-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, NDnlQkeery4xaHd4D2DiTyE7vLSrxOr+S/BMhclyVGi0JgkUrvyh/KpznuSy6QBD sMAbJ/yTKz/R3YuetRRZcA== 0001012870-98-001351.txt : 19980518 0001012870-98-001351.hdr.sgml : 19980518 ACCESSION NUMBER: 0001012870-98-001351 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980331 FILED AS OF DATE: 19980515 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: YES ENTERTAINMENT CORP CENTRAL INDEX KEY: 0000943747 STANDARD INDUSTRIAL CLASSIFICATION: GAMES, TOYS & CHILDREN'S VEHICLES (NO DOLLS & BICYCLES) [3944] IRS NUMBER: 943165290 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-25916 FILM NUMBER: 98623857 BUSINESS ADDRESS: STREET 1: 3875 HOPYARD RD STE 375 CITY: PLEASANTON STATE: CA ZIP: 94588 BUSINESS PHONE: 5108479444 MAIL ADDRESS: STREET 1: 3875 HOPYARD ROAD STREET 2: SUITE 375 CITY: PLEASANTON STATE: CA ZIP: 94588 10-Q 1 FORM 10-Q FOR QUARTER ENDED 3/31/98 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, 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 - ------------------------------- ------------------------------- (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 March 31, 1998, there were 16,440,733 shares of the registrant's common stock outstanding. This quarterly report on Form 10-Q contains 23 pages of which this is page number 1. YES! ENTERTAINMENT CORPORATION INDEX Page ---- Part I. Financial Information Item 1. Consolidated Financial Statements Consolidated Statements of Operations - Three months ended March 31, 1998 and March 31, 1997............................ 3 Consolidated Balance Sheets - March 31, 1998 and December 31, 1997.......... 4 Consolidated Statements of Cash Flows - Three months ended March 31, 1998 and March 31, 1997............................ 5 Notes to Consolidated Financial Statements...... 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations... 10 PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K................ 22 SIGNATURE PAGE.................................................. 23 2 Item 1. CONSOLIDATED FINANCIAL STATEMENTS YES! ENTERTAINMENT CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
THREE MONTHS ENDED MARCH 31 --------------------------------- 1998 1997 ------------ ------------ Net sales $11,869 $ 9,042 Cost of sales 7,201 5,325 ------- ------- Gross profit 4,668 3,717 ------- ------- Operating expenses: Marketing, advertising and promotion 924 880 Selling, distribution and administrative 5,597 6,118 ------- ------- Total operating expenses 6,521 6,998 ------- ------- Operating (loss) (1,853) (3,281) Interest income 3 13 Interest expense (403) (657) Other expense, net (36) (52) Gain on sale of assets 5,913 --- ------- ------- Income (loss) before provision for income taxes 3,624 (3,977) Provision for income taxes -- (795) ------- ------- Net income (loss) $ 3,624 $(3,182) Non-cash dividends and discount on preferred stock (623) (1,550) ------- ------- Net income ( loss) applicable to common stockholders $ 3,001 $(4,732) ======= ======= Basic earnings (loss) per share applicable to common stockholders $ 0.19 $ (0.34) ======= ======= Shares used in computing basic earnings (loss) per share 16,043 14,044 ======= ======== Diluted earnings (loss) per share applicable to common stockholders $ 0.19 $ -- ======= ======== Shares used in computing diluted earnings (loss) per share 16,116 0 ======= ========
See accompanying notes. 3 YES! ENTERTAINMENT CORPORATION CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)
MARCH 31, DECEMBER 31, 1998 1997 UNAUDITED AUDITED -------------- ----------- ASSETS Current assets: Cash and cash equivalents $ 781 $ 624 Accounts receivable, net of allowance for doubtful accounts of $236 on March 31, 1998 and $137 on December 31, 1997 3,682 8,659 Inventories 9,837 13,513 Prepaid royalties 600 955 Prepaid expenses 1,275 1,254 Other current assets 2,496 1,989 -------- -------- Total current assets 18,671 26,994 Property and equipment, net 4,957 5,345 Intangibles and deposits, net 172 156 -------- -------- Total assets $ 23,800 $ 32,495 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Loans payable $ 1,560 $ 10,709 Accounts payable 8,981 11,716 Accrued royalties 2,132 2,406 Accrued liabilities 1,501 2,178 Deferred royalty income 300 -- Dividends payable 113 123 Capital lease obligations 4 5 -------- -------- Total current liabilities 14,591 27,137 Convertible debentures 1,786 1,741 Stockholders' equity : Series B convertible preferred stock, $0.001 par value: Authorized shares 2,000,000 Issued and outstanding shares of 359,244 on March 31, 1998 and 387,770 on December 31,1997 (aggregate liquidation preference of $8,981,100) 7,859 8,500 Common stock,$.001 par value: Authorized shares 48,000,000 at March 31, 1998 Issued and outstanding shares - 16,440,733 on March 31,1998 and 15,537,159 on December 31,1997 17 16 Additional paid-in capital 91,854 90,434 Deferred compensation (564) (606) Accumulated deficit (91,743) (94,727) -------- -------- Total stockholders' equity 7,423 3,617 -------- -------- Total liabilities and stockholders' equity $ 23,800 $ 32,495 ======== ========
