agreement"). In addition, in the first quarter of 1997, the Company
raised net proceeds of approximately $9.3 million from the sale of convertible
debentures, preferred stock and warrants and, in the third quarter of 1997,
satisfied trade debt of $3.1 million by issuing common stock to several of its
vendors.
To meet seasonal working capital requirements during 1998, the Company has
borrowed substantial amounts under the ARM Agreement. The terms of the ARM
Agreement, as amended, provide that BNY Financial Corporation 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. As of December 31, 1997, the Company was
required to maintain a monthly quick ratio of 1:1 under the ARM Agreement. The
ratio at December 31, 1997 was 0.5:1 and the Company obtained a waiver for the
month of December 1997 with regard to the quick ratio requirement. Since the
month ended December 31, 1997, BNY Financial Corporation and the Company have
amended the ARM Agreement to require that a monthly quick ratio of 0.5:1 be
maintained for the quarter ending March 31, 1998, which ratio decreased to 0.4:1
as of June 30, 1998 and shall increase to 0.5:1 thereafter. The Company was in
compliance with this covenant requirement at June 30, 1998. As of December 31,
1997, the ARM Agreement
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required that a ratio of earnings calculated before interest, taxes,
depreciation and amortization to total interest expense of 5:1 on a
retrospective rolling four quarter basis be maintained. The Company recorded a
loss before interest, taxes, depreciation and amortization for the four quarters
ended December 31, 1997. The Company obtained a waiver from BNY with regard
to this covenant for the fourth quarter of 1997. Since the month ended December
31, 1997, BNY Financial Corporation and the Company have amended the ARM
Agreement to require that a ratio of earnings calculated before interest, taxes,
depreciation and amortization to total interest expense of 5:1 on a prospective
rolling four quarter basis be maintained for the year beginning January 1, 1998
and reverts back to a retrospective rolling four quarter basis effective January
1, 1999. The Company was not in compliance with this covenant requirement at
June 30, 1998, however a waiver is anticipated. A tangible net worth of $32
million at December 31, 1997 was required under the ARM Agreement. As of
December 31, 1997 the Company had a tangible net worth of $3.5 million. The
Company obtained a waiver with respect to this requirement from BNY Financial
Corporation for the fourth quarter of 1997. Since the month ended December 31,
1997, BNY Financial Corporation and the Company have amended the ARM Agreement
to require a tangible net worth of $6.9 million at March 31, 1998, $3.8
million at June 30, 1998, $4.3 million at September 30, 1998 and $3.0 million
at December 31, 1998. The Company was in compliance with this covenant
requirement at June 30, 1998. 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 or to
grant security interests in the assets of the Company. As of June 30, 1998,
the Company had borrowings of $6.7 million under the ARM Agreement. The $30
million under the ARM Agreement is subject to a borrowing base which limits
the ability to utilize the full amount of the line.
The Company's 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. As a result of seasonality in the toy industry, the
timing of new product introductions, the Company's planned growth, and the
current financial condition of the Company, there can be no assurance that the
Company will not require additional funding. There can be no assurance that
any 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 business and
operating results.
15
<PAGE>
BUSINESS RISK FACTORS
History of Losses; Accumulated Deficit. The Company incurred operating losses of
$38.2 and $12.6 million for the years ended December 31, 1997 and 1996,
respectively. In 1997, the Company had a net cash outflow of $1.4 million. In
the second quarter of 1998, the Company incurred an operating loss of $3.3
million and an operating loss through the six months ended June 30, 1998 of $5.2
million with a resulting accumulated deficit of $95.6 million. As a result of
these 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 1998 Products. In 1998, the Company has introduced and expects to
commence sales of a number of new product lines in new product categories, such
as the W-3 Wild Water Weapons, Air Vectors SFX, Yak Live, Fistful of Aliens and
Teddy Ruxpin. In addition, the Company also expects to expand its existing
product lines in 1998, particularly its YES! Gear 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 1998 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
1998 product lines, the Company's operating results and financial condition
would be materially adversely affected.
Dependence on Yak Bak and Power Penz. The majority of the Company's current
product lines are sold under the YES! Gear brand and consist of Yak Bak and
Power Penz products. The Company had a significant decline in the sales of its
Yak Bak products in 1997 as compared to 1996 and, while Power Penz revenues were
stable, gross margins on its Power Penz sales declined due to a shift from
domestic to international sales. These product lines accounted for 51% and 72%
of net sales in 1997 and 1996 respectively. The Power Penz brand accounted for
26% and 22% of net sales in 1997 and 1996 respectively. The Company expects
these brands to continue to account for a substantial percentage of the
Company's business, but there can be no assurance that they will be able to
sustain sales at the 1997 level, or at a level necessary to maintain its overall
sales and revenues. In addition, a number of toy manufacturers have attempted to
duplicate the Company's success in these areas and there can be no assurance
that the sale of these competitive products will not impact the sale of the Yak
Bak or Power Penz product lines.