See accompanying notes 4 YES! ENTERTAINMENT CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (IN THOUSANDS)
THREE MONTHS ENDED MARCH 31 -------------------------------------- 1998 1997 ---------------- --------------- OPERATING ACTIVITIES Net income (loss) $ 3,624 $ (3,182) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Gain on sale of product lines (5,913) -- Depreciation and amortization 519 719 Advertising expenses funded by inventory (21) 78 Debt discount and warrant amortization 113 270 Accrued interest converted to convertible debt 24 67 Employer contribution to 401(k) plan funded with common stock 39 58 Deferred compensation 42 Changes in operating assets and liabilities: Accounts receivable 4,977 13,173 Inventories 1,214 28 Prepaid royalties, expenses and other current assets (413) (1,297) Accounts payable (3,273) (8,571) Accrued royalties and liabilities (1,121) (458) Income taxes payable __ (182) Other long-term liabilities __ 3 ------- -------- Net cash (used in) provided by operating activities (189) 706 INVESTING ACTIVITIES Proceeds from sale of product lines 9,859 -- Acquisition of property and equipment (346) (801) (Increase) decrease in intangibles and deposits (16) 41 ------- -------- Net cash (used in) provided by investing activities 9,497 (760) FINANCING ACTIVITIES Proceeds from issuance of convertible debentures -- 1,500 Principal payments on loans payable (9,149) (10,460) Principal payments on capital lease obligations (2) (4) Proceeds from issuance of redeemable convertible preferred stock, net of issuance costs -- 8,014 ------- -------- Net cash (used in) provided by financing activities (9,151) (950) ------- -------- Net increase (decrease) in cash and cash equivalents 157 (1,004) Cash and cash equivalents at beginning of period 624 1,572 ------- -------- Cash and cash equivalents at end of period $ 781 $ 567 ======= ========
See accompanying notes. 5 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 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) March 31, December 31, 1998 1997 -------- ------------ Raw Materials $ 415 $ 496 Work-in-process 74 600 Finished goods 9,348 12,417 ------ ------- $9,837 $13,513 ====== ======= 6 3. SHAREHOLDER LAWSUITS The Company is defending several shareholder lawsuits, as follows: The State Securities Class Actions - ---------------------------------- Two class actions have been 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 April 15, -------------------------------------------- 1997; and Miller v. YES! Entertainment Corporation et al., filed on July 3, ----------------------------------------------- 1997. In Miller , Gary L. Nemetz, a former director of the Company, is also ------ named as a defendant. The Wang lawsuit is purportedly brought on behalf of purchasers of the Company's ---- common stock between October 23, 1996 and December 12, 1996, inclusive. It challenges certain statements made by defendants regarding the Company's V-Link product, as well as its impact on the Company's sales and profitability. The Wang lawsuit alleges that these statements violated Corporations Code Section 25400 and 25500, which provides 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 is based on the same facts as the Wang lawsuit, alleges a ------ ---- longer class period of March 29, 1996 to December 12, 1996, and challenges certain additional statements made by defendants. The Miller first amended ------ complaint states only one count, which is for violation of (S)(S)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 defendant's 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 Section, 1709, 1711 and 1717. Defendants filed a demurrer to the second amended complaint which was sustained with ten days leave to amend on March 31, 1998. Plaintiff has not yet filed their amended complaint. 7 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, 1998, plaintiff filed a second amended complaint. Defendants filed a demurrer to the second amended complaint which is scheduled to be heard in May 1998. In addition, the plaintiffs have served on the Company two separate requests for production of documents and have noticed the deposition of Donald D. Kingsborough with a request for the production of documents. A date for the deposition and production of documents has 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 on June 27, 1997. On ----------------------------------------------- August 6, 1997, the three Federal actions were consolidated for pre-trial 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 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 complaint for violation of the Securities Exchange Act of 1934. Defendants filed a motion to dismiss the consolidated complaint on January 5, 1998. The hearing date for the motion is set for May 22, 1998. The Federal class actions are based upon claims under the federal securities laws, which impose liability on persons who make false or misleading statements in connection with the sale or purchase of securities. The State and Federal securities class action lawsuits have been tendered to the applicable directors and officers insurance carriers who have responded with a reservation of rights pending a final determination of coverage. Directors and officers insurance coverage totals $5 million. The primary insurance policy is subject to certain deductible and retention provisions. The Company believes that it has meritorious defenses to these lawsuits and intends to vigorously defend them. However, no assurance can be given as to the outcome of the lawsuits. The Company believes it will incur substantial time and expense to defend these lawsuits, and an adverse result in any of the lawsuits would have a material effect on the Company's operating results and financial condition. The State and Federal actions seek compensatory and punitive damages, interest, attorneys' fees and other costs, as well as equitable relief to preserve defendants' assets. The inability of the Company to prevail in the 8 lawsuits could have a material adverse effect on the Company's business, financial condition, and results of operations. 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. The company reported a gain of $5.9 million for the period ending March 31, 1998 related to this transaction. 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 first quarter of 1998 and 1997, total comprehensive income (loss) amounted to 3,624 and (3,182). 9 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."
Results of Operations - ------------------------------------ (Dollars in thousands) Three months ended March 31, -------------------- 1998 1997 ------- ------- Net sales $11,869 $ 9,042 Cost of sales 7,201 5,325 ------- ------- Gross profit 4,668 3,717 Gross profit % 39% 41% Operating expenses 6,521 6,998 Operating expense % 55% 77% Operating (loss) (1,853) (3,281) Gain of Sale of Assets 5,913 -- Interest and other expense, net (436) (696) ------- ------- Income (loss) before provision for 3,624 (3,977) income taxes Provision for income taxes -- (795) ------- ------- Net income (loss) $ 3,624 $(3,182) ======= ======= Non-cash dividends and discount on preferred stock (623) (1,550) ------- ------- Net income (loss) applicable to common stockholders $ 3,001 $(4,732) ======= =======
10 NET SALES: The Company's net sales for the first quarter of 1998 increased $2.8 million or approximately 32% to $11.9 million from $9.0 million in the first quarter of 1997. Net sales in the first quarter of 1998 were comprised of approximately $2.4 million in sales of lower margin close-out goods pertaining to V-Link and Radical Air Weapons ("R.A.W.") product lines. International sales in the first quarter of 1998 represented approximately 35% of total sales as compared to 30% in the first quarter of 1997. In absolute dollars, international sales were up approximately $1.4 million. The increase in net sales in the first quarter of 1998 was due primarily to an increase in lower margin close-out sales related primarily to V-Link and R.A.W. product lines. Net sales in the quarter reflected lower sales of older products as compared to the prior year period offset by sales of products which were introduced subsequent to the first quarter of 1997, such as Air Vectors and W-3 Wild Water Weapons. The company expects that net sales in the second quarter of 1998 will be lower than in the first quarter of 1998 and that the subsequent loss will also be greater. 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 COST OF SALES: Cost of sales were approximately 61% and 59% of net sales in the first quarters of 1998 and 1997, respectively. The increase in cost of sales as a percentage of net sales in the first quarter as compared to the first quarter of 1997 was primarily the result of an increased percentage of lower margin close-out sales related to the Company's V-Link and R.A.W. product lines. The percentage increase is also a result of the higher percentage of international sales in the first quarter of 1998 as compared to the first quarter of 1997. International sales have a higher cost of sales in general as compared to domestic sales. In absolute dollars, cost of sales increased by $1.9 million or approximately 35% to $7.2 million in the first quarter of 1998 from $5.3 million in the first quarter of 1997. This is due primarily to the higher sales volume with a much higher percentage of low margin close-out sales.