16
<PAGE>
Just in Time Inventory; Compressed Sales Cycles. Most of the Company's most
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. 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 prior to Christmas; these may include drop-
shipment expense and higher advertising allowances which would otherwise be
borne by the Company's customers. In the event that anticipated reorders do not
materialize, the Company may incur increased inventory carrying costs.
Changes in 1998 Product Line. The Company constantly evaluates the toy markets
and its development and manufacturing schedules. In March 1998, the Company
sold its Food line, which accounted for a significant portion of its gross
margin in Fiscal 1997. See Note 4 of Notes to Consolidated Financial
Statements. As the year progresses, the Company may elect to reduce the number
of products it currently plans on shipping in 1998 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 1998 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 applicable.
Sales Concentration Risk. The Company's ten largest customers accounted for 73%,
85% and 87% of sales for the years ending December 31, 1997, 1996 and 1995,
respectively. For the year ended December 31, 1997, the Company's two largest
customers, TRU and Wal-Mart, accounted for 21% and 13% of net sales,
respectively. For the year ended December 31, 1996, the same two customers
accounted for approximately 21% and 20% of net sales, respectively, and for the
year ended December 31, 1995, TRU and Wal-Mart each accounted for 27% of net
sales. 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
17
<PAGE>
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 of 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 the future. Any 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.
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
18
<PAGE>
Company can maintain sufficient flexibility with respect to its working capital
needs or its 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. Failure to accurately predict and
respond to consumer demand may cause the Company to produce excess inventory
which could materially adversely affect the Company's operating results and
financial condition. Conversely, if a product achieves greater success than
anticipated, the Company may not have sufficient inventory to meet retail
demand, which could adversely impact the Company's relations with its customers.
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 product lines to achieve or sustain market acceptance 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.
International Business Risk. The Company will rely in 1998 principally 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 1995, 1996 and 1997 are 7%, 21% and 32%,
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 US 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 US dollars,
currency exchange fluctuations in the countries where the Company does
19
<PAGE>
business could materially adversely affect the Company's business, financial
condition and results of operations.
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, there can be no assurance that political or social tensions
will not develop in Hong Kong that would disrupt this process. In addition,
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
1998, 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 Donald
Kingsborough, the Company's Chief Executive Officer, 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. In the event the
Company falls out of compliance with the ARM Agreement, or BNY Financial
Corporation does not provide additional financing, and the Company is unable to
obtain financing from other sources, the Company would not be able to finance
its operations as contemplated, and its operating results and financial
condition would be materially adversely affected.
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, Mark
Shepherd, the Company's Chief Operating and Financial Officer and other
20
<PAGE>
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.
Impact of Year 2000. The Company is in the process of evaluating and updating
its internal management information systems so that they will have the
capability to manage and manipulate data involving the transition of dates
from 1999 to 2000 without functional or data abnormality and without
inaccurate results relating to such dates. The Company expects to complete the
updating of its current systems before 2000. Any new systems implemented by
the Company would be Year 2000 compliant. Other participants in the Company's
industry may also experience functional or data abnormality. Any failures on
the part of the Company or the Company's manufacturers, lending institutions
and key customers to ensure their respective software complies with Year 2000
requirements, could have a material adverse effect on the financial condition
and results of operation of the Company.
21
<PAGE>
PART II. OTHER INFORMATION
---------------------------
ITEM 1. LEGAL PROCEEDINGS
See Note 3 to the Consolidated Financial Statements on pages 7-9
hereof.
ITEM 5. OTHER INFORMATION
In April, 1998 the Board of Directors appointed Gary L. Nemetz to fill
a vacancy on the Board.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
A) EXHIBITS
10.1 /(1)/Asset Purchase Agreement dated as of February 27, 1998 by
and between YES! Entertainment Corporation and Wham-O (the
"Asset Purchase Agreement")
10.2 /(1)/Amendment No. 1, dated as of March 20, 1998, to the Asset
Purchase Agreement.
27.1 Financial Data Schedule for the quarter ended June 30, 1998
/(1)/Previously filed on Current Report on Form 8-K filed April 1,
1998.
B) REPORTS ON FORM 8-K
A Current Report on Form 8-K was filed on April 1, 1998.
22
<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 August 14, 1998 /s/ Donald D. Kingsborough
--------------- --------------------------
Donald D. Kingsborough
Chief Executive Officer
(Principal Executive Officer)
Date August 14, 1998 /s/ Mark Shepherd
--------------- -----------------
Mark Shepherd
Chief Financial Officer
(Principal Financial and
Accounting Officer)
23
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