OPERATING EXPENSES: (in thousands) Three months ended March 31, ------------------ 1998 1997 ------- ------- Marketing, advertising & promotion $ 924 $ 880 Selling, distribution & administrative 5,597 6,118 ------ ------ Total operating expenses $6,521 $6,998 ====== ======
Marketing, Advertising and Promotion. Marketing, advertising and promotion expenses increased by approximately $44,000. As a percentage of net sales, marketing, advertising and promotion expenses were 7.8% in the first quarter of 1998 as compared to 9.7% in the first quarter of 1997. Selling, Distribution and Administrative. Selling, distribution and administrative expenses decreased by $521,000, or approximately 8.5%, to $5.6 million in the first quarter of 1998 as compared to $6.2 million in the first quarter of 1997. Selling , distribution, and administrative expenses as a percentage of net sales were reduced to 47% in the first quarter of 1998 as compared to 68% in the first quarter of 1997. Net reductions in this expense category were the result of cost control measures implemented by the Company in the quarter ended March 31, 1998. 12 INTEREST EXPENSE: The following table shows interest expense and interest income for the applicable periods:
(in thousands) Three months ended March 31, ------------------ 1998 1997 -------- ------- Interest income $ 3 $ 13 Interest expense (403) (657)
The decrease in interest expense in the quarter ended March 31, 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 March 31, 1998 was $148,000. The decrease in interest income is the result of the lower cash balances maintained by the Company during the quarter ended March 31, 1998 as compared to the comparable period in 1997. PROVISION FOR INCOME TAXES (INCOME TAX BENEFIT): No income tax provision has been computed for the three months ended March 31, 1998 as the Company has sufficient net operating loss carryforwards to offset the first quarter net income. The Company does not expect to earn a profit during 1998. LIQUIDITY AND CAPITAL RESOURCES At March 31, 1998, the Company had cash and cash equivalents of approximately $781,000, a $157,000 increase from approximately $624,000 at December 31, 1997. The increase in cash and cash equivalents was due to $9.5 million provided by investing activities, primarily offset by $9.2 million used in financing activities and $189,000 used in operating activities. The cash used by operating activities was due primarily to the Company's net income which includes a $5.9 million gain from the sale of two product lines, a decrease in accounts receivable of $5.0 million, a decrease in inventories of $1.2 million partially offset by a decrease in accounts payable of approximately $3.3 million. 13 The $9.5 million provided by investing activities related primarily to proceeds from the sale of two product lines which were used primarily to pay down the Company's line of credit. In March 1998, the Company sold its Licensed Food line, including its Mrs. Fields Baking Factory and Baskin-Robbins Ice Cream Maker products, and its girls activity business unit, including its Dance Studio and Cheer Leader products, to Wham-O, Inc. The total purchase price included $9.8 million in cash for purchase of the lines and related inventory, a contingency payment of up to $2.5 million to be earned based upon certain performance criteria for the food line in the first year, royalties of up to $5.5 million over a seven year period and an allocation of $50,000 of such purchase price to Donald Kingsborough as compensation for his agreement to a noncompete provision in the asset purchase agreement. 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 anticipates borrowing 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 14 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 shall decrease to 0.4:1 as of June 30, 1998 and increase to 0.5:1 thereafter. The company was in compliance with this covenant requirement at March 31, 1998. As of December 31, 1997, the ARM Agreement 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 has 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 in compliance with this covenant requirement at March 31, 1998. 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 has 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 March 31, 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 March 31, 1998, the Company had borrowings of $1.6 million under the ARM Agreement. 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 and the Company's planned 15 growth, 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 operating results. 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 first quarter of 1998, the Company incurred an operating loss of $1.9 million with a resulting accumulated deficit of $91.7 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 16 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. 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. 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 17 Company expects to continue to depend on a relatively small number of customers for a significant percentage of its sales. Significant reductions in sales to any one or more of the Company's largest customers would have a material adverse effect on the Company's operating results. Because orders in the toy industry are generally cancelable at any time without penalty, there can be no assurance that present or future customers will not terminate their purchase arrangements with the Company or significantly change, reduce or delay the amount of products ordered from the Company. Any such termination of a significant customer relationship or change, reduction or delay in significant orders could have a material adverse effect on the Company's operating results. Price Protection; Stock Balancing; Reliance 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 18 until later in the year and, even when placed, such orders generally are cancelable at any time without penalty. Accordingly, the Company generally must enter into tooling, manufacturing media and advertising commitments prior to having firm orders. As a result, there can be no assurance that the Company can maintain sufficient flexibility with respect to its working capital needs or its 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 19 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 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, 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. Dependence on Key Personnel. The Company's future success will depend to a significant extent on the efforts of the key management personnel, including 20 Donald D. Kingsborough, the Company's Chairman and Chief Executive Officer, Mark Shepherd, the Company's Chief Operating and Financial Officer and other key employees. The loss of one or more of these employees could have a material adverse effect on the Company's business. In addition, the Company believes that its future success will depend in large part on its ability to attract and retain highly qualified management, operations and sales personnel. There can be no assurance that the Company will be able to attract and retain the employees it needs to in order to ensure its success. Impact of Year 2000. The Company 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 PART II. OTHER INFORMATION --------------------------- ITEM 1. LEGAL PROCEEDINGS See Note 3 to the Consolidated Financial Statements. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K a) Exhibits 10.1/(1)/ Third Amendment to Accounts Receivable Management and Security Agreement by and between Registrant and BNY Financial Corporation. 27.1 Financial Data Schedule for the quarter ended March 31, 1998. b) Reports on Form 8-K No current reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 were filed by the Company during the quarter ended March 31, 1998. (1) Previously filed as Exhibit 10.28 to the Registrant's Annual Report on Form 10-K. 22 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 15, 1998 /s/ Donald D. Kingsborough ------------ -------------------------- Donald D. Kingsborough Chief Executive Officer (Principal Executive Officer) Date May 15, 1998 /s/ Mark Shepherd ------------ ----------------- Mark Shepherd Chief Financial Officer (Principal Financial and Accounting Officer) 23 EX-27.1 2 FINANCIAL DATA SCHEDULE
5 1,000 3-MOS 3-MOS DEC-31-1998 DEC-31-1997 JAN-01-1998 JAN-01-1997 MAR-31-1998 MAR-31-1997 781 0 0 0 3,918 0 236 0 9,837 0 18,671 0 15,969 0 11,012 0 23,800 0 14,591 0 1,786 0 0 0 7,859 0 91,871 0 (92,307) 0 23,800 0 11,869 9,042 11,869 9,042 7,201 5,325 7,201 5,325 6,521 6,998 24 20 403 657 3,624 (3,977) 0 (795) 3,624 (3,182) 0 0 0 0 0 0 3,624 (3,182) 0.19 (0.34) 0.19 (0.34)
-----END PRIVACY-ENHANCED MESSAGE-